Compounding Wealth Through Real Estate (course class 6)
All right, now, it gets really exciting. Now, remember I said, the purpose of this course is not to just show you how to buy a house. The purpose of this course is how to make you wealthy. So we're going to get into that now because I know you want to become wealthy, but we have to change your mindset from, wealth is about saving money and just throwing it in a retirement account, way more to it than that. So now we're going to get into the process, but my core goal is I want you to become wealthy.
You can become wealthy because saving money is not necessary. Whatever you save is great. I'm all for it. I'm not discouraging it, but saving money is secondary. It's about understanding what we talked about before, the science of building wealth and then understanding how to put the pieces together. So we're going to get into it at the next level.
But if you're a doubter still, I'm going to work real hard because we can get you there. So I need you to start loosening your mind up, but we're going to get into this process. So here's the first step, buying your first property. So what's the starting point? When I'm talking about your starting point, we look at how old are you? Time is a huge factor with wealth growth possibilities. The younger you are, the better because we have more time. But if you're a senior, still, understanding all these dynamics and the truth of the matter is, I work with more seniors than anybody else because of the fact that they are more wealth conscious than young people are.
Young people are more fun conscious and they don't become wealth conscious usually until they're 40 plus, which is a shame. So if you're young and you're all about getting rich, then I'm all for it too and I'm going to help you to get there. So if you're young, you have a big advantage. All right next starting point, balance sheet. Your balance sheet is basically we want to know what the starting point as far as where your net worth is. What do you have to work with?
So we look at your balance sheet. Your net worth on your balance sheet is your starting point. A balance sheet, if you're in accounting you deal with these all the time, but if you're not, a balance sheet is basically it's like a back of a loan application or it just lists here's what your assets are, here's what your expenses are. What's awesome again about real estate is you get this gigantic leap forward because we can secure an asset worth hundreds of thousands and even millions of dollars with little or none of your own money.
So not only do you not have to save money, you really don't have to have much money, a few hundred dollars and you can get in the game and get started because there's so many down payment assistance programs and even closing cost assistance. So money is not an obstacle. The obstacle really is you got to have a job. You have to have some income. So if we're going to borrow money, you have to have the ability to make that payment back.
So currently, are you a renter, a homeowner or an experienced investor? If you're a renter, we can get you there. If you're a homeowner, we can get you there. If you're already an experienced investor, I'm going to show you how to accelerate your wealth growth. So what are your financial objectives? The price of lifestyle. This is a tough decision, but the decision that you're going to have to make. I cannot tell you how many people I talk to that look like they got it going on, but they're renting a place that they're paying a lot of money for that.
Because they're paying for an address, they're paying for a location, but they're renting so they're building no wealth. They have a gigantic car payment, lots of credit cards and so their lifestyle is costing them $10,000, $12,000, $15,000, $20,000 a month. But their net worth is zero, zero net worth.
So you have to make a choice right now. Lifestyle, meaning just looking like you're rich and being rich. There's a great book called The Millionaire Next Door, I encourage you to read that. You know the number one vehicle most millionaires drive is? Number one, Ford F150. A lot of millionaires that live modestly because it gives them the capacity to save some money to invest and they can invest over and over and over and over. Low lifestyle allows you to make investments and accumulate other assets. So lifestyle is a big challenge.
I know if you're young, you're looking at this going, should I have a $400 car payment or $1,000 car payment? Or even more? I mean you can get $1,500, $2,000 car payments. Lifestyle is going to be your biggest challenge. And what that challenge is really comes down to really your ego and your pride and maintaining that and monitoring that, controlling that. So if you feel this constant pressure to have these high lifestyle items, just know it's going to make it really difficult for you to build wealth.
Buying a home versus buying an investment or a little bit of both. And here's what my point is about buying a home versus buying an investment or a little bit of both. In this course, what we're talking about is helping you to become wealthy, but not at the expense of your life. When you're looking, the home is for most people, the biggest investment they'll make. But I also want you to look at this. I have a saying is, your path to wealth is through your home. When you buy a home, you're going to be accumulating wealth at an incredible level.
That's awesome, but we do not want to ignore your life. Now, let me give you some specific examples of what I'm talking about when I say your life. Let's say you're married and you have a couple kids. The family is a factor. We want to buy a home. We need to own a home. But we cannot ignore the safety of the children. So example, being on a corner street of two busy streets, corner house, two busy streets. Not smart when it comes to having kids. So there are different factors. Now, most people when they buy their first home, the investment component, on a one to 10, the investment component is zero.
Most real estate agents are not trained in wealth growth. So they sell the home as if it were an appliance, meaning that it has no asset value, no wealth growth value. It's all about the colors, the bedrooms, the baths, the square footage. How nice is the kitchen? Does it have granite? How nice are the bathrooms? All of the amenities. It's about the bells and whistles. Well, that is no good.
Looking at the home purely as an appliance of amenities is no good, but we don't want to go to the other extreme where it's exclusively about the numbers. We're looking to build wealth because we want to build the best life possible. So my point is, buying a home versus buying an investment, it should be a little bit of both. We want to factor in both components. Your home is your path to wealth, so we have to get you into a home. And you're going to have to sacrifice some things, lifestyle wise, but we also want to look at what your family needs are as well.
Do you want to retire as soon as possible? What is your plan? For some people retirement ASAP is very real. I've talked to people that are 30 years old, 35 years old and they want to retire at 40, 45, 50 years old. Others are like me, they don't plan on retiring ever. I love working with people. I don't really see what I'm doing. Even like this, to me, this is not a job. This is great fun. Doing my client consultations is not a job. See to me, a job is taking the trash out. A job is mowing the lawn. A job is doing things I don't really like to do. Helping people is awesome.
Being in client consultations, sharing with you what I've learned over my life journey in a very challenging way is really rewarding to me. But for you, if you want to retire as soon as possible, then we need to have a plan to get you there. So we need to look at that. So that's part of it. Where you are today and do we want to get out of the game as soon as possible?
Because the key to getting out of the rat race of work is creating as much income as soon as possible. And that's one of the things I love about real estate especially is that 401k or IRA, you can't get any of the income until your 59 and a half. Well with real estate, we can get you into a property and start getting some income assistance almost immediately. In some cases we can do it immediately, especially if you're getting into a duplex or more. But you're getting income in your 30s, 40s, and 50s and you don't have to wait till you're 59 and a half. So do you want to build maximum wealth and retirement income? Are you focusing mostly on the wealth? Are you focusing mostly on the retirement income or do we want to balance that? That's where we'll talk about all those things in your wealth building plan.
Next, is financing options. Now, I've been in the mortgage industry for well over 40 years now. There are all kinds of financing options. We had the whole subprime where they got crazy and if you're not aware of this, I will share with you. In April of 2004, I did 13 interviews. Three TV interviews, a national radio show and the rest were various magazines and newspapers around the country. And I was warning the people to not take these subprime loans because they were bad loans and they were setting people up to fail. Now we saw that meltdown, that was 2004. I said in the next two to three years, we're going to see massive foreclosures and it came to pass.
Now, we've seen the world evolve. There are new regulations that prevent that kind of crazy lending. But as the economy got better, a lot of different new financing options have evolved. So what's great about that is it creates all kinds of opportunities and we need these financing options because there are a lot of people that are retired that have a lot of assets, but they don't have a lot of income.
Or you don't have self-employed people that you can't really document their income very well. So financing options is really important. Now amount of down payment as I mentioned there's all kinds of down payment assistance programs. Cities have them, states have them, there's many, many programs. And one of the biggest mistakes and I don't know where this comes from. This is kind of just this false myth that you need 20% down.
I cannot tell you how many young people I've talked to. And I'm talking to people that are 30 to 35 that have not bought because they're saving to get to 20% down because they believe they need 20% down. You don't need 20% down. You don't even need any down. And the problem is, is they've cost themselves, some of them, literally hundreds of thousands of dollars because they can't save anywhere near fast enough to get 20% together. Forget that. Down payment is secondary.
Getting in the game is primary. Qualifying. There are all kinds of qualifying guidelines. You need to get qualified. The range is from conventional loans, much more stringent on their qualifying. These are your Fannie Mae, Freddie Mac type of loans. Those are great loan programs because their rates are really good. But they're also the strictest qualifying. There's FHA.
Then there's VA loans. These are government backed loans. These loans are good gloves as well, but they're much more liberal in their qualifying. FHA is much more liberal when it comes to credit. And as far as credit scores and what they'll tolerate and the debt ratios. Now, they're more expensive than conventional because the mortgage insurance is much higher. But the reason it's much higher is because they're taking much bigger risks.
So if you need to go FHA, it's well worth it. Way better to get in the game than sit and wait and try to avoid that mortgage insurance. It's expensive mortgage insurance. There's no question about that, but it is cheap compared to renting and not getting into the game. And VA, if you're a veteran, that's the best of all. Great interest rates, may have a funding for you, but the cost of it is really minimal and you can buy with no down and even no closing costs.
So financing, there's all kinds of options, but be aware of these options because this needs to be part of the planning as far as where we're starting from and what kind of financing is available. And in that conventional, there's a category called non-QM. And the non-QM, non qualified mortgage is that's where... and this works best with investors, but there's all kinds of scenarios where we can pick up properties using these non-QM loans.
All right, your first property is generally your home, but it doesn't have to be. Some of the advantages of buying owner occupied. Now, let's say you don't have... There aren't that many people that will start with a rental property, but it does happen. But don't wait for that. Buy your first property as soon as possible, because that's going to create... it's going to get us in a game and we're going to create the massive wealth growth as soon as possible.
But here are the big advantages of buying owner occupied. Is number one, when you live there, you can get in with little or no down payment. So that is huge. So the amount of money you need is minimal. Next is owner occupied is much lower interest rates. When you buy investment property, the interest rate can be anywhere from 1/2% to 1% higher than an owner occupied rate and those are on the best loan programs. If you go into the non-QM category, then it's even much higher than that.
And then we want to get the wealth building process going. Now here's the other point about buying your first property is we want to get into to that first property. And so let's say you buy... you're renting someplace, you buy owner occupied, you getting into that property, but keep in mind that all these rules, these things that I talk about here, all these are always going to be applying every time you buy owner occupied.
Here's my point. If we get into that first property and you're living there, the fastest and easiest way to build this wealth is to own lots of properties. The fastest way to own lots of properties is turn your house into a rental and move on to the next one. But you're going to have some challenges with doing that. Here's what those challenges are going to be is the temptation to say, wow, if I sell this house, I'm going to get all this equity and I can buy a much bigger, nicer house.
But what you're doing is you're dramatically reducing your wealth growth and the non-employment income. Remember, the number one focus. Remember it's all about focus. The number one thing I want you to focus on is non-employment income or investment income. So I'm going to repeat that. Number one thing I want you to focus on, we're going to move in the direction of what we focus on. What are we focusing on? Building non-employment or investment income. If you don't have rentals because you bought a house, build equity, sell it and pour it into a bigger house because of the lifestyle desires. You're never going to be financially secure or seriously wealthy.
All right. So what should I buy? Condos or townhouses? SFRs means single family residence, units, or commercial? I'm going to show you some math, but let's talk about this. What should you buy? Where should you get started? Which one of these should you start with? Well, first point is if you have the luxury of choosing any of these, that's great. Now we talked about commercial and we're going to put that on the back burner, but I wanted to address that. As I said before, if you're a business owner and you're paying a lot of money in rent, let's get rid of that.
Being an owner user for your business, that's a great thing, but very few people start there. So we're going to focus on these three categories, condos, townhouses, single families, homes or units. Here's where most people, where their mindset is and where it is with the agent is the consideration of wealth growth and investment income is not on the radar at all.
It's okay. The realtor is talking to them, holding an open house or maybe knock the doors or prospecting. And they say, Hey, are you interested in buying a house? Well, yeah, you know, I rent it and I've always thought about buying. And then they immediately say, okay, great, well, let's sit down and talk about what you want to buy. And the conversation of building wealth and building your financial security never comes up.
And so we're in this mode of the property is like an appliance and you sit there and say, well, I think I want to buy a condo or townhouse. Okay. All right. That's fine. As we look at that, but I want you to be aware of the math. Wealth growth is about math. You need to know the numbers. So I'm going to walk you through the numbers of buying a condo or townhouse versus buying a single family versus by units.
Now, remember, I'm not trying to discourage you. I'm trying to educate you. We're going to grow wealth far faster in real estate than we are in other asset classes. But there are certain kinds of properties that we're going to grow wealth and income far faster than others. And you need to know because I'm telling you most agents don't know. The sharpest agents know, but that's like the top 10%. So you need to know. All right, so let's get into the math. All right. First, what is the cap rate? We're going to go through the analysis of... I'm going to share with you what a cap rate is. A caps is short for capitalization. Now, a simple way to look at capitalization meaning is if you put money in the bank and you say, what interests are you going to pay me?
That's essentially the same thing as a cap rate is what is the rate of return that you're earning on your money? Now, cap rate versus return on investment, which do you think is more important, cap rate or return on investment? They're not the same. Cap rate means like the return, as far as you know, the interest that you'd be receiving. But the return on investment on real estate is different. Here's why it's different.
Is if we look at properties, geographically is properties in the inner city of Los Angeles are going to appreciate at a different rate than beachfront properties. That's a huge part of your return on investment and your wealth growth. And the same thing if we look at return on investment, on properties out of state. So we need to understand the difference between cap rate versus return on investment. Return on investment is the most important because that means how much money you're making in total on whatever you've invested. Cap rate is really focused on the income that the property is created, the gross income and then the net income as a percentage of the asset value. We'll come back to that.
So how much are you need to beat inflation? So that's the other factor we want to look at. Here's why this is important. How much return on investment do you need to be in inflation and comparing states? Here's my point on this is I see a lot of people make this mistake. I've had many of these consultations where they live in Southern California, their cost of living is really high. Inflation is much higher here, but because they're just getting started or young, they go, I think I don't have that much money to invest.
And they say, I'll invest out of state. And they're only paying attention to cap rate, not return on investment. And you look at some of these states around the country where the property values don't go up and the rents don't go up. The increases are so minuscule. There's a website called departmentofnumbers.com and the website department of numbers, it's abbreviated D-E-P-Tofnumbers.com. But here's, what's great about this website, go to the department of numbers website. Then you look on the home page and on the right, you'll see a category, says, rents. Click on rents and then it'll show you the rent appreciation for all 50 states.
And then it'll break down the cities and counties in that. So you can take a look at that, but here's the point that I'm making. They're salespeople, I'm sure you know. Well, maybe you don't know, but I hate to break this news to you, but some salespeople lie.
I know it's startling to hear that, but some lie. And here's what they're going to tell you. They're going to say, why do you want to invest in California, when the cap rate is four to five, and I can take you to another state and get you a cap rate of six or seven. Let's say four and a half versus seven. And you're going, well, that makes sense, four and a half, seven. I'd rather get seven. But here's what they don't tell you. They don't tell you what the return on investment is going to be on your money. And here's the other thing they don't tell you. See, you get a cap rate, you put some money into a property out of state and let's say the property is going up 1% a year. And the rent is going up 1% a year, but you live in Southern California.
And in LA and Orange County, property values are going up. California is average 7.3% for the past 50 plus years. So if you're in a place where you're going to live in Southern California for the long haul and your property values and your expenses are going up 4% to 5%. If your inflation rate on your lifestyle is 4% to 5%. And you have investments where your return on investment, as far as your income is only going up 1%, 1 1/2%, you're losing the inflation battle.
But here's again, the sales person you're talking to. They may or may not know this, but what they're doing is they're selling to your ignorance of the difference between cap rate and return on investment, because it makes it easier to sell. So that's why we're going through this. And then we can analyze different states, but the key to this is growing wealth to create the best life possible.
So this, all of this, this whole course is really, it's not that we want to build the wealth and the income, but really what's the core objective? The best life possible. And so we can't lose sight of what your lifestyle costs are. What's inflation going to do to those lifestyle expenses and how do we have a strategy so that we can win that battle and have our life get better and better and not worse and worse.
So in our cap rate formula, here's the cap rate formula. We have a cap rate calculator that you can see this as a screenshot of it on our website, which is mark1wealthacademy.com. In the right hand corner it says retirement calculators. There's three calculators. This is the bottom one. This is one of three. Here's our cap rate calculator, it's really simple, but you can see you put the property value, annual gross income.
So you can see the annual gross income on... so whether it's a house or unit, so you just take what the monthly is and annualize it, then operating expenses. And I'm going to show you how we detail the operating expenses. What the vacancy factor is, what the annual net income is and then what the cap rate is. Now, this is a really rosy situation here. You can see this, if you can get these numbers in Southern California, you're crushing it. All right. All right. So here's an example. Within that sheet it said operating expenses, and it was the numbers were grossed together. So we need to break out the operating expenses. So if you have a pen and a paper, you want to write these down because you don't want to underestimate what your operating expenses are.
So first we look at, we're talking to condo, you had property tax bill. Let's say it's somewhere around $10,000. And they say it should be normally it's 1.2 to 1.25, but it could be less, could be a little bit more depending on the city in that. So be aware of identifying exactly what your property taxes are going to be. Insurance on the property. Now on a condo, we could get insurance way less than this because the condo you're going to be paying associations and the structures insurance.
So we could probably have insurance on this that maybe even a third of that cost. And it depends on what kind of things you're insuring. If you have some personal items that you want to add to that. So the next is insurance, maintenance and repairs. You can see this is a low number. The reason it's such a low number, 1% is because of the fact that we're talking about a condominium or a townhouse.
So a lot of the repairs is structured into the roof, outside lawn. All those repairs are included because they're maintaining the property. So that's one of the positives of condos is that your expenses, remaining repairs are going to be really minimal. It's going to be interior like paint, carpet, maybe a washing machine, as far as your dishwasher, appliances or range, things like that that are built in.
Property management. This scenario is zero because let's say you bought your first property as a condo and then you're going to turn it into a rental and you go to the next one. Now and you're going to manage it. But this is important. So if you're thinking about buying a condo and again, here's my point. I'm not trying to tell you what to do. What I'm trying to do is educate you on the numbers. If you say I want to buy a condo, we want to buy a townhouse.
I want you to be aware of the difference in the numbers when it comes to your wealth growth and retirement income or investment income. So property management companies usually average around that 7%, 8%. Now there's an HOA fee. This is $350 a month is where we get the $4,200 a year for homeowners association. Now I've seen these HOA fees go from $200 to $1,200. Some of these high rent districts, they have associations with all kinds of features, but it gets really, really expensive.
So we have to look at that. Mello-Roos, going to see if there's any kind of Mello-Roos tax or bonds or things of that nature where you could be paying that. So it's just showing $200 a month for there. So total operating expenses. So you can see here's what the total is 38.6% and that's without property manager. If you're a property manager, we're closer to 45%.
So this is where your operating expense be aware of all the operating expenses because they're not the same. And you can see in a condo or a townhouse, it's very often you're going to have these expenses, which are significantly more than what you're going to run into. So now we look at the math on this. Here's the property value. We entered the gross income, enter in the operating expenses, we're only showing a 1% vacancy factor and that's because we're in Southern California.
Southern California vacancy factor is, that's what it is. One is really, really low. If you in a nice community, you'll have no problem renting properties. Annual net income and here's the cap rates, 3.4%. So this is a condo or townhouse. So you look at the cap rate on condo and townhouses are typically going to be less. So that's my point in this conversation is our core strategy really starts with this best life possible. To make the best life possible we have to grow the maximum amount of income possible, non-employment income to make that happen. You can see because on condos the expenses are higher. Our capitalization rates are going to be lower.
All right. Scenario two, a single family residence. So let's walk through these numbers. $800,000 property. Here's the same income, but you can see the expenses are significant, significantly lower. Same vacancy factor and now we can see our cap rate is higher. So a single family residence, what you're going to see is and the other part on a single family residence that's important is the amount of land. Is if you're in a place where land is where properties are contracted because there's not a lot of land.
Southern California now has moved in that category where we're seeing smaller and smaller lots. So older properties then have bigger lots, the land value becomes more important. So that's a factor. With land you might be able to add a unit on there that creates another advantage and we'll do a whole training on how to do that, how you can buy a house and basically turn that house into a duplex and start creating income. That's a fantastic strategy for getting yourself in a position where you can buy a property with basically no money. Get into it, add a second unit and go from there.
But you can see the return on investment here. As far as we're looking at our cap rate is higher and then that's going to contribute to the return on investment. The other part of the number that's not in here and your return on investment is your tax benefits and your appreciation level. Homes usually appreciate better than condos.
Third scenario is units. So we're taking four units. Now, these... by the way, each one of these scenarios, these are actual properties that we pull from the MLS. So these are real scenarios, $840,000 property. This is in the Inland Empire here in Southern California. Here are the gross scheduled rents. Here's the rental income on it. The operating expenses on this are low. Now, if you add property management now 7%, 8%. It's going to be closer to 30% vacancy factor.
It could be 1%, 2%, 3% depending on the condition of the property. Now, the other part of looking at the operating expenses is how old the property is or the structure is important. If it's newer, you're going to have less expenses. If you're looking at a property that's pretty beat up that's 40, 50, 60 years old, then you need to factor in much higher on your operating expenses.
So look at that number, look at the condition, bring an inspector out there. If you're a young single person, this is a great way to get started getting into a duplex or a fourplex. But look at the cap rate on this. It's phenomenal. These deals are out there, but when you're starting, if you don't ever have any of this conversation and when you're looking to buy your first home, I'm telling you 99.9% of the time, the consumer and the agent will not have this discussion.
They won't do any of this math. They won't look at it. They will not have this discussion. The conversation will be basically how many bedrooms, how many baths are you looking for? It's all about amenities and it has nothing to do with what are the numbers to the property that you're looking to buy. And it's important that you be aware of this because we want to have a strategy to everything is about creating the best life possible for you.
That's what this is about. And every financial step you make matters. Let me repeat that. Every financial step you make matters. They're all important. The more right decisions you make, the faster you're going to get, where you want to get, the more mistakes you make, the longer it's going to take you. And the more painful the process is going to be.
All right, so that concludes our class on analyzing property and how to understand the numbers. You can see there's a lot of moving parts to that. So I hope you enjoyed this class. And this is if you want to dive into this deeper than you can reach out to me at mark1wealthacademy.com and we can look into this. And we'll go on to the next class.