Afford Anything - Invest Anywhere: Six Strategies to Make Money in Real Estate

Episode Date: June 3, 2022

#384: Welcome back to the third episode in our special series, Afford Anything Presents: Invest Anywhere. Invest Anywhere is a new monthly series that runs on the First Friday of each month. It lays out the information you need to invest in real estate at a distance. Many of you want to invest in real estate, but you live in a high-cost-of-living area. (Ahem, California and New York). The homes in your city are prohibitively expensive, and they offer lackluster returns. You could invest in a lower-cost area like Cincinnati, Indianapolis, Omaha or Wichita … but HOW? That sounds terrifying. We’re here to dismantle that fear, piece by piece, by sharing our knowledge and experience. The Invest Anywhere series is dedicated to giving you the guidance you need to make smart, confident choices about investing out-of-state. It’s co-hosted between myself (Paula) and esteemed real estate investor Suni Rao, who’s experienced everything ranging from buy-and-hold rental investing to (accidentally) wholesaling. She’s managed short-term and long-term rentals. She’s owned houses, multi-units, and even a mobile home park.  She joins me in this episode to talk about a variety of strategies that will help you make money in real estate. For more information, visit the show notes at https://affordanything.com/episode384 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to any limited resource you need to manage, like your time, your energy, your focus, your attention. Saying yes to something implicitly carries all kinds of trade-offs. This opens up two questions. First, what matters most? Second, how do you align your decision-making around that which matters? most. Answering these two questions is a lifetime practice. And that's what this podcast is here to

explore and facilitate. My name is Paula Pan. I'm the host of the Afford Anything podcast. We are typically a weekly show. These days, we've been airing every Wednesday. But once a month, on the first Friday of the month, we air a special First Friday bonus episode. So welcome to the June 2021 first Friday bonus episode. And we've recently started doing something really fun and special with these first Friday bonus episodes. We have a special presentation dedicated to long-distance real estate investing. It's called Invest Anywhere. And my co-host for the Invest Anywhere series is Real Estate Investor, Sunny Rao. We want to make real estate investing approachable for everyone, not just the hedge funds on Wall Street. No matter where you live,

and the choices you've made, we want to make sure that you have the opportunity to invest so that we can all work together to move wealth back into the hands of ordinary people. I'm Sunny Rao, the co-host of the Afford Anything, Invest Anywhere podcast series. And today, Paul and I are going to walk you through some popular investing strategies in their ensuing tactics, as well as the related nuances. So you can think through which strategies would be a good fit for your current life and your future. I know there are a lot of people who are torn between this cacophony of different strategies in the world of real estate investing. I often hear questions like this. I've been hearing

about so many different strategies with real estate investing, like flipping Airbnb, getting mailbox money, and even being a landlord. But I don't really know what those terms actually mean. What he's really asking is, what are the different types of real estate? investing strategies. Before we can answer that, we need to first define what is a strategy and how does it differ from a tactic. To break this down, let's use the mental model of a tree. A tree has different components, right? At the bottom, there are the roots. Then as we move out the tree, there's the base. Then you have the trunk, you have the extension to limbs, you have the branches, and you have the leaves. All of these different parts are going to represent a different piece of how

to think through investing in real estate. Starting off with the roots, those would be the values that you hold dear. So for example, I value freedom. And then as we move up the tree, we have the base of the tree, which would be the principles. That's how the value would manifest itself. Okay. So I value freedom. That's the root of everything. And because I value freedom, I have a principle of wise money management. Yes. Then moving up one space farther on the tree, we have the trunk. We have the goals and objectives. So if you have the value of freedom and then you have the principle of wise money management, perhaps a goal is to set aside a certain amount of your salary and put it into a retirement fund every year. Absolutely. That all makes sense.

After the trunk, we go a little bit farther up the tree and hit the limbs. The limbs represent strategies. The strategy is the what you do to make money. Right. So that tree trunk are your goals and then the strategies are what you do to hit those goals. goals. And specifically in this case, if the goal is to make money or using the wise money management example, it's the strategy of what do you do? When we talk about the what you do, examples of that include buying and holding real estate. It could be flipping homes for an extra source of income so that then you can save more towards your goals and your objectives.

So like buy and hold is one particular strategy and flipping is a different particular strategy. So those are all examples of strategies, strategies being what you do in order to make money. After you figure out the what and after you hit the limbs of the trees, you have to move forward to your next step, right? Which would be the branches. The branches represent the tactics that you would use. That is the how of the strategy. What's an example of a tactic then? That would be like the question between, would you rent your place for a year?

Would you only want to rent it for a few days at a time? Do you want a long-term rental? Do you want a short-term rental? Do you only want to buy single-family homes? Or do you want something grandiose, like an apartment building to own one day? How do you go about implementing your chosen strategy? Right. So the strategy is the what?

And the tactic is the how. The what is building a stream of residual income by buying and holding properties. And the tactic is having Airbnb or having long-term rentals or buying mobile home parks. The next step after that, after you go from the roots to the base, you figure out your goals and objectives at the trunk of the tree. Then you hit the limbs for the strategies. You figure out how to implement those strategies through your tactics. The very last piece of the tree are the leaves. The leaves are the products and services you will use to help you with your tactic.

This is where questions like, do I put my properties in an LLC? Do I hire a property manager? Is there a specific kind of software I would use? Those are very, very specific questions that come at the very end of this journey. Right? This growth process. Through wildlife. Right. Well, the leaves are the last thing that form on a tree and they're the first of all.

They're the most transitory part of a tree. They come and they go as the seasons change. Exactly. Sometimes you'll hire property manager and sometimes you won't. Right. Exactly. Exactly. And the issue that I've seen is that because the leaves are the most visible part of the tree, oftentimes when people start down the road of investing in real estate, they start with with questions about the leaves. They start with questions about the products and services.

So their opening question is, do I put my properties in an LLC? Do I hire a property manager? Right. They open with these questions about products and services and leaves when in fact, that leaf canopy, that's the, frankly, least important part, right? Yeah. And just like there's so many leaves on the tree, there's so many questions in the details of the execution that can come up. And that can make the decision to invest in real estate so much more intimidating complex when it doesn't have to be. The addition to invest is way farther down the tree. It is one of the more simple and basic things to consider. Right. Exactly. Because once you know your values, your principles, your goals and objectives, you know, once you've established the roots, the base, the trunk through taking a personal inventory, that foundation. from there, the particular strategy that you want to choose and the tactics that are the how to

that strategy come into sharper focus. And once you know your strategy and your tactics, then the leaves are kind of the details. Yes. The pieces that we really want to focus on today are those branches and those limbs, the strategies and the tactics. Because even though the roots, the base in the trunk require personal inventory, it's a very, very, difficult to take that personal inventory when you don't know what the strategies involve, when you don't know how much work it's going to be, when you don't know how often you will have to be involved with your project, once you know what the projects involve, you can take a step back and think about how that will impact your life and whether that's truly a good

fit for what you want to be doing. So in today's episode, we're going to break down six major investing strategies. They are on a spectrum of passive to active. We will be starting off with the most passive strategies with the note that as with everything, this is a general rule of thumb. And you can always spend more time or less time on the given strategy that you choose. All right. So along the spectrum of passive to active, of the six major investing strategies that we're going to cover, let's start with the most passive ones. What's over to the passive side of the spectrum? On the most passive side of the spectrum, your projects and your investments will basically involve handing your funds over and not being evolved at all in the day-to-day of the real

estate asset. And there are two strategies that will allow you to do that. The first of these strategies is utilizing reits. And the second of these strategies is utilizing crowdfunding. And the common thread between utilizing reits and utilizing crowdfunding is that you hand your money over to somebody else. So it's super hands off. Let's talk through both of those. Let's start with utilizing reits. What is a reet? A reet is a real estate investment trust. These options have been around since the 1960s. It is buying real estate in the form of a mutual fund. The way that this works is that there will be a real estate company that will own and manage a variety of real estate holdings. Everything from the residential homes that we like to talk about to warehouses to cell phone towers.

There are all kinds of options that REITs hold. And REITs allow investors to buy shares of the corporation. And then the REIT will pay dividends. to their investors. And that's an important distinction. So if you own a reit, you don't technically own the property. You own shares of the corporation, the trust, that holds the property. And there are three kinds of rates. One is an equity rate. Then there's a mortgage rate. The last option, there are hybrid rates. All right. What's the distinction between equity rates and mortgage rates? With an equity reet, the analogy is that the reet basically acts like a landlord.

They will own the assets. They will maintain the assets and they will operate the assets. They are in the details of the day-to-day operations. The other end of that spectrum is the mortgage rate. Mortgage reeds are not involved in the day-to-day operations of the asset. They don't hold the asset at all. They buy the mortgage from the bank, and then they collect on those payments. In between the equity and the mortgage rate is the hybrid.

And it is how it sounds. It holds a little bit of both. They have a little bit of equity holdings, and they have a little bit of mortgage holdings. All right. So those are the three types of reeds. Are there any other ways that reeds are classified? Yes. Reets are also broken out by how they're traded.

Reeds can be publicly traded, non-publicly traded, and privately held. Many, but not all, reed options are publicly traded, and they have to meet a set of requirements in order to qualify. A few of these requirements include needing to be managed by a board of directors, pay out at least 90% of their taxable income as dividends each year, and at least 75% of its assets need to be invested in real estate. Non-publicly traded and privately held reits have a few important distinguishing characteristics. These type of reits are typically more illiquid. You can't get your money back easily.

Non-publicly traded reits usually have higher fees up front, and both non-publicly traded reits, as well as privately held. reits will be harder to evaluate because they just have less public information available. So the majority of people who are listening to this who want to invest in reeds will most likely invest in a publicly traded reet. There's more information to do solid due diligence with a publicly traded reed. And the fact that publicly traded reeds need to, as you said, pay out 90% of taxable income as dividends means that publicly traded reeds, have returns that bias in the form of dividends, which is one of the draws of the category of

real estate in general. So along this spectrum, you know, zooming back out, we started talking about REITs as our first stop in covering these six types of real estate investing strategies, and the six strategies that we're covering live along this spectrum from passive to active. And so one of the benefits of reeds is the passivity, the fact that you don't have to bother finding the deal or operating the deal. You can just hand your money over. You can just go online, buy a publicly traded reet. And all you need to do is the due diligence for the reet itself. Do you want an equity reet?

Do you want a mortgage reed? Do you want a hybrid reet? You need to do that. But other than that, you don't have to make offers on properties or do any other active investing. tasks. What are the drawbacks? Typically, when people think about investing in real estate, you think you would have more control over how your funds are used. With a REIT, it's very similar to investing in any other type of fund. You don't have a say over how they're going to run their business, and in this case, how a specific property will be run. You can vet the company when you

decide to invest with them or before you decide to invest with them. But then what the company does with your money after you invest with them, that's out of your hands. When you think of owning real estate property, there are a multitude of tax advantages. The IRS has set up the tax code as such. Those same benefits do not apply to those who invest within a REIT. So you miss out on the tax advantages of direct ownership of a property? Yes, like depreciation, for example. That is not a tax benefit that you'll receive when buying a share of a REIT. All right. So those are some of the pros and cons to REIT investing. And REITs are one of six real estate investing strategies. And they're the furthest to the passive side of the passive to active spectrum. Also on the passive side is crowdfunding.

Can you tell us about crowdfunding? Crowdfunding platforms are much newer to the scene, unlike REITs, which have been around for decades. Crowdfunding allows investors to pool their money and purchase property together, allowing investors to become shareholders in a property. On the flip side, it also allows real estate professionals to raise capital that they normally wouldn't otherwise

be able to access. While many REITs are publicly traded, many crowdfunding investments are privately held. With crowdfunding, investors buy into a specific asset, a home, an office, a building, instead of a share in the company, which is how REITs work. And that is an important distinction. So in crowdfunding, you partially own the property, whereas with a REIT, you're a shareholder in a company. Here's what's interesting. Reeds have been around since the 1960s, but 10 years ago, nobody was talking about crowdfunding. Now, crowdfunding is trendy. I get all kinds of questions

about it. Why is that? Whenever a particular type of investment skyrockets in popularity and in the zeitgeist, it's important to pause and ask yourself, not just why this investment, but why now? Why are people beginning to talk about it now? And the reason is, it used to be the case that only accredited investors could participate in crowdfunding. But in 2016, the Jobs Act, which was passed in 2016, allows ordinary individuals who are not accredited investors to take part in equity crowdfunding. And with that legal change came this massive proliferation of websites. and I won't name any specific brand names, but many people who are listening to this have heard of some of the more popular brand names of websites. This huge proliferation of websites dedicated to real estate crowdfunding

exploded after the 2016 legal change. Now, for the legal historian nerds in the audience, it is true that the Jobs Act was passed in 2012, but it wasn't until October 2015 when the SEC finalized some key provision, related to permitting non-accredited investors to participate in equity crowdfunding. And that's why 2016 was the year that those provisions went into effect and real estate crowdfunding suddenly became this trendy thing that everyone is doing. Now, when that happened, when crowdfunding

exploded in popularity, unfortunately, a lot of people saw this as a get out of due diligence free card and as a have your cake and eat it two opportunity because a lot of crowdfunding platforms started touting a sales pitch of easy money a sales pitch of

getting higher returns than you otherwise might with direct real estate ownership coupled with not having to deal with tenants and toilets. Well this sounds easy. Higher returns. I don't have to deal with broken furnaces. Is there anything that I should be aware of?

There are definitely things to be aware of when investing in crowdfunding or when considering crowdfunding as a potential investment. First of all, there's more risk involved. The real estate professionals on these platforms typically have less of a successful track record versus a publicly traded rate. And like with any investment, there's always a risk of losing your principal. In order to invest in crowd, funding, investors are dependent upon the platforms that connect the real estate professionals and the investors. And these platforms can charge fees for their service.

And sometimes these fees are really high. Private investments can be far more illiquid, harder to draw your money out versus just selling a share of the company that you purchased. And lastly, the tax situation is similar to that of the REIT. you receive income from purchasing an investment related to real estate, but you don't get all the benefits of owning real estate property. Right, the tax benefits of direct ownership. That first point you made, I think is particularly important, and I want to call attention back to it. You mentioned that oftentimes the people who are putting together a crowdfunded deal, the people on the other side of that transaction, they may.

may or may not be qualified, right? They may or may not have a successful track record. They may or may not have sound judgment. You know, they may or may not be the type of people with whom you would want to entrust your money. And I think that is an important point to emphasize because we see in the world of mutual fund investing, for example, there are entire professions dedicated to doing due diligence on, mutual fund managers. Every now and again, you'll get some breakout celebrity fund manager. You'll get a Kathy Wood or a Bill Gross. And they become famous. Bill Gross is famous for being one of the best performing bond managers ever. Kathy Wood is controversial. She has supporters and detractors, but no matter how you feel about her, she is indisputably famous for her contributions and her impact as a fund manager. And, And so the importance of careful management selection cannot be understated. And that I think often gets overlooked when people look to crowdfunding as what they hope is a get out of due diligence free card, but what might actually be a hand your money over to some untested, unqualified group of people card. And I really like to use that as a segue into our next strategy. Because in the next strategy, which is,

is also involving handing your funds over to someone else, there is also the opportunity to do more due diligence on the person or the management team accepting your funds. Okay, so then what's that next strategy? It's called private lending. To zoom out for a second, with REITs, you give your money to a company to buy a share or own a piece of the company. With crowdfunding, you give your money to own a portion of the asset. These are pretty strict terms.

You're not going to go to a publicly traded rate and say, hey, let me negotiate with you. Right. With private lending, there are more options available and you can negotiate different terms. Private lending agreements can be set up in different ways, including being placed in a fund. but many times the easiest and the cleanest way to do this, especially with the smaller investor, is to be the sole capital source. So you're giving your money to investor to buy an entire asset. Sunny, an example would be if I gave you $100,000 so that you could use that money to buy a single family home in Indianapolis. Yes, that is a great example. And that is a lot of money.

Absolutely. So you might be wondering, why would I do that? It sounds like so much money. The benefit of this setup is to receive a return that is directly secured by a tangible asset. In doing so, you're reducing the risk of the loss of principle because the investment is backed and tied to an asset. Also with private lending, you as the lender, can vet the investor and the asset that they want funding for. And that's a distinction from both crowdfunding and REITS, where it's very hard to vet the investors, to vet the management team. It's also much more difficult to vet the underlying asset. 100%.

Another way that private lending differs from investing in REITS and choosing to go the crowdfunding route is that when you, you negotiate your terms, when you find someone you want to invest with, you can set up the agreement however it best suits you and the real estate professional that you're working with. You can be a debt partner and act like the bank can get interest payments, or you can be an equity partner and get a piece of the ownership and thus any upside or downside in the property value in the operations. There is a lot of flexibility to negotiate the best situation for you. That being said, it does come with more work in terms of building relationships with the

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That's your commercial payments of fifth third better. So if a person were interested in private lending, if there's someone who's listening to this, who's like, all right, of these six strategies for making money in real estate, private lending is the one that I'm most interested in, what should that person do in order to reduce the risk of loss of principle in the event that things do not go well? To understand that, let's think about what the situation would look like, both when things are going wall for the real estate investor and when things are not going well for the real estate investor. When things are going well, the property's operational, they're getting their rent payments, and they are sending you your cut of the monthly check

if you're a debt investor, let's say. If things head south for the real estate investor and they are not able to make the payments that they owe you, then you want to set up the agreement so that you can foreclose upon the property. If you absolutely need to do that, then you can always sell it and recover your principal. So hopefully with the due diligence that is done, no matter whether things go well with the property or not for the real estate investor you're working with,

hopefully you can be protected with your principal investment. And so you do that by treating the underlying asset, treating the property as the thing that secures your part of the deal. It is the collateral. In order to execute the strategy, you want to get a lawyer to draw up the necessary documents. the exact contents and the exact documents can vary slightly by state. However, in most situations, you will need a total of four documents. Two to enter the agreement and two to exit the agreement. In order to enter the agreement, the first document is a promissory note, which serves two functions.

One, it spells out the agreement. It will tell you how much payments will be, what the interest rate, will be when payments will be made, who the borrower and the lender are, and it has both parties agreed to the loan. That is the function of the promissary note. What it does not do, it does not provide collateral. The second document that we are going to talk about does secure the collateral, and that is the mortgage security document. In some states, it's known as the deed of trust. this gives the lender two rights. One, it places a lien on the property so that if the investor you're working with doesn't

pay you as agreed upon, you can foreclose upon the property. It also states that the investor you're working with cannot resell or refinance the property without your permission. And typically, a title company will file this mortgage security document with the county. Now, throughout this episode, we will sprinkle in a few. Pro tips that we have learned as a result of our experiences. Yeah, the school of hard knocks. And the first of these has to do with private lending.

And we even have a special sound effect for pro tips. All right, let's hear this first pro tip. If you as a lender want to feel more financially protected when lending, there are an additional two documents that you can request from your real estate investor. The first is a personal guarantee, and the second is the deed in lieu of foreclosure. A personal guarantee will hold your investor personally liable if they don't follow through on the terms so that if in the original agreement you lend to an LLC or they hide behind their LLC, you can still try to get some of the funds and recover some of the damages from the deal that went bad.

Right. because otherwise if you try to recover funds from an LLC that has no money, you're screwed. The second document is a deed in lieu of foreclosure, which would allow you to take ownership of the property immediately versus going through a foreclosure process that could take months. While the ability to foreclose on a property as additional security might make you feel better, it's a very important thing to have when entering into these agreements, you might not want to go through the hassle of actually having to foreclose and go through that legal battle. So this could be a very attractive option to have just in case the real estate investor doesn't perform. Right. So basically, to mitigate the risk of everything getting clogged up by the court system, the deed in lieu of foreclosure, fast.

forwards the process and you can take ownership of the property right away. As with anything, there are pros and cons. And it's important to know the limitations of this strategy and of this document. And the drawback to this specific document is that if you execute on a deed in lieu of foreclosure, all debts that are on that property will follow the person holding the deed. It will follow you. So let's say you worked with the real estate investor. who didn't pay property taxes or who inadvertently placed liens on the property. If you execute a deed in lieu of foreclosure, there's a chance that those debts could then become your responsibility.

At which point you would want to lean on that personal guarantee so that you could then go after your non-performing partner for any debts that were transferred to you in the transference of the deed in lieu of foreclosure. So I can already see zooming out a bit when we talk about strategies for real estate investing. It's clear that being a private lender requires a greater input of hours up front and a greater knowledge hurdle. You need to know what documents to gather. You need to negotiate these terms. You need to find someone to partner with.

You need to understand how their business model works and how they plan to operate the asset. and if that's a good fit. Right. What strikes me as we talk about this is that when we talk about doing this level of due diligence with private lending, it seems very intimidating. But to go back to what we talked about earlier, many people are drawn towards reeds and crowdfunding. And again, I'm going to specifically point to crowdfunding. People are drawn towards it because they believe that it's a get out of due diligence free card. But the reality is, if you're doing it right, you would be doing the same level of due diligence.

throughout. You ought to be doing as much due diligence on a crowdfunding deal as you would in private lending. It's just that in this example that we're talking through right now, the private lending example, you have to do it. Whereas with the example of a REIT or with crowdfunding, you technically don't have to, putting have to in air quotes, you could technically e'nie-mini-mo your way into those investments, it's just not a wise allocation of capital. But that said, going back to this discussion around private lending, Sunny, you mentioned there are two necessary documents and also two additional documents that you need when you enter into a private lending deal. So you need a promissory note. You need a mortgage security

document, also known as a deed of trust. And you may also, in addition, want a personal guarantee and a deed in lieu of foreclosure. So those are four documents that you might want when you're entering into one of these agreements. What are the two documents that you would want when you're exiting an agreement like this? The first of the two documents that you will need is the mortgage release document. It is the sister to the mortgage security document that the title company files, and it states that both parties fulfill the agreement and that the deal is done. The second document is a payoff statement, which shows the original principal loan, how much is due, the interest rate.

It's basically the guts of the agreement. The lender signs off saying that the promissory note and the mortgage are paid in full. And in this case, you are the lender. Correct. So you sign off saying everything's done. We're all good here. All right. So let's zoom back out.

We're talking about private lending as example number three of our. are six examples of real estate investing strategies. So far, we've covered reeds, we've covered crowdfunding. Now we've gone into detail around what private lending looks like. Why would a person choose private lending, particularly with the intimidation factor of, oh my goodness, there are all of these legal documents that we're going to have to deal with. What are the benefits to private lending? One of the benefits is that everything in the deal can be negotiated. The types of returns, whether you want to be a debt partner or an equity partner, you can negotiate when you want your payout. You can negotiate interest rate and terms if you're a debt

investor. You can negotiate how much cash you want the other person to put in the deal, which leads us to our next pro tip. Pro tip. Skin in the game is always beneficial. When you are lending to someone, you want them to also be invested in the deal. They are just as motivated. to make the deal successful. So if you're lending on a property, whoever you're partnering with, you want that person to also have some skin in the game. Other benefits include being able to vet specific assets

and the investor. The one that you're partnering with? Correct. There's the fact that pretty high returns can be made through these agreements. Eight to 10% interest rate on the principal for a debt investor is pretty standard. And if your real estate investor doesn't perform,

you can find a way to own the property. Right. Which then leads us to pro tip number three. When entering into these deals, you want to invest in a property that's worth more than the loan. So if you are giving $100,000 to an investor, to buy a property, you want to make sure there's instant equity in the deal and the property is worth $110,000 or $120,000.

Right. Okay, so this makes sense. So, Sonny, if I were to give you $100,000 to buy a single family home free and clear in Indianapolis, I would want to make sure that you're not just buying a move-in-ready home off of the MLS. I would want to make sure that you are aggressively searching for that deal, your drive-and- for dollars, you're putting out a direct mail postcard campaign, right? You are using some fairly sophisticated tactics to find that deal so that you can buy a deal for under fair market

value, which means that we, me as the lender and you as the investing partner, we get instant equity on that house at the closing table. And that is important because if in the event the real estate investor that you are working with doesn't perform. When you go to foreclose upon the property, you're not losing money. So Paula, if you gave me $100,000 and I did not perform, when you take the property and you go to sell it or do what you would like with it, you essentially get your principal back. Right, right, because there are transaction fees associated with selling a property. plus you just want some cushioning and you want some money for all of the hassle. Exactly.

While there are many benefits to private lending, there are also plenty of challenges. One of those is that more cash is needed. Right, yeah. Yeah, versus investing in a re or crowdfunding platform. Because in those other options, you're just buying shares. You're buying a piece of the company, a piece of the property, not the entire thing. And it's also risky because like crowdfunding, typically lending to smaller investors with less of a proven track record versus a publicly traded rate, there's always the chance that that investment could fail and that you might not get your money back. Right. And you can foreclose on the property, but the foreclosure process is slow and it can be really drawn out.

And what if property values drop? What if the investor you chose to work with didn't make a sound investment choice in the property that they chose? So that is one way some of your principle could be compromised. Right. And those risks highlight why due diligence is so important, why it's so important to vet both the person making the investment, the person who's directly making that investment, your local boots on the ground, as well as due diligence to vet the asset itself. And again, not to be too much of a broken record, but private lending makes it obvious why that due diligence is so critical. But the The reality is that same level of due diligence is critical for any type of real estate that you're buying and particularly crowdfunding deals. So the risk of REITs and crowdfunding to go back to the more passive side of the spectrum is that it's not as intuitively obvious that due diligence is important. And as a result, many people skip over it. One of the drawbacks to private lending is that like investing in REITs, and like investing in crowdfunding, lending on a property doesn't generally have the same tax advantages

as owning and operating rental properties. However, when you're lending, there are some tax advantage vehicles that you can look into, like self-directed IRAs or solo 401ks, with the help of a tax professional to assess your specific situation. Okay, lending money to people to buy real estate sounds interesting. What are my options if I ask? actually want to own property. So now we are moving from the more passive strategies with

real estate investing that basically involve lending money to investors without actually getting involved in the day-to-day operations to actually being involved in the purchase, the maintenance, the operations of the asset. And that brings us to our fourth strategy, which is the buy and hold strategy. Ah, my favorite. So what is buy and hold? How is it defined? This means that you buy a property. It could be a single family house. It could be a five-un apartment building. It could be a mobile home park, an office space, a warehouse. You basically buy any space that another person or business can rent out. And then you just hold on to it forever. Dramatic. Forever. So you definitely don't have to hold onto it forever, but the buy-in-hold strategy implies that you'll hold onto it for

at least a year. Right. And often longer, there are buy-and-hold investors who hold for 10 years, 20 years, 30 years. And the reason that some of them will hold onto a property for 10, 20, 30 years is due to the residual income that can be earned when you get your monthly rent. The idea is that you buy the property wants and that you get paid forever. Right. Because in the world of real estate investing, as you can tell, just from everything we've discussed so far, the effort is front-loaded. The due diligence, the work, the workload comes at the beginning of the deal. That's when the most intense workload happens. So once you've gone through all of the workload of the due diligence of finding a property, finding it, vetting it, financing it, once you've done all of that,

may as well kick back and collect the residual income, right? Absolutely. One of the other really huge benefits of the buy-and-hold strategy is that you can access all five of the aspects of making money through real estate that we discussed in episode 373. And let's review what those five ways to make money are. So the first is the cash flow, which is also an option in REIT's private lending crowdfunding. But with buy and hold, you also definitely get the appreciation of the property.

And that's a second of the five. You get the full universe of tax benefits from right off to depreciation. Cool. So that's a third of the five. You get instant equity if you purchase the property correctly. And the last benefit, if you purchase the property with debt, you get access to the principal paydown, which is when your tenants pay down the balance of the loan for you. But it's not always sunshine and roses, is it? All right. So what are some of those drawbacks to buy and hold? Competition.

Right. It is hard to find properties in this market. And when I say it's hard to find properties, it's hard to find properties that have that gap between what your mortgage will be and what your rent will be that will allow for the positive cash flow that you can put in your pocket. Right. Well, not just the mortgage, but mortgage plus operational costs. Absolutely. And that's getting tougher today because property values have been increasing and interest rates have been increasing, which will work together to increase the monthly payment that you owe to

other people. Right, right. Which is why it's even more important. It's such a filtering mechanism. The people who think that this is easy money get filtered out and the people who are committed to learning the skills behind how to find a property, right? So many people think that because they bought their primary residence for themselves, that that means they know how to search for properties. But that's the equivalent of thinking that because you cook dinner for yourself, you know how to be a chef. And I'm going to take this one step further. The market has been very kind to investors who got in a few years ago when purchase points were much lower. For many, because properties were purchased at a lower purchase point and we had such strong economic growth,

success was sometimes close to inevitable. These days, you have to really know what you're looking at. You can't just assume that in three years the property values will go up and you can sell it at a profit. You can't just assume that companies are going to keep hiring for the next five years, increasing the supply of renters in your area, you can't make these assumptions about the economy and property values at this point. So you really have to critically know what drives the factors for being successful in real estate in order to make that choice. Exactly. That's why real estate education is so important. Part of the reason not to tout our course, your first rental property,

But part of the reason that I built it is because I saw so many people basically blindfolding themselves and iny, me, mini, miny mowing their way into real estate, essentially throwing darts at a dartboard and hoping that it works out and not knowing what they don't know, operating at that level of unconscious incompetence where you don't know what you don't know. And then you suffer from the Dunning Kruger effect of believing that you're more skilled. at something than you actually are because you know so little about a topic that you don't know what you don't know. Exactly. There are a few other challenges to also keep in mind, as you think, through the buy and hold strategy. The residual cash flow is great, but let's know the quantities that we're talking about.

So if you purchase a house with a debt after the mortgage, after insurance, after operating expenses, the total cash flow can be pretty small. You're looking at a few hundred bucks a month, and that's when there aren't repairs or replacements needed. And when you look at more active forms of real estate investing, like flipping or wholesaling, which we will go into later in this episode, there's no big payday. It's not like one day you sell the property or take some action where suddenly you have $50,000 in your bank account.

You do a lot of upfront work to get the property ready, to rent it out, to get your couple hundred bucks a month. And the money keeps coming, but the work, it'll still be there from time to time. Right. And that is a definite drawback to buy and hold investing. It takes a number of units before you're collecting a decent amount of free cash flow. We'll come back to this episode in just a minute. But first, earlier in this episode, we talked about. the distinction between strategy and tactics. Strategy is what tactics or how. So a buy and hold

strategy, that's a strategy of what you do to make money. You buy and hold so that you can collect residual income, front load the workload, and then collect payments in perpetuity. Right. That's the what. That's the strategy. What are the tactics, the how of how a buy and hold strategy can be implemented? Let's look at what you can buy and let's break that down by the size of the asset. Any property that has four or fewer units that people can live in are considered residential. Any property that has five units or more that people can live in are considered commercial properties and are subject to different underwriting standards by lenders. One of the cool things about commercial properties is that the value of the property is heavily

influenced by the net operating income of the property, which means that if you know how to operate your property really well, you receive good rents, you keep expenses low, you keep low vacancies and turnovers, you can have a huge say in the equity and appreciation of your property. Residential properties that are less than five units usually have better financing terms because they all fall under residential financing guidelines. Residential loans are typically for homeowners. Commercial loans are typically for businesses. There are, are still more nuances within the properties that people can live in. And some of these can be market-specific, so it's really important to learn your market. One example is with single-family

homes. Single-family homes with more than one bathroom, families tend to stay in those longer because they tend to outgrow spaces due to number of bathrooms. And many times, families just tend to stay in single family homes longer than apartments because apartments just have a more transient vibe. People know that they won't be there forever. Whereas if you rent out a home in a nice final village in a good school district, a family might be there for five or six years. So when you're running your spreadsheet, when you're assessing and analyzing properties, understanding the different vacancy rates or the different turnover rates that are associated with different neighborhoods or different types of properties, that's one level of new.

that you would need to know as part of that local market knowledge. What are some other examples? Multi-family apartments, five units or more, are usually pretty cool because you have multiple rents covering the mortgage and the expenses. And even though the systems and related expenses are bigger with the bigger buildings, it's easier in the long term because you can fix one large roof with five sets of rents and then be done with it for the next 20 years. Versus if you buy five single families, you are then on the hook for five different roofs that are all covered by their own specific and single stream of income and on their own timeline. Right. Right. So you get consolidated overhead with a multifamily. Another branch of tactics that can take place in any

asset class where people live are renting out spaces for different lengths of time. So you can have long-term rentals, you can have short-term rentals, and you can have medium-term rentals. Long-term rentals typically involve leasing a space for around a year or longer. It's pretty straightforward. You're providing a good living space for your tenant, and you can do this in an unfurnished home. There are variations even within long-term rentals like student rentals near college campuses or renting by the room in larger cities where rent is really expensive. And different variations will utilize different strategies for success.

And different lease stipulations. These different lease depulations can be having common area rules when renting by the room or involving parents in the leasing and screening process when leasing to students. At the other end of the spectrum are short-term rentals, which people refer to as vacation rentals or Airbnbs or VRBOs. This tactic requires the most activity in the residential buy and hold space because it requires furnishing the property. You're essentially acting as a hotel, making sure each set of guests is greeted and taken care of during their stay. So you're moving outside of just real estate

investing and also entering the hospitality industry. Right. Exactly. Owning an unfurnished dwelling unit is more comparable to owning a commodity, whereas hosting an Airbnb is comparable to being a hotel owner. It's the hospitality industry. In the middle of this spectrum between long-term rentals and less work and short-term rentals and a lot more work are medium-term rentals. And these are typically rentals that can be leased from one month to a little under a year. These are also usually furnished like short-term rentals. And the tenants are made up of groups like traveling health care workers, corporations looking to place their employees in a location for a few months, and even people

who may be building or selling a home, basically people who are not permanently committed to an area yet. Right. Yeah. There are a lot of people who need a place to live for three months. And the good thing is that if you have a short-term rental set up and something changes in the environment, i.e. regulations or 2020, you have a pandemic. A short-term rental can easily be converted into a medium-term rental because it's already furnished. Right. The one thing to look at will be the regulations in the area of your rental, which is our next pro tip. You want to make sure that you have the correct documents in case you need to enforce behavior or if you're forced to remove someone. For example, if you have someone staying in what was a short-term rental for more than 30 days in some districts, then you are required by law to go through the eviction process if you don't have certain documentation in place.

And that's a perfect example of why having a system in place, having systems, structures, guidance, checklists, having a group of peers who have done this who can offer feedback and highlight for you any blind spots, that's precisely an example of why that's so important. Before we move on, so again, zooming out, we're talking about six strategies for making money in real estate that exist along the spectrum of more passive to more active. And we've covered REITs, crowdfunding, private lending, and now we're talking about buy and hold. So far, we've talked about the buy and hold strategy as it applies to single family homes, duplexes, triplexes, and apartment buildings. but there are other real estate niches out there. And so that leads to an interesting follow-up question. These are interesting, but are there any other tactics I can use to invest in real estate? There are three others that we'll talk about right now.

The first are mobile home parks, which involves buying the park, ideally renting out the lot space and having tenants own their homes and take care of the utilities that they use, while you take care of the, the grounds. Then, there's self-storage. These are private units that people rent to store their belongings, never used to occupy as a living space. There's been a growing demand for storage units, especially in densely populated areas where space is expensive and hard to come by. This investing tactic has relatively low overhead, but that can vary based on amenities like climate control, electricity, and security. Lastly, there are taxes. liens, which are very nuanced. At a high level, when a property owner doesn't pay their taxes, the county or the state will place a lien on the property. If enough time goes by without the

taxes, whoever's in charge of the property taxes, the state or the county, will then sell the lien at a tax lien sale. The tax lien will provide the investor who bought it with the first lien position, and the lien will accrue interest from the date of the investor's purchase. The property owner then has a certain amount of time to pay off the lien. And if they don't, the investor who purchase the tax lien can foreclose on the property. If the property owner does pay off the lien within the time period they're given, the investor gets their principal invested in the tax lien plus any penalties or accrued interest. There are still many more tactics that don't involve being hands on with the property, such as buying land and no investing. And all of those

fit under the purview of buy and hold. So that goes to show how the strategy of buy and hold can be executed through this massive variety of tactics. All right. So far, we've covered four of the six strategies. Let's move to strategy number five. And again, we're moving towards a more active side of the scale. What's the fifth strategy? Wholesailing. And it's categorized as more active than buy and hold because you're only making money as your closing deals. With the buy and whole strategy, there'll be times when there's less activity and you can receive your residual monthly income with very little hustle. But with wholesaling, you're only making money when you close the deal. Okay, so what is wholesaling? It's when a person will call them the wholesaler,

finds an owner who wants to sell their property, but the wholesaler doesn't actually want to buy the property. The agreement is that they will find a buyer for the property. So they will get the property under contract at hopefully a below market purchase price and find someone else. It typically has to be a cash buyer to purchase the property. No money actually changes hands until the deal closes between the original owner and the new buyer. The wholesaler makes money when the deal closes through an assignment fee, which is basically a finder's fee that's placed on top of the price that the original owner wanted for the home. And the buyer, the new buyer, must pay the assignment

fee and the price negotiated with the original owner in order to take possession. So basically, somebody who wholesales finds a property owner, puts that property under contract, flips the contract, and then gets paid a finder's fee for flipping that contract. Exactly. And the strategy is popular because it's touted as a way to get into real estate without a lot of money. And it doesn't involve having to deal with tenants, toilets, or even holding on to the property itself, hopefully. Mm-hmm. The catch is that the wholesaler needs to find an end buyer

within the time frame negotiated with the owner and at the negotiated price point. And it's really important to check laws regarding wholesaling in your state. You need to be aware of local regulations, which can differ. So it sounds like wholesaling is a type of strategy where you need to build out a really well-developed network so that you can tap a whole bunch of cash investors, cash buyers, to be like, hey, yo, I got this property under contract.

Do you want it? You have a week to answer. And also the network to find the deals because you're only making money when you close the deal. So you need to have a very active funnel coming in to consistently be closing on those deals. These days, wholesaling mostly involves residential properties like single-family homes or even small apartment buildings, but technically just about any property can be involved. Which leads us into our next pro tip. Wholesaling can be considered an exit strategy. And for those who are ever in a direct-to-seller acquisition, knowing what wholesaling involves is a really good thing to keep in mind because it can be a profitable and mutually beneficial exit. if needed. This can be executed by making the contract assignable, and it works best if the deal you

find is really, really, really good. I actually did this last year on a mobile home park. I found a park that was an excellent deal, but I am not a mobile home investor. I wanted to be a mobile home investor for about five minutes. And then when I got into the due diligence and realized how much was involved and how much it was out of my core skill set, I didn't want to do it anymore, but I had it under contract. And I had made the contract assignable. Luckily, just in case, once I realized after my due diligence that this was not something that I wanted to be involved in long term, I was able to find another buyer for it, bring them in, tack on an assignment fee. And then when they closed, I got some money for my work, which

which is pretty nice. Right. So you became an accidental wholesaler. I did. And that's a great illustration of how experienced real estate investors, people who don't just go in blindly, but who actually know what they're doing, have multiple exit strategies. Like what you did when you made that contract assignable, your intention when you went under contract on that mobile home park, you intended to own that mobile home park. Oh, I wanted to own that mobile home park. Yes. Yeah, exactly. But you knew to have multiple exit strategies. And that ended up working out really well. It did. So let's talk about zooming out and talking about wholesaling in general. What are the benefits of wholesaling? One of the benefits is that

you don't need a large amount of capital front. You don't need to save up for a down payment or funds that require licensing, et cetera. And you can have large paydays. If you get a really good deal under contract, far below market price, you can put a slightly larger assignment fee and still have it be a good deal to your end buyer. On the flip side, there are multiple drawbacks. One of these drawbacks is that properties usually have to be distressed because that is when sellers are most motivated to sell because they don't have the money to fix it up. This limits the buyers available to the whole seller.

If it's a real fixer upper, a lot of retail buyers will exit from the picture. They don't want to move into a home that requires a sales. ton of work right at the beginning. The buyers would typically need to be other investors, and the wholesaler will need that network of buyers who be interested in buying and be able to buy fast and in cash. So the income can be really unpredictable as you build out this network. Yeah, it sounds like wholesaling is for extroverts. Exactly.

All right. So wholesaling, zooming back out, is the fifth of the six strategies. We've covered Reed's crowdfunding. private lending, buy and hold, wholesaling, and then what's the sixth strategy, the sixth and most active on the passive to active spectrum? It's the most active and the most glamorous, thanks to HGTV. It is flipping. All right. So flipping. The HGTV reality TV show promise is that it's so simple. You just buy a place and you make it pretty and then you sell it and then you hang out in Aruba all day long. What does it actually like? It takes a lot of savvy to be consistently successful when flipping. You have to know how much the rehab will cost and the rehab is influenced by material costs and labor, which is both of which are tough in this market and costs are increasing for both of them. You have to know how much the property will sell for. after you complete the rehab.

Right. There's even a fancy acronym for that, ARV. Is that after repair value or after rehab value? After repair value. After repair value. You have to have the money to buy the property and the best deals are usually distressed and wouldn't be financed by a bank. So you wouldn't be able to get the really good financing terms at 5% interest.

So you would either have to have cash or a specialized lender. and these types of lenders usually charge higher rates, like the private lenders we talked about earlier in the episode that can get 8 to 10% on the principal. And then you have to know how long it will take to fix up the property because time is money, especially if you're working with a lender and you're paying interest on the loan.

Right, right. And that's one thing. People who are new to flipping often forget about what I refer to as holding costs, which is just the cost of holding that property for an extra month. The prorated property taxes, the utility costs, the interest rate on the money that you're borrowing. And you need to have the network of contractors and or the free time to fix up the property yourself.

So being able to manage all of the costs, the timelines, the team over the course of several months in order to sell the property and make a profit, that's a lot to manage. Right. Flipping is very active. So why do people do it? Because there's the potential to make a lot of money. With inventory being so low in the market, there have been a lot of buyers chasing a few sellers. So it seems like, okay, I can probably sell it at whatever I want and exit. That doesn't always happen. Right. Right. But the potential for big profits is there and the potential for a one-time big payday. These paydays can be huge. That is the primary benefit that draws investors to the strategy. There are plenty of drawbacks and challenges

to face while chasing that big payday. Mainly being, there's just a lot of risk to navigate. There's a potential to lose money at many different stages. And it's a lot of work to actively manage all parts of the flip process, from the purchase to the rehab, to the teams, to the staging, to the selling, there is a lot to do. And you only make money while you're active and closing the deal. You're only making money when you're selling the property once you have sold it. Right. And you get a one-time payment and then you're done. There's no more residual income. You have to go back to the drawing board. So in that regard, something like buy and hold, where you do the work up front and then you get a stream of residual income in perpetuity

is more of a financial independence early retirement model or a financial independence early retirement strategy, whereas flipping, by contrast, would be a better fit for someone who wants a full-time job in the field of real estate. Absolutely. All right. So those are six strategies for how to make money in real estate, each of which have different pros, different cons, different types of risks, and different forms of reward. And so this, going back to that metaphor of a tree, this is why understanding your root structure, what are your values, your base, what are your principles, and then that tree trunk of what are your goals and objectives, this is why having a solid understanding of that tree can help you decide which strategy is the best fit for you.

As we've outlined all these different strategies, which strategy of the ones that you've heard fit your goals, your vision for what you want your life to look like, right? And that set of goals, that's built upon a foundation of your principles and your values. And that's by starting with these lower parts of the tree, the roots, the base, the tree trunk, and the big limbs, that's where the decision-making needs to start. So many people, like we mentioned at the beginning of the show, so many people begin with these superfluous questions about the leaf canopy. People will start with the question, should I put my properties in an LLC?

Should I get a property manager? Should I, what kind of bookkeeping software do you use? Who cares? Right? Those are leaves. The software I use, that's going to come and go in the same way that leaves form and fall and form again. But the strategy, which is anchored by goals and principles and values, that is the more solid place to start. So thank you, Sunny, for sharing these strategies with us.

Thanks, Paula. So after listening to this episode, I'm sure that many people who are listening have follow-up questions. right? We've talked about accredited investors. We've talked about different types of reits like equity reits versus mortgage reits. We've talked about contingency clauses and solo 401Ks or self-directed IRAs as vehicles that can be used for private lending. There's a lot of information out there. So we have assembled a free PDF that points you to a whole bunch of free resources. that can give you some great follow-up information. To download that PDF, go to afford-anything.com slash episode 384. That's afford-anything.com slash episode 384. While you're there, you will see the opportunity to download this PDF that will link you to a whole bunch of resources for a ton of follow-up information.

When you download it, you will also join our VIP list. and we send loads of informative, actionable real estate investing information with a particular focus on buy and hold to the very active community of real estate investors who are on our VIP list. So again, afford anything.com slash episode 384 for some follow-up resources totally free that can super help. Sunny, as you know, we have a course coming up as well. You've been through it.

It's amazing. Yes, I have been through it. As someone who went through it after having already invested and built a portfolio, I still learned a lot, which is pretty cool. Yeah, it's incredibly robust. And a lot of what we've talked about, the checklists, the systems, the structure. The community. Yeah, the importance of going in with your eyes wide open and not being blindsided by your unknown, unknown. right? That's what this course was designed for. In previous years, we have opened up this

course twice a year. In previous years, we've had a spring semester and a fall semester. We're not doing that this year. This year, 2022, we are only opening this course for enrollment once, once and only once. And it opens this month, June. And it also closes this month, June. So this month, later this month, is your only opportunity this year to enroll in our course. It is an incredible experience. If you want details, including videos that describe what's in the course, a detailed breakdown of all of the modules and the lessons inside of those modules, videos with interviews from our alumni, you can access all of that by going to afford anything.com slash enroll. And while you're there, join our VIP list. Again, that's afford anything.com

slash enroll and join the VIP list so that you don't miss any of the bonus content that we are sending to all of our subscribers, including a lot of material around this particular time. Inflation, the risk of recession, how to handle the specifics of 2022. We'll send you all of that for for you when you join the VIP list. And you can do that. at afford anything.com slash enroll, or you could also do that by downloading this free resource guide at afford anything.com slash episode 384. Sunny, thank you for being my esteemed co-host and walking everyone through these six strategies for making money in the world of real estate.

You're very welcome. This has been a lot of fun. And thank you to everyone who's listening for being part of the Afford Anything community. If you enjoyed today's episode, please share it with a friend or a family member. And make sure that you're subscribed to this podcast so you don't miss any of our amazing upcoming episodes. Thanks again for tuning in. My name is Paula Pant. I'm Sunny Rao. This is the Afford Anything podcast, and I will catch you in the next episode.