What Can Go Wrong (course class 8)
All right, this class is called What Can Go Wrong? Now, when you're making investments and well, in just in life in general, we all know lots of things can go wrong and it's impossible to live a problem free life, but I can tell you one of the things I've learned over my life is that problem solving is not fun. Problem avoiding is much better in life and we can avoid a lot of problems. So the purpose of this class is I want to give you an overview of the things that can go wrong. A lot of things that I've either personally experienced or been involved with on transactions, where there have been issues and not. And so let's just get into what can go wrong and how you can avoid these.
A word that I want you, or words I want you to acquire, if you don't already use them, is due diligence. Write those words down. I want you to use them when you're talking to realtors, when you're talking to sellers is, do your due diligence or say, "I need to do my due diligence." The words due diligence are like code. Here's what they say, when you're talking to an agent and say, "Well, okay, let me do my due diligence." Here's what they think. They say, "Uh-oh, this guy knows what he's talking about." And that's what you want them to think, is that this guy knows what he's talking about. This guy is going to do his homework. We want people to back off and give you the respect that you need so that you can do your due diligence and you don't get pushed around by some aggressive salesperson, because doing your due diligence means you're basically just doing your research so you can make a smart decision.
All right, so location, location, location, and those three words have been since the beginning of time basically the key when they talk about real estate, is it's all about location. Now, humans love being close to water, whether it's the ocean, whether it's a lake, a river, whatever, that pushes value, views, so properties that are on hills, views, they're always really desirable. Now here's what's important about real estate, and how it differs from stocks. See, I think I said this earlier, but when I was in high school in the 70s, Sears was the number one retailer in the world. IBM was the number one technology company. Kodak was a major force. Nike didn't exist, they were just being born in the late 70s or early 80s, and that.
Now we go forward 40 plus years, and you look at the number of companies and how the landscape has changed with technology companies, retail, online, all of these things. Here's my point, when is beach front property going to go out of fashion? When are people going to go, "You know what, God, that Newport Beach man, that just is a hell hole to live in." It's never going to happen. Everybody wants to be on the beach. Everybody wants to have an ocean view. Everyone wants to hear the ocean. This is another reason why real estate is far safer than stocks. You don't need to be paying some financial planner big bucks to tell you that beach front property is always going to be desirable. Forecasting companies is an art and a science, very, very difficult and you need to have someone if you're going to dabble in that, that really is studying financial statements, and not just financial statements because financial statements look backwards, they don't look forward. And so things are always changing, but some things never change and the desire for waterfront property never changes.
Properties that have views never change. Now, density, that's about to change. This whole COVID virus experience, Manhattan Island in New York is some of the most expensive real estate on the planet, but is it going to continue to be? New York City has contracted and population growth for the last three consecutive years, after the COVID virus and the number of people that died over there, and all the other craziness that's happened over there, what do you think the chances are that, that contraction is going to continue? I would say it's really high. Additionally, is the evolution of technology and people being able to work from home. A lot of people are working online, a good friend of mine has been in Southern California her whole life, did a lot of business, but now her business evolved to online, and now she moved to Georgia to a community that's much less expensive and all her clients are still in California. She is working remotely, so the remote world is going to change, so density is a factor.
Typically, most highly dense areas though, the areas, they get older, they get more worn out, and the property values don't go up as high or as fast. So the cap rates, and we talked about cap rates earlier, are important, when you look at a cap rate and you say, "Oh God, in Newport Beach, the cap rates' really low, but the cap rate in an inner city where it's highly dense is much better." Well, there's a reason and the appreciation rate in those areas, isn't going to be as good. So the future prospect is analyzing all of that. That's your due diligence, is understand these factors, communities at extremely dense, low land levels, a lot of times, as the years go by, they start to suffer from that, unless they're really well-planned communities.
I mean, the city of Irvine, a lot of it is highly dense, but then they're high end and they've added all kinds of other amenities, security, and this, that, and the other that are in the area to prevent this kind of thing. So you need to be careful of that. You see highly dense areas, the future for growth rate a lot of times isn't nearly as good. All right, property condition, this is obviously a huge one. Now you can see, home inspections, that's a must. Bring someone in there to inspect the property. Don't just do your visual.
We had a loan just recently where I was contacted by the homeowner that was looking for information. They had bought the property and they were having all kinds of problems with their sewer system. And they thought there was a sewer, it wasn't a sewer, it was a septic, but they never knew it was a septic. Why didn't they know it was a septic? It wasn't disclosed, but the seller didn't know. Why didn't the seller know? Because they bought it as a flip, and no one did an inspection, and the buyer signed all these releases saying, "Yeah, I didn't inspect it. No one's inspected it. I don't need an inspection. I'm just going to eyeball it and we're good." Well, big problem, because their whole septic system was wasted. It was just trash, and they had to replace it, and that was a ton of money.
All right, pristine versus fixer. Now here's the reality, most people want a pristine property and the reality I'm talking about is here's why they want to pristine property, is in most cases I've found that the women, when they buy a property, they want a kitchen, and bathrooms are really important, and they want them to be in good shape. They don't want to operate in a place where the kitchen and the bathrooms are disgusting. And here's the challenge with that, repairing or providing new kitchen and new bathrooms is super expensive. They're the most expensive rooms in the house and so most people when they buy a property after they pay their down payment or closing costs they're broke, so they don't have the money to spend to totally remodel a kitchen or bathroom. As I said, it's very expensive. So they want a pristine property. Here's the problem with that. Everybody wants a pristine property.
So remember we talked about supply and demand, the supply of homes with brand new pristine kitchens is low and the demand is very high. So you will pay a big time premium for it. Now, if you're flipping homes, any home flipper is going to tell you, they know this, right? And that's the first thing where they focus is they want to make sure the kitchen and the bathrooms, that's where they pour the lion's share of the money and they make them look really, really nice, and because the demand is extremely strong for pristine properties. Now what's the other side of that, the other side is where's the economic opportunity? The economic opportunity is here with fixers. Now, if you're the kind of guy that I'm not, which is someone that is great, kind of a mini contractor, that loves to fix things and has the saws, and the drills, and does all that stuff, this is a great sweet spot for you. I'm not that guy, but if you are, the fixers are the opportunity.
Look for the properties that are old and beat up and the ones that have been listed for a while, where someone came out and said, with their own rose colored glasses, they looked at their house and they go, "My kitchen, doesn't look that bad. I know it's 40 years old and I haven't put a nickel into my house in 40 years, but I still think it's nice." And they over list it and it sits there. And then they reached a place where they either have to say, "Am I serious about selling and if I am, I'm going to have to really cut my price." Or they're taking it off the market, but the fixers are where the opportunities, and there's all kinds of financing. There's renovation loans that you can get where you can get the money to buy the property. You can put 5% down, buy a property, and then they'll loan you the money on the improved value to make the home improvement.
So you don't need to have all that money in your pocket, but most people aren't aware of these renovation loans and so they're stuck here in the pristine category and they totally miss the fixer opportunity. And getting a home warranty, now home warranty is good for you, but it's especially good on rentals, is if things start to break down, if you are buying an older property, 400 bucks, you can get a home warranty, there's different programs and what have you, so don't hold me to that figure, but there's different kinds of programs, and different kinds of costs, and that. But you can get these warranties that'll cover all the appliances and different points, but a home warranty could be a really good thing for you to avoid... But property condition, this is huge. It could be a huge opportunity and it can also be a huge nightmare.
Do your due diligence, spend the time, eyeball things, bring in an expert, look at what you're getting involved in, know and understand what you're getting involved with, so that you can strategically plan and maximize your return on investment and your wealth growth by knowing how property condition and poor property condition can actually turn out to be a huge, huge win for you, because most people, most people the truth is are just lazy. They don't want to deal with it. They'd rather just give me pristine and get down the road. All right, so who really owns the property? Now, here's why I bring this up, is we talk about title insurance and what title insurance companies do is anytime you buy a property, title insurance pretty much is an automatic. And title companies, what they'll do is they'll do a background and identify the chain of title, so all of that's important, but I can tell you again, I've been involved with situations where there are corrupt people bottom line.
I had a situation where, as you know, I own a mortgage company, we have a private division where we make private money loans. I personally make loans. And we had a situation where we had a son defraud the parents and transfer the title, and forge their names, their signatures, and paid a notary off, all the kind of stuff. Now it was a nightmare to deal with in the court systems, and it took quite a long time to find out and finally figure out where this happened, but the good news was, is we had title insurance and the title insurance company paid all the legal fees. And it was, like I said, it was a nightmare and it took literally years to sort all this out, but we finally got to it and we finally found out in all the investigation that it was the son that had defrauded the parents. My point is, is that title insurance never, ever, ever, ever get involved with a property without having the due diligence on the title, and paying for the insurance, and making sure that you have that insurance, because there's all kinds of craziness.
There's a new company out there that's marketing, Title Lock. I don't know. I mean, I'm not going to really comment on that because I've just seen with title insurance companies are very secure now. I was talking to a client that was from another country and they were talking about how in other countries this is one of the biggest frauds, is that you buy a property and then someone will illegally transfer the title, transfer your property, and they will transfer it and record it, and then you only have so much time to fight this, and you can literally lose your property because most people aren't always checking. So anyway, I mean, in this country it can be an issue, but if you get the title insurance, you shouldn't have too much of a problem.
The other thing is you want to be aware of is not just the existing liens that are on there, but the encumbrances, meaning what requirements are attached to that property. You could have a common driveway, you can have different factors on there, there's the liens, there could be judgements that are on property, there could be contractors, and lis pendens, things like that. But you want to take a look at getting a title report and examining everything that has to do with the property limitations, with respect to the properties that you're interested in. But look at that, examine it, and know exactly what you're getting into.
All right, existing tenants, if you're buying a property and there's existing tenants, I have a saying, the best in life is people and the worst in life is people. It's all about the people, so do your homework on the people that are involved. Now, the estoppel certificate, it confirms the current details of the lease between the landlord and the tenant. This is huge. This is so critically important to you, is let's say you're buying a rental property and the landlord has a lease with a close friend for the next five years and they're only going to pay $500.00 a month. And you know the rental market is $2,500.00 a month, and you buy the property, and you don't ask for the estoppel certificate, and then you go to the tenant and you say, "Hey, I'm changing your rent." And he says, "No, you can't change my rent. Here's my lease agreement and my rent is at this level for the next five years." You're pretty much stuck, when you buy that property you're assuming those existing contracts.
So getting this estoppel certificate is a huge item, and who knows what agreement or terms could be in there. So get this, the tenant signed it, everybody signs it, so you know exactly what agreements the owner and the tenant have already made and what agreements that you're basically taking ownership of, what you're getting into, so that's huge. So all the terms that exist in the leasing agreement, the security deposit, how much of a security deposit do they have in there, or if you're going to be the new landlord, security deposits are really important.
And then what the rent is relative to the market, a lot of landlords fall behind what the actual market is on that, so you want to take a look at that and if the existing property, let's say they're collecting $1500.00, and then in the current market is $2,500.00, for you to bounce it up that quickly and that high, in some cities with rent control, you're not going to be able to. In other cities, you do that to somebody and they simply can't afford it and then you could have a battle with that tenant, and so there could be a lot of problems with that. Now, another point on this before I get into the cashflow, about tenants and what I said earlier about the best in life is people and the worst in life is people, do a background check on any tenants. And here's what I'm talking about when I say background, is it's really inexpensive, but we can run a credit report, you want to run a credit report on people.
The credit report reveals someone's character, if you have a perspective tenant that's never paid anybody ever on time, they're not going to pay you on time. People that respect their credit and paying their bills on time, it's important to them, those are the ones you want so it's really important. The other thing is you could also include not just a credit report, but do a background check and find out if you have someone that's dangerous, someone that has a criminal record of abusing, beating people up, hurting people, somebody that's violent. You don't want to be afraid to go knock on the door and collect your rent or afraid to go talk to somebody. So do background checks, you can do it, you can hire someone, they're property management services out there. There are a lot of laws you need to be aware of if you're going to be your own property manager, be aware of the laws, but do these background checks. They have to authorize it so that you can run the credit and do the background check.
All right, next we're talking about cashflow. All right, now on our cashflow, what the objectives are and what the reserves are. First objective, is keep in mind, and we've shown you this before about the five economic benefits of real estate, is let's say your rental, your principal, interest, taxes, and insurance, your total payment on a property is $2,500.00 a month and you're collecting $2,500.00 a month. Now you ask the typical person, "Okay, $2,500.00 a month is my PITI, I'm collecting $2,500.00 a month. How much am I making?" And the average person is going to say, "Well, nothing. It's a breakeven." Well, that's not true. You have the principal reduction, you have the tax benefits, you have the appreciation, and so on, but here's the thing is when should you run a negative cashflow?
Meaning let's say the PITI is $3000.00 and you can only collect $2,500.00. I'm not a big believer in that. Here's the one time I would say that, that's worth considering, is if you're younger and you have incredibly high income, if you're at a place where you're making $50,000.00, $100,000.00 a month, you're making big dollars, and you're younger where the rents are going to go up, you could use some of the tax write-offs, then that's a different factor, but always sit down and talk to your accountant, really bring in some other eyes. This is what we do in our consultations, know what you're getting into, but for the average person, for 90% of the people, maybe 95% of the people I wouldn't recommend it, I wouldn't encourage it, we want to have cashflow. What I love about real estate is not just the wealth growth, the wealth growth factor is amazing, but I love the fact that it can start helping your life now.
The 401k and the IRA, there are so many things about the 401k and the IRA that I just, to me is, to put it nicely, a big disappointment. One of those big disappointments is it doesn't help your life along the way. When I sit down and talk to people that are 25, 30, 35 years old, and their whole mind, the only thing is it's all about the 401k. And I just look at them and say, "It's not going to start helping you until you're 59 and a half." Well, if you're 30, your 30s, your 40s, and your 50s are gone before it starts to help you. To me, that's crazy. You get into a rental, you start creating this wealth, the property is going to be building all this wealth and you're getting income and a lot of it's tax-free in the early years. It's almost all tax-free.
Now you're getting this extra money and you can use this extra money now, especially if you have kids, you can use it to help accelerate your mortgage, or you can use it to help with your college expenses with your kids, or there's all kinds of things. When you have children, children only get more and more expensive as the years go by. That's the thing about real estate that's so important and why cashflow to me, getting the cashflow as soon as possible is important, and let's keep it going. Reserves is super important. Now, when I talk about reserves, reserves a lot of people are going to say, "Well, how am I going to get reserves?" Here's how you get reserves. As the property value's going up, you're building all this equity, and remember what we talked about, this is another reason why you want to do owner-occupied. You get into a property, you start to build some equity, and then as soon as you can get a line of credit on that property, and whether you use it or not is another story, but it's easy to get a line of credit on your home.
Now during the COVID virus, that went away, but historically, I mean, that was an aberration, historically, getting a line of credit on your home is very simple. Then once you get it, they don't worry about if you're still there or not, then you go to the next property and you buy a property, you get into that, build some equity, get another line of credit. So you don't have to use it, but here's what's nice having a 10, 15, 20, 25, $30,000.00, maybe $50,000.00 line of credit, that that can work as your reserve. And so you can tap that money when and if you need it, if you don't need it, it's kind of no pain, no gain, so there's no problem with that. All right, selecting the tenant. So we talked about this, is the character of doing the background check on your prospective tenants. That's super important. Here's another one though, is setting expectations. In human relationships, this is probably the number one issue that is overlooked in every relationship, personal or business, is setting expectations.
So think about, so people can't read your mind and you can't read their mind, set the expectations and this is why writing down what you expect. Now we have a lease agreement that says, "Hey, I expect the rent to be here on the 1st, if I don't have it by the 5th, there's a penalty." But there are other things to talk about with expectations, which is the condition of the property, and who's going to mow the lawn? How are you going to keep the property? Are you going to do inspections on that property? I would encourage you to go into your property minimum once a year, when you're renewing the lease and inspect the property, stay up with it, make it clear. And I'll tell you here's another super important expectation, and write this down because it's super important, is set the expectation that rents are going to go up every year, like clockwork.
Probably the number one mistake that landlords make is they don't set this expectation and here's what happens, and here's how you end up doing a disservice to yourself and to your tenant. Let's say we get into a property, you turn it into a rental. You sign a lease for one year of $2,500.00, a year goes by, lease is up, and you go, "Oh, everything's gone great. Tenant made every payment on time. Feel great about it, love them. We've become friends. They don't hassle me. It's just easy. I'm not going to raise the rent." So you just signed a new lease, the same $2,500.00. Another year goes by, same thing. Now you're like best buds with the tenant. They're always paying on time and they give you a call if there's ever any issues, but they take care of the things most of the time. They really take care of the property. Love these people, you don't raise the rent.
Four or five years goes by, it's still $2,500.00 a month. Are your bills the same? No. Inflation's bigger than you. Inflation's bigger than your personal world. All your expenses are going up in your life, including on that property. The plumber isn't working for the same thing, the electrician, supplies, nothing costs the same, but four or five years has gone by and now the market rent for that property is not $2,500.00. The street value is $3000.00. You're losing $500.00 a month. And you're looking at now you've caused yourself a problem, and now you're like going, "Okay. I can't be losing 500 bucks a month, that's $6,000.00 a year, and my costs on this property has gone up," et cetera, et cetera. And then you go to the... The lease expires and you say to Mr. Tenant, "I'm going to raise your rent from $2,500.00 to $3,000.00." How do you think they're going to react to that? They're going to choke and they go, "I can't do it." And they're going to start looking.
Now they may or may not, because if that's genuinely the market rent, they may say, "Okay, you know what? I'm staying." But I'm going to tell you what happens in most cases, they leave. Here's why they leave because they're so upset at you because now you're the greedy landlord because you're raising their rent 20%. Had you set the expectation where you said, "We're going to raise rents every year, 4%." That's what I do because it keeps me up with inflation and all my increased expenses. And after year one, what's 4% of $2,500.00? $100.00 a month. So now it goes from $2,500.00 to $2,600.00.
Here's what the tenant has to look at. They have to ask themselves the question, they say, "Okay, I was in here, it's been a year at $2,500.00, now I'm signing a new lease it's $2,600.00. Is it worth it to move, for me to pay an extra 100 bucks a month? For me to move, I got to go look around. I have to displace my family. I've got to spend a couple 1,000 dollars, maybe $2000.00, $2,500.00 to move, everything changes. Do I really want to do that for 100 bucks a month?" 99% of the time the answer to that question is no, and so if you set the expectation every year, every lease, and you tell them, you put it right in the lease, annual increases of 4%. Now I'm going to tell you, that 4% in Southern California is on the low side. Big companies, like Irvine Company, a lot of times they're like 10%.
Now, some cities have rent controls of 3% or 4%, so you need to be aware of that, but 4% to 5% is a very conservative number. I use 4%. It's a conservative number, but it's higher than inflation, as far as our national inflation, it's more current with the local inflation rate. So it's a win for you and I think it's a win for the tenant, but the key component is you've set the expectation. And remember I talked about problem avoid, you're avoiding a problem for you and you're avoiding creating a problem for the tenant because you created the problem, because you didn't set the expectation, and the time went by, and now you're trying to go back and trying to fix it. So set the expectation, be fair to yourself as much as be fair to the tenant.
And then the lease terms, is use a lease document. The California Association of Realtors has documents, there's different property managers, but the lease documents are important. Always be aware of legal changes, if you're going to do your own property management, lease laws change every year. There are some attorneys that specialize in eviction services. Have an attorney that specializes in evictions. You'd need to stay... Legal is important, so stay up with what's going on in the legal world. The city you live in really matters, so be familiar with what that city, what their tenant protection rights are, and so on. And landlord, there aren't very many landlord protection rights, it's mostly tenant. So be aware of what those are, because it really varies city to city and county to county. Make sure all that stuff's in your term, but I'm a big believer in just one year leases.
All right, next, what to do now? In our whole what can go wrong, I gave you kind of the tip of the iceberg there. There's all kinds of things that can go wrong, especially if you don't do your due diligence, if you do your due diligence you're going to minimize that. In my book, I have a chapter that elaborates on this a little bit more, but it's important to problem avoid, not problem solve. All right, so this completes our course. I'm really excited about where you are in your journey, what you've learned, but here's the next critical point is, your journey to a better life revolves around these three things.
Number one, what you believe. We talked about that in the beginning, 90% of the people never change their life circumstance, meaning life never get better because of what they believe, and what they believe is wrong. They don't believe it can get better. They believe that saving money is their only path, "I can't say very much so I guess I'm just screwed with life, and that's just the way it is." All of that's wrong. So I hope we've opened your mind and started to change your beliefs. You got to change your beliefs because not only can you be secure, amazing things are possible, but I know I've given you a ton of information, but now you can watch it again and gradually start taking the steps. So the first thing is change your beliefs.
Second is knowledge, that's what this whole course is about. It's about learning and understanding. Now, as far as the knowledge, these, I'm reminding you, these are the five critical questions that you need the answers to. We talked about this in the beginning is, how long will your life savings last in retirement? For most people, it's not very long. That tells us there's a problem. Next is how much will inflation increase your expenses? We need to know that number because that's the bar. What are your expenses going to be a time of retirement? Whether you're 25 and we're going to forecast out where you're going to retire at 45, or 50, or 55, or if you're 50.
And I can tell you, I have a ton of client appointments with people that are in that 50 to 60 category, and they want to retire in the next five to 10 years and they don't believe it's possible, and their financial planners have told them it wasn't possible, and they come in and then we show them how they can make that happen. But we need to understand where inflation is going to be at all times and factor that in the equation because that's the bar, we need to know the bar. You can do amazing things when you have a focus and you know what the target is. How much monthly income you'll need including the taxes? So we need to bring in your accountant, I'm not a CPA. This is a team effort with some real pros, we either work with your CPA, if you need a CPA, I'm happy to introduce you to a few CPAs, but I'm not a CPA, but taxes is a big part of it and real estate is a game changer to your tax situation.
Number four is, how to create the monthly income? We showed you in the previous class about how, in laying out this plan we start out with a really super simple two investment strategy, if you already own a property, big headstart, if you already own a rental, I mean, there's so many amazing strategies and possibilities. So let's understand and break these down in how we can maximize that. And then number five, so critical, is how do we protect your assets? Protecting your assets, not only for you, but for your family. There's legal obligations, lawsuits, the wealthy know how to protect their assets, and this is where we bring in an attorney. There are different types of attorneys, but one is, trusts are really important and trust attorneys, and having strategies to protect your assets so that you're protected from any kind of litigation.
And one of the most... One of the highest risks that a parent has is when they have a high school student that has a driver's license. Imagine having a high school student that has a driver's license that goes to a party, drinks too much, runs a red light, kills somebody, who are they going to come after? You. That kid's your responsibility and they come after everything you own and everything that is in your name, your personal name is at risk of disappearing. So the question I have for you is, are your assets like your home, in your name? If they're in your name, you have the chance of losing them. There are way better strategies. There's some brilliant attorneys that are really good at this that you can work with. And again, these are the things I've learned on my journey of starting from zero, knowing nothing, and as I started to make money, my friends, I started associating with high net worth people, and they start sharing these things, and high net worth people play a completely different game. They work with all kinds of experts to protect their assets.
The other thing is having the strategy so that we create this income that's going to weather the storms. The world is always in flux, always changing, but a roof over your head is one of the most basic requirements that we all have. Real estate does not change in this country anywhere near the way the business landscape changes. Who knows the future for commercial real estate? Malls, because I'm talking about it, we know companies, how companies come and go, but even malls, malls were big, now malls are bankrupt. Now with everybody going remote and who knows how all that's going to change, but residential real estate, different story. People are always going to need a roof over their head, but we need to get all the answers to this. So what to do now?
Here's what to do now, here are your options, is one, is you can go it alone. You say, "Hey, I've done the course. I feel real comfortable," and you can fly solo and go it alone. Or you can schedule a free consultation, go to Mark1WealthAcademy.com and request a free consultation, and we will sit down and talk about where you are right now, and where's the next level of helping you to advance your life. So it starts with, I hope we've changed your belief system about what is possible, being a multimillionaire is very real, very, very real. Okay? Number two is the know-how, this course is the beginning of that know-how, and number three is you've got to take action. Nothing's going to happen, and even if you don't think you're ready today, even if you have credit issues or whatever, you should still sit down and have a consultation, if you have a job, if you're employed and you're making any level of income at all, you should sit down, get into a consultation and say, "Okay, how close am I? Maybe I can't get started today, but how close am I?"
Because keep in mind, with all these government programs, and down payment assistance, and all that, $500.00, a decent job, and you can get started, and you can be on this path and never have to worry about saving money, create retirement income, and create serious wealth, and we can change the landscape of this country. 10% of the people have 90% of the wealth, it doesn't have to be that way. The primary reason that 10% have 90% of the wealth is, number one is what people believe and number two is they don't have the knowledge to take the steps. You got to believe, got to have the knowledge, and have the courage.