What are the four wealth generators in real estate? Welcome to the Truly Passive Income podcast, where we dive deep into the world of passive real estate investing and explore the strategies that can help you build wealth and achieve financial freedom without being a landlord. In this episode, we take a closer look at the four key wealth generators of real estate— leverage, appreciation, tax benefits, and cash flow—and how they can work together to create a truly passive income stream. We also discuss some common misconceptions about real estate investing and share tips for getting started in the industry. So, whether you’re an experienced investor or just getting started, join Clint and me as we explore the powerful world of real estate investing and show you how you too can create truly passive income that can help you achieve your financial goals.

Time Stamps

[00:00] Intro

[03:14] The concept of leverage in real estate investing

[07:12] Appreciation: natural and forced appreciation

[13:45] Tax benefits: depreciation, 1031 exchanges, and Opportunity Zones

[20:32] Cash flow and the importance of multi-unit properties

[26:07] The three immutable laws of real estate investing

[31:12] The challenges of generating cash flow with single-unit properties

[34:10] Applying the four wealth generators to various types of real estate investments

[36:20] The importance of having multiple exit strategies and cash reserves

Key Take Aways

  • The Four Wealth Generators of Real Estate: Leverage, appreciation, tax benefits, and cash flow are essential elements for building generational wealth in real estate investing.
  • The Power of Leverage: Clint Harris discusses how leveraging allows investors to control more assets with less money and increase their financial velocity.
  • Forced and Natural Appreciation: Clint and Neil explain the difference between forced and natural appreciation and how they can increase the value of real estate assets over time.
  • Tax Benefits of Real Estate: The podcast highlights the importance of understanding and utilizing tax benefits to maximize overall returns on investments.
  • Cash Flow Reserves: Neil emphasizes the need to have cash reserves for surviving market fluctuations and avoiding forced sales of real estate assets.
  • Quote: “You never wanna be forced to sell your real estate asset. It’s much better to be in a position where you can wait for when the market is advantageous.” – Neil Henderson
  • The Synergy of Wealth Generators: Clint Harris summarizes how combining leverage, appreciation, cash flow, and tax benefits can create generational wealth and opportunities for real estate investors.
  • Adapting to Market Conditions: The podcast showcases the importance of adapting investment strategies to changing market conditions, like the COVID-19 pandemic.

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Transcript
Neil Henderson:

What are the four wealth generators of real estate? Welcome to the truly passive income podcast, where we dive deep into the world of passive real estate investing and explore the strategies that can help you build wealth and achieve financial freedom without being a landlord. In this episode, we take a closer look at the four key wealth generators of real estate, leverage appreciation tax benefits and cashflow, and how they can work together to create a truly passive income stream. We also discuss some common misconceptions about real estate investing and share tips for getting started in the industry. So, whether you're an experienced investor or just getting started join Clint and me as we explore the powerful world of real estate investing and show you how you too can create truly passive income that can help you achieve your financial goals.

Clint Harris:

Welcome to the Truly Passive Income Podcast. I'm Clint.

Neil Henderson:

And I'm Neil. Today we're gonna talk about the four wealth generators of real estate investing. and those are leverage, appreciation, tax benefits, and cashflow. and we're gonna go into a little bit more detail about each one, but let's start with leverage. And you want me to jump in? You want me to start?

Clint Harris:

Yeah, go ahead. Take this up.

Neil Henderson:

Okay. Alright. So. first one is leverage, and that refers to using, basically using debt to acquire a property. It allows an investor to control a much larger asset than they could o otherwise control with a relatively small amount of their own money. and because an investor is using only a small amount of their money, it juices their returns quite a bit. And, to keep things simple, we're gonna use nice round numbers. if someone is buying a hundred thousand dollars, house, a hundred thousand dollars property, and the bank requires them to put down, let's say $20,000, they're putting down 20% of the overall value of the property. So, if the property increases in value by 10% from a hundred thousand dollars to $110,000, the investor's equity in the property would increase by 10%, but their resulting return would increase by 50%. you went from having $20,000 in equity to now having $30,000 in equity. However, without leverage, let's say you use your entire a hundred thousand dollars to buy a property, and it increases by 10%, then your return is only 10%. so that's, the real power of leverage. The other thing is that if you use long term fixed rate debt, you're locking in a mortgage payment for a long term, let's say 25 to 30 years That mortgage payment doesn't change over time unless you've gotten an adjustable rate mortgage, which we discourage people from doing. and as, inflation takes hold and, your, the value of that property increases in that the cash flow that it is producing. All that stuff increases. Your expenses don't increase at a higher rate. Go ahead.

Clint Harris:

That's exactly right. So another way to look at it is leverage increases the velocity of your money in your portfolio and your cash flow over time. So specifically if in your example, if you have a hundred thousand dollars and you go buy a house for a hundred thousand dollars and you pay cash for it, and over time it goes up. 10, 20%, you're gonna make that extra 10, $20,000. But if you look at the opportunity cost of what you could do with that money in other places, what's the long-term benefit or loss that you would have over a 15, 20, 30 year period by leaving that money in there? Whereas if you took a different approach and you used the traditional approach of leverage by going to a bank and getting a loan, you could go. Five properties just like that and put 20,000 down on each one of them. So you got a $20,000 down payment on five different properties that you purchase each of 'em for a hundred thousand dollars and they're all cash flowing or at least breaking even. You have tenants in place that are paying the rent over time, that equity is being paid down and you are technically creating. Value right there for yourself. But on top of that, over time, the properties typically appreciate and as they do, you've used the leverage of that amount of cash that you had to maximize and buy up to five properties and increase the value over time. The other way that you can do this, Is that as you have properties that are being paid down, you can use that as leverage as well. So you can use the equity that you have in your properties to leverage. Because the reality is most of us have financial goals outside of just our nine to five. We're trying to create value for ourselves because we have some kind of long-term goal or financial, situation that we're trying to accomplish. And you can't do that with one property. Leverage is all about. The ability for you to take a certain amount of money and maximize it as best you can to increase, increase the portfolio, increase the cash flow, and over time, that's gonna create obviously more equity that you can use that to leverage as well.

Neil Henderson:

It's also important to remember that leverage cuts both ways. and I'm a shining example of that. And then by shining, I mean a really terrible example. back in 2005, I bought a, a condo by my first house for $205,000 for 10% down. Back in the wild and wooly days when, you could fog a mirror and get a loan. Now that property had doubled in value in a year. so learn my first lesson. Probably don't buy a property that's doubled in value in one year. chances are that's a good ch a good sign that the. The market is overheated. So now, and that was great. It was great when, when it rose from $205,000 to $275,000, my, my ROI, which I wasn't really looking at. but it was insane if you did the math on that. Now, when it turned around and it started going down, I was then stuck. I was stuck with P m I, cuz I, I paid less than 20% down, which we can go into. and, I didn't have a lot of equity in the home and other people in the market also didn't have equity because the banks had been handing out loans to everybody. and so that accelerated the market losses as people started going, I've only got. 10% equity in this property. I'm just gonna I'm just gonna let it go. And they started fire selling their properties. as my, as that asset dropped all the way down to $60,000. And that was literally what it was worth. I had nowhere to go with it. I couldn't do anything with it. I was, I was into it and I couldn't get out of it. I couldn't refinance. I had no equity to leverage my way out of the bad decision.

Clint Harris:

Yeah, that was, quite a tumultuous time and there was a lot of people stuck in the same situation. I think the lesson with leverage, and there's certainly a lot of lessons to be taken from that, but specifically, and you alluded to it a little bit earlier, is that if you're gonna use leverage, which most people should in order to scale, to hit the level, to achieve the financial goals that you have, whether that be cash flow or lump sum or appreciation or whatever it may be, with. Becomes a responsibility of obviously looking at the market and how rapid the appreciation is. you can never time the market, but you should be looking at an asset that is going to cash flow. Meaning if you rent it out or whether you Airbnb it or whatever you may do with the asset, that it has potential to cash flow. And the reason it can cash flow is because it's secured with safe, relatively low interest rate debt over a long period of time. Meaning your monthly payment is fixed, it's not going up or down or change every couple years. So if you have safe, secure, low interest rate debt with cash reserves on the side, and it's a cash flowing property and you have money set aside and you factor in things, On occupancy in between guests or when people move out or if you have an eviction, as well as things like capital expenditures, like AC units and windows and things like that. If you factor all that in safe, secure, low interest rate debt in a property that cash flows, that has multiple exit strategies, and you have cash reserves set on the side, that's the safest way to do that and the best way to use leverage over time. The value of the property, it may go up and it may go down in the short run, but over time, typically in the United States, Properties appreciate if you buy 'em in the right area. And I'm a good example of that and I've done it the wrong way. And that's gonna lead us to the second of the four Welch generators in real estate. And that's the concept of appreciation. And so one of the things that I did wrong with my first investments was, I bought my first house hack was a duplex, and after that I started buying single family homes. I was specifically looking at cash flow, which is not a bad thing. In fact, we'll get to it, but just looking at cash flow, I was, 24, 25 years old, and I'm looking at this, okay, I can buy these properties in the post 2008 crash. And I can pay, 30, $35,000 all in to have a small brick house with a decent roof Fixed

Neil Henderson:

without leverage. Correct.

Clint Harris:

Without any leverage. I didn't even understand the concept at the time. I'm just paying cash because then I don't have any debt on it. And they're cash flowing. I'm making a round after property management and things like that. I'm making around $6,000 a year and I'm strictly looking at the cash flow, which on paper is great. The problem was, These weren't the best tenants, it wasn't the best areas of town. And over time as a tenant would move out, inevitably there's 3, 4, 5, $6,000 worth of repairs that need to be made to the property every time, especially if you're going through an eviction, the doors are kicked in and things like that. This was not section eight, but it wasn't much better, and they just didn't take care of the property, and so I was strictly focused on cash. And the lesson that I learned is when I got sick of all the headaches and it was time to move on, the good thing is that I had my money locked into those properties, and so I couldn't go spend it on anything else stupid, because I didn't know what I was doing. So luckily it was a very illiquid asset, meaning I couldn't get to the money unless I sold them. Eventually when I unloaded those properties, because I realized the cash flow was not all that was cracked up to be, that's when I started to understand the concept of appreciation or lack thereof specifically. I'm buying these properties for 30, $35,000 and then four, five years later I'm selling 'em for 30, $35,000, sometimes 40, maybe 45, And typically it was more in the, 40, 45 range, but you still gotta pay a realtor and also. A realtor really doesn't wanna work very hard for commission on a $40,000 property,

Neil Henderson:

neither does his property manager.

Clint Harris:

Yeah that's a whole nother conversation for a whole nother day. I used to be very, like I said, I was quick to hire and slow to fire, and I had to learn to change that. Yeah. The one property that I had, That really stuck with me in terms of the concept of appreciation is a property that I bought in the Avenues in Casey, South Carolina. It's right across the river from Columbia and an Amazon distribution center went in down the road. that property, I was all in on that property for $28,000. When I bought it, I didn't put a seven into it, so I was into it for 35 total. By the time the tenant moved in, I had a tenant in there for several years, and when I sold it, I listed it for one 15 and I had multiple offers and I sold it for 1 23. That concept was a light bulb moment for me, even when the first time I looked to see what it was worth, what the a r V was, the after repair value. I was like, wow, this is over a hundred thousand dollars. So it's a conversation for another day, but I sold that property. I did a 1031 exchange into a rental property that I could refinance and pull the money back out to avoid the taxes in a legal, ethical way. But ultimately, what happened? I understood the concept of appreciation. When my wife and I moved to Wilmington and we started investing in small multifamily homes, we were looking at ways to try to maximize the appreciation, and there's a couple different ways to do that. So appreciation in general that refers to the increase in value of a property over time says the value of the property increases, the investor's equity increases as well. Putting value basically straight in your pocket. Now you don't realize that value until you either sell or you refinance the property, but you can also borrow against that equity to increase your portfolio and continue to scale. So that's natural appreciation and things like an Amazon distribution center going in down the road, that's natural market conditions that I could not do anything. There was nothing that I could do to really increase the value of that property besides the first $7,000 worth of renovations that I did. There are, however, a lot of opportunities where you can force the appreciation. That can come in a lot of different ways. Traditionally, an example that comes to mind very easily is house flippers. You buy a house that's in a really bad shape, you force the appreciation by going in, spending some money and swinging some hammers, and you make it nice. You put in L V P floors and countertops and everything else, and you fix it up and all of a sudden you may be spent 20, $30,000, but it increases the value of the property by 50 to $60,000. Right? So that's forced appreciation. But there's a lot of different ways that you can do that. Traditionally, we always. Swinging the hammer or right in the check, right? A contractor. That's the way that they're gonna force the appreciation, but there's more to it than that. One of the things that my wife and I utilized with ours is we would go buy a quadplex, a nasty beat up old Quadplex in a great location right by the beach, but had bad tenants that it had, $900 rent for 12 years. This has been completely just outta sight, outta mind. People are chain smoking in the whole place. It's nasty. So we go in and buy a property like that and do all the total renovation and there was a lot to it. And kills the wall, get the smoke, smell out new floors. We were, raking needles out of the back alleyways. It was rough area,

Neil Henderson:

fun stuff.

Clint Harris:

Yeah. But what we did is that's forced depreciation. By increasing the value of the property by making it nice. So we may spend 80 to a hundred thousand dollars and it may increase the value of the property by 150 to $200,000, but we didn't stop there. What we did then is instead of putting long-term tenants back in there, we converted it. We converted it to an Airbnb property, so now you've got four Airbnb properties and it's a gross rent multiplier of about three to 3.5 x over what you're making with each of those properties as long-term rental unit, cuz it's right at the beach access. It's just a good location for short-term rentals so we can increase the value of the. By fixing it up, and we did. But on top of that, if you three x the cash flow on the property by converting it to a separate asset class, that drastically increases the value of the property as well, because then the valuation is not necessarily just on the bricks and the sticks, it's on the business. And the rent coming in from the property. So when a bank looks at that, they see, okay, we see the brow value of the brick and mortar, but also this is generating, $180,000 a year in gross rents with a net of after all debt service and everything else is paid of around 85 grand. After property management taxes and everything else. So that's an example of forced appreciation that doesn't come from swinging a hammer. It's an asset class conversion. And another example is if you take an old Kmart building and you, it's been sitting empty for eight to 10 years and you've got the inside and you cut a hole in it so you can drive inside of it, and you put 600 self-storage containers inside of it. So it's climate controlled, self-storage, that completely changes the valuation. So the valuation of that property may have been worth, what's a warehouse worth? 12 bucks a square foot or whatever it may be. All of a sudden you convert it to something that may be 20, $25 a square foot, depending on the market. Completely changes the valuation. So natural appreciation is over time. There's really nothing we can do about that except for looking at the path of progress and trying to buy in an area that we know is gonna increase in value over time. Like the island where you and I live, I think we both agree that over time, land on an island next to the beach is a limited commodity, and there's. Likely to be natural appreciation here. On top of that, we look for ways to do forced appreciation, and on our rental property, it may be converting it to an Airbnb. If it's already an Airbnb, it may be from. Go into pet friendly or putting an electric vehicle, charging station, anything that changes your bottom line of increasing your net operating income increases the value of the property because it's not just the property, it's the business that, that the property contains. And on top of that, like you said, a sell, storage or expansion. One of the things that we do is, we buy self storage facilities and we look for opportunities to pick up two or three acres next door and add boat and RV storage, or covered boat storage, or build a whole facility, sometimes going up and adding a mezzanine to existing facilities and things like that. So all of those refer to the increase in the value of the property. That is actively pursued by the property owner or investors through improvements in other strategies, marketing strategies and things like that. So those are all ways that we can force that appreciation and the appreciation in that property then goes back to the concept of leverage. A lot of times we can take the equity that we've created. Created through that natural or forced appreciation and then leverage that to go on and continue to scale. Yeah. And that's gonna bring us to, to the next concept on our list.

Neil Henderson:

before we move on, I want to, also encourage you to talk about the fact that smart reals face investors, and you alluded to this, maximize both natural and forced appreciation. and really the only way that, as you mentioned, that you can. Maximize the natural appreciation is to buy, right? Buy in the right area, buy in the path of progress. buy in areas where, the land is limited. Commodity buy in, areas where the jobs are being created, where employers are coming in. and then on top of that, if you can also, then force the appreciation like you've done with your Airbnb properties like we've done in areas where we're doing Kmart conversions that are, where they're building. They're building 540 million casinos. that is what we mean. That's a market force there. That is a, and not to say that we're brilliant, mean we, that's a tough one to predict. but you can do your best by looking for areas where there seems to be, that natural appreciation that's happening.

Clint Harris:

And some of them are not hard to predict. there's a 550 million casino going in Danville, Virginia that has broken ground recently, That one was coming a mile away. And the only issue we had there is then it's really hard to get a permit to build because there's 10,000 people putting in for permits because it's an area that's going to appreciate, yeah. So dramatically. But on top of that, this is all a game, right? In a lot of ways the government incentivizes development in different areas, and so qualified opportunity. Is another example of that's the path of progress and part of the, it's the natural appreciation of a lot of money pouring into an area and making it nice. But it also is the tax benefits that come from being in a qualified opportunity zone on a local level city council zoning. Pay attention to new roadways and things like that. Going in are always that you can't control it, but you can try to keep an eye on where the path of progression is buying in that area. Trying to buy under market before a lot of people realize the change that's coming and then forcing the appreciation.

Neil Henderson:

Gotcha. Alright, as you mentioned, the next wealth generator in real estate are the tax benefits. I don't think it's any secret that the government likes to encourage real estate investing, by providing a lot of tax benefits. we had a, a real estate investor president a few years ago love him or hate him. he, he maximizes, real estate and the tax benefits for his benefit. Almost every representative on every side of the aisle left, right and center, use utilizes real estate to build wealth. and I always. I always challenge people when they say, they're gonna get rid of that tax benefit at any time. okay, so they're gonna do something that's going to hurt them. chances are no. So what are those different tax benefits that are available to, A real estate investor. The first one, the obvious one, is just deductions. and that's, the IRS allows you to deduct the expenses associated with running the property, from your income. So the repairs, the me the cost of management, you name it. Anything that's an expense that lowers your income, is going to be, can be used as a deduction in the year that you took it. the other avenue is what's called a 1031 exchange. now if you're not familiar with this, a lot of people aren't. This allows investors to defer paying the capital gains that you would pay on an investment property on the sale of that property by using the proceeds from the sale of that to basically, Purchase a new similar property.

Clint Harris:

That's right. yeah, I actually mentioned an example of that in the previous concept, and I'll expound on that a little bit. the property that I bought in the Avenues in KC, South Carolina, I was all in on that property for 35 grand. And when I sold it for 1 23 obviously that was gonna, that was gonna show quite a capital gain there. So the way that I mitigated that is I used a 1031 exchange to take the money from the sale of that property. And it was a rental property. It can't go into my primary. It has to go into some other type of rental property that is of equal or greater value. It's a way that the government is incentivizing people to take their money and reinvest it and continue to improve. And really what you're doing is you're taking the taxes that you would pay from that capital gain and you're just kicking it down the road, you're, it's deferred to a later date. So I did a 1031 exchange where I sold that. And then within the way a 1031 exchange works is that I have 45 days to identify up to three properties that I'm interested in and a total of 180 days to close on one of those properties. So you use a 1031 exchange specialist that's an intermediary when you sell one property. They take the cash, they put it into a, basically a holding account, and then when I identify and purchase another property, they show up at the close with that money. And I purchased that property that allowed me to not pay all those taxes that I would've had to pay on the sale of that first property and roll it into another property. Now, one of the ways that you can leverage that is by doing, basically that property was essentially a flip. Even though I did it over time and then I took that flip money, I did a 1031 exchange into another long-term rental property that I bought at a discount because it was in very rough shape. I did $17,000 worth of improvements to that, and then it drastically increased the value. I was able to refinance and pull $108,000 back out, but because that came by way of a refinance. It was a non-taxable event that doesn't count as a capital gain, and I'm not trying to get too into the weeds on this, but it essentially, the 1031 exchange allowed me to sell the first property. Instead of realizing that capital gain and paying the taxes on that, using a 1031 exchange into another property, I used forced appreciation to increase the value of that property, and then I refinanced and I leveraged the property. To pull the cash back out at an 80% loan to value rate, which put $108,000 back in my pocket

Neil Henderson:

tax free.

Clint Harris:

Be completely tax free. Yeah. Yeah. And then on top of that's the 1031 exchange. And then,

Neil Henderson:

hey, before we move on I wanna talk about, so in a perfect world, someone could 1031 exchange. From a small property to a medium sized property, to a large property, to a larger property, to a massive property. They could continue to do this their entire life, never paying capital gains. And then at some point we're all gonna die. I hate to break this to you. when you die, that property, the way the government looks at that, there's a step up in basis to your heirs and the capital gains are. So someone could potentially ta turn $10,000 into 10 million via a 1031 exchange. And at the end of it, if they die before they sell the property, that step up and basis wipes out all those capital gains.

Clint Harris:

That's right.

Neil Henderson:

Now that is really challenging to do. but in a perfect world, that's what someone.

Clint Harris:

The idea is you keep leveraging up until you get into, eventually you, you start getting outta single family properties or even multi-family. You get into portfolios. You may buy a portfolio of apartment complexes or something like that. You put it into a trust. You let it just continue to roll on. Then eventually, the tax liability would go away.

Neil Henderson:

And we're not gonna get down into the weeds on 1031 here. it's a fairly complex process and that's why you need an intermediary. and it's not, you can't do it with just any property, with just any asset class. It has to be, it has to be a like kind. It has to be, what did you call it? Has to be,

Clint Harris:

property that's the same or greater in value. It also has to be a rental property or commercial property.

Neil Henderson:

Got it. Okay. the next tax benefit is depreciation, and that's the process of gradually reducing the value of the property over time for tax purposes. the IRS realizes that, a structure over time starts to deteriorate and allow you basically to depreciate that at a certain rate over. I think with

Clint Harris:

27 and a half years for primary residence or just a single family home is 31 and a half years for commercial properties.

Neil Henderson:

Got it.

Clint Harris:

I believe I have to double check, but I'm pretty sure that's right.

Neil Henderson:

but, and by doing so, investors can claim that tax deduction on that property every year. and that, again, that reduces your tax burden and that includes, Any kind of investment property, whether you're investing directly in a single family home, multifamily Airbnb, or if you're investing indirectly with a syndication.

Clint Harris:

Yeah. So that's a great benefit that over time you just get to take a little bit of the value and write it off every year, and everybody's accountant should be doing that. However, There's a little bit of a loophole that we're dealing with these days where you can take that depreciation a little bit faster. specifically it's an idea that works really well with Airbnb properties, and it's something that I've done on several of nine and have more to do. But basically what it do does is it breaks down the various components of the property, such as the land, the building, and then all the personal property inside of it, the fixtures, even bedding and things like that. It allocates d. Value to each of those components and then allows you to depreciate it more quickly. Instead of doing it over a 27 and a half year period, or 31 and a half for commercial, you can take it a lot faster for people specifically that have. High income jobs and you have a lot of W2 income that you're paying taxes on. If you can take a rental property and take 50, 60, $70,000 of depreciation upfront, it writes off that amount of your income. It has tremendous tax benefits. Now, we've got in 2022, you could take up to a hundred percent of the depreciation off of a property in a single year. 2023 is the last year that we can. After that and 2024 drops to 80% and then continues to drop back down, it's going away. It was an incentive program that's been in place, but the way that you utilize that is through something called a cost segregation study. It used to be something that was really only for the ultra wealthy. it's become something that's very palatable. I think it at some point we're gonna have a cost segregation specialist on to talk about that a little bit more in depth. But you can usually get a cost segregation study done. I think mine recently was under $3,000, and ended up saving us around $60,000 in accelerated depreciation. And so that's something that is a vehicle that can be used now and next year, or I guess it's almost next year right now, probably will be by the time this comes out. So that's another tax benefit. in terms of just the straight line depreciation, you can utilize a cost segregation study to have accelerated depreciation.

Neil Henderson:

So let me just touch on that again. We're not gonna get really into the weeds here on taxes, cuz neither one of. We're both terrible CPAs. and I think we'll have an expert back on here at another time, but one of my understanding of what the way it works is you can actually put that depreciation, that accelerated depreciation into a bucket, and then use it at any time in the future. You don't have to use it all in that year. I mean, so if you have some ability to take $120,000 in accelerated depreciation, but you only need. $20,000 this year, you can just take $20,000 and you still have a hundred thousand dollars in sitting in that depreciation bucket.

Clint Harris:

That's exactly right. It carries forward and so that's why it's such a good idea to anyone that can do it in 2023 for any property you should, especially if you have a short-term rental Airbnb style property. I've got another quadplex that we're doing this coming. Just because I probably won't need the depreciation, but it carries forward and it carries forward at a hundred percent. So if you can take it, take it, and it carries forward.

Neil Henderson:

Gotcha. Okay. So the last. Wealth generator of real estate that we're gonna talk about is cash flow. And we mentioned that so many people put this as number one. Like when they, when people think about investing in commercial or investing in real estate, they're most often thinking about the cash flow that it produces. But we actually put it here last because I think in some respects it's the least important. So what the cash flow refers to is the income generated by the property through the rent or other means minus any expenses with owning and maintaining the property. in addition to, debt service, things like that. If a property it is has positive cash flow, which I highly recommend that any property that you do, has positive cash flow, it means the property is generating more income than it costs to own, which can produce a steady stream of income for the investor. And it also provides a margin of safety, provides a margin of safety for you. And it also essentially means that the tenants are the ones paying down.

Clint Harris:

That's exactly right. I think most of the time what people find is that if you're, it's difficult to get rich off of single family homes. There are people that do that, do it at scale and buy them at the right price and understand the concept of leverage and forced appreciation and things like that. But ultimately what happens is Everyone looks at the cash flow on the property as king. The reality is, if the cash flow coming in is usually in a one-to-one ratio to the fixed overhead expenses that you have on the property, it tends to cannibalize each other. What I mean by that is if you have a thousand dollars in rent coming in on a property, but that property also has, a mortgage. Taxes. Sometimes the HOA or utilities and things, insurance like that. Exactly. You're different fixed expenditures as well as capital expenditures and things like that. It's difficult to create very much margin and the margin you do create can be wiped out very quickly. Like in my example when tenants were moving out and I had to go back in and fix things, usually people that start investing. In properties where the cash flow isn't a one-to-one relationship to the fixed overhead, get disenchanted fairly quickly and until they run into multi-family. Multi-family is really a multiplier there because, and the example of a quadplex, you got four units rented out. You may have $4,000 a month coming in, but you still just have one mortgage, one set of taxes, one set of insurance, and things like that. If you can then change that to, for instance, like an Airbnb property, then it might be the equivalent. Three to $4,000 per unit coming in every month, and it really maximizes the cash flow. So everyone looks at cash flow and specifically looking at, okay, well how do we maximize the cash flow? Can we do that through forced depreciation and put some money into the property, increase the rents to 1500 and things like that. That's really, it's obviously important, but I think that the reason. That we have this at the bottom of the list is because this is actually not where most millionaires are made. The cash flow is important. In fact, it, you absolutely have to have it for a property to operate and understand your portfolio in the long time, in the long term or else it's gonna erode your portfolio. But the cash flow in general, it's nice to put that money into your pocket that you can rein. But that's not where most of the value comes from over time. Yeah, the cash flow is extremely important. The tax benefits are extremely important and things like that, but ultimately, the appreciation is what has the opportunity to create the fastest increase in value and the biggest swing and change to the velocity of your life in terms of financial implications. You have to have the cash flow, but if you get the cash flow in an area that's appreciating and you tie all those things together, That's where the real value comes from.

Neil Henderson:

So, again, sort of what you talked about was, it's very difficult to get a single family, a single unit property. And I'm gonna, we're talking about units here, to cash flow because like you said, it gets the cash flow gets cannibalized by all the things you mentioned before. The expenses, the CapEx, vacancy. whereas where you start, when you start getting into multi-unit properties, from small multi-family to large, multi-family, to self-storage with multi-units, you're not, it's a lot harder for that one unit to cannibalize the cash flow and it starts to expand on it. Did you want to add anything on that?

Clint Harris:

Yeah, I do. And I think, I don't wanna get lost on the fact that a lot of what we're talking about doesn't really tie into the title of our PA podcast, which is truly passive income. But these concepts, this is the ground floor, this is the foundation and these concepts, a lot of what I learned the hard way and some of what you learned the hard way by getting most of it wrong, and a few things right here and there, the underlying concept and the idea of cash flow, appreciation, understanding the tax implications and things like that leads. Where we are now, which is the understanding the value of multi units, right? Where you have multiple sets of income coming in by cash flow against a single set of fixed to overhead. That same concept applies whether it's a Quadplex or a duplex or 120 unit apartment building, or a 600 unit self storage facility, and the idea of forced appreciation and asset conversion taking something. One time I took, I took a triplex. And it needed some help, needed some work. So we purchased a triplex and we used forced appreciation to swing hammers and go in and fix it up and make it nice. And then we converted it to an Airbnb property, which really jacked up the rents. And then we realized that a two bedroom, two bath was doing around $50,000 a year in short-term rentals, but a one bedroom, one bath was doing around. So we took one of those two bedroom, two bath units and we split it in half and we put, a kitchenette in and we created a quadplex out of the triplex. Now, it's not always easy to do that, and you have to deal with zoning and permits and things like that, but that drastically, it increased the cash flow on the property by another $30,000. So you could look at that and be like, will that really increase the cash flow? It's a lot more money in my pocket, but what it really did was increase the forced appreciation on the property by maximizing that cash flow and over time. That increases the value of the property by up to a couple hundred thousand dollars, which I can then leverage and refinance. The underlying concept of what we're talking about here and what we've done with these properties has not been passive, but the same concepts apply when you take it to a bigger level and you get to the apartment complex, the self storage facility. RV parks, whatever it may be, the underlying concepts are the same. So these are the nuts and bolts. The only thing that changes is the numbers. You add a few more zeros on it, but the rest of it is the same.

Neil Henderson:

So the last thing I wanna say about cash flow is how it ties into the three immutable laws of real estate investing. and you alerted alluded. Earlier you sort of started to touch on it, which is one, invest for cash flow. Two, invest with long-term low leverage debt. Don't over-leverage yourself, and don't invest with an adjustable rate mortgage. and three. Is have sufficient cash reserves. if you do those three things, most of the people who did those three things survived the 2008 crash. The people who got wiped out in 2008 either bought properties that weren't cash flowing, they bought them with, they over leveraged. They, like I did, with an adjustable rate mortgage, and they didn't have sufficient cash reserves. I think what cash flow, what I often describe cash flow. The primary purpose, the first purpose of cash flow is to allow you to leave the lights on. It allows you to keep the business running while those other three wealth generators do their work.

Clint Harris:

So one thing I would add to that, and those are obviously the three laws that have stood the test of time. One thing that I think was really important, especially during Covid, was understanding that there is a fourth principle that if possible, and you can add it in and it creates an added buffer, is multiple exit strategies. So if you have a property, for instance, you know if you're buying a warehouse and the deal works as a warehouse, but then you're converting it to a self storage facility, it can be multiple things if you need it to. If I'm buy. A property that's got bad long-term tenants in there and fixing it up. and then I'm converting it to an Airbnb and then all of a sudden Covid in March of 2020 happens and short-term rentals in our market are shut down. If I need to, I can convert it back and put long-term tenants in place. Now I had the cash reserves. We didn't have to do that. A lot of people did and ended up in big trouble, and then all of a sudden the supply was greater than the demand and it got ugly. But the last thing I would add is if you can find something that has either the opportunity to change unit density, add additional units, or have multiple exit strategies, that's another added benefit that will really help stand the test of time along with those other three.

Neil Henderson:

Well, and again, what you just talked about is that having those reserves allowed you to survive while you shifted your strategy with the market. people who, when Covid hit. And everyone got shut down for three months. if someone didn't have reserves, then they didn't, there's a good chance they didn't survive that they would, they got to the point where they probably were forced to sell. You never wanna be forced to sell your real estate asset. it's much better to be in a position where you can wait for when the market is advantageous. And I, that's all I wanted to add to that.

Clint Harris:

Yep, you're exactly right. I think that about covers cash flow. so that just kinda leads us to the wrap up. So the four wealth generators, when they work together especially, that's really where real generational wealth and opportunity is created. So, when they work together to create wealth for real estate investors, you're talking about leverage. Which allows investors to control more assets for less money and increase the portfolio, and increase the financial velocity, of your future. You have appreciation, both forced and natural appreciation. It increases the value of the assets over time sometimes. Very quickly. And then, you're talking about the concept of positive cash flow that provides a steady stream of income that you can continue to leverage and purchase more properties. And then at the same time, you should be capturing those tax benefits and that really helps increase the investors overall return. and a lot of times that can come in a way that carries forward over time. Thank you so much for listening to this episode of the Truly Passive Income Podcast. If you like this show, if you think it'll be useful for someone else, the greatest compliment you could give us would be to share the episode with a friend and leave us an honest review wherever you listen to podcasts. If you have any questions, don't hesitate to let us know on Twitter. @TrulyPassive And remember, with truly passive income comes Freedom of Time, place, and the freedom to pursue your higher purpose. That's cool. Okay. Ready? Yep. Welcome to the Truly Passive Income Podcast. I'm Clint. And I'm Neil. Good talk. Good talk. Yeah. Thanks for joining us today. Uh,