Strategy

On one hand, you want to invest in real estate to build a solid portfolio and achieve financial independence. On the other, you are currently located in a market where real estate is too expensive to make the numbers work.

What do you do? The obvious and easy solution is to consider investing opportunities in out-of-state markets where prices and rents are much more balanced. But the ease quickly ends when you have to get tactical and select a good market to invest in.

This is the point where I see real estate investors make the BIG Mistake: They rely on “Best Real Estate Markets to invest in 2020” articles to select their target market. I can certainly understand the allure. The research criteria for selecting these markets seems rigorous. They are looking at population and job growth plus real estate price and rents growth. What’s more, they offer a “silver bullet” that reduces the overwhelming task of picking from a multitude of options into a few neat bullet points.

“Why is that the wrong methodology to select a real estate market”, you ask?

One major reason: All the data they’re using to select the target market is backward-facing which means that it only tells you what has already happened. It is telling you that it was great to invest in that market 5 years ago. Investing in a real estate market because of its performance in the past is like deciding to invest in Apple stock because it is up huge over the last 5 years. The blind spot investors are falling prey to is the untrue assumption that the upcoming future will be just like the recent past. And as they tell you in those stock market investment commercials: Past performance is not a guarantee of future results.

By the time a real estate market makes it on one of those lists, you are likely too late to the party. Best case scenario, you are catching the very end of the wave. Worst case scenario, you are buying at the top.

A Better Way to Select a Real Estate Market to Invest

It is always easier to point out the fault in something than to offer an alternative that actually works better. But that’s what I’d like to offer you now. Let’s dive in.

Instead of using those articles as the end of your search for a great market to invest in, use them as your starting point. If X metroplex has experienced population and job growth in the recent past, what are some of the towns in the edges, in the fringes that may have not experienced the same growth… yet.

To continue with the Apple stock analogy from before, you focus your search on the technology sector and try to figure out the next company that might grow in the future. In Wayne Gretzky’s famous words: You skate to where the puck is going, not where it is.

It’s important to understand that metroplexes are like magnets. As they grow, their “pull” on surrounding areas grows as well. So if you can figure out the path of growth, you can acquire properties ahead of it. Then, maybe 5 years later, you might see that area on the list of best markets to invest in 2025.

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What method have you used to determine the right market to invest in? Drop us a comment below – we’d love to hear from you.

I want to share with you a tale of two investors. Picture two childhood friends who went to and graduated from the same college with a degree in the same field. They possess the same natural talents and intelligence. Further still, they earn the same income and live the same lifestyle which results in the same savings rate and same amount of investment capital.

Fast forward a decade or two. One of these investors goes on to build an impressive real estate portfolio with multiple streams of income at different stages of her life. Meanwhile, the other does some sporadic investing and ends up with a couple rental properties that while they provide a good return on investment don’t change his life in a meaningful way.

Key Question: What made the difference?

If all the ingredients are the same, what was the cause of such vastly different results in the end? Why did one investor manage to succeed at a much higher level while the other fell short?

While the above is a hypothetical scenario meant to isolate the critical difference maker in success for long term real estate investors, I can tell you that in my experience I’ve seen similar scenarios often. Based on that experience, I can tell you that the critical factor that separates successful investors from those that fall short is the presence of a thoughtful strategy and the execution of a plan of action that flows from that strategy.

Why successful investors need a strategy to succeed?

You see, the process of building an impressive portfolio is too complex for it to just happen by accident. No one has ever woken up after a decade of dabbling in investing and said: “Look Honey, it turns out we built a word class portfolio and didn’t even realize it…”

It takes a certain amount of critical mass for your portfolio to generate the kind of income that change substantially change your life. It takes a lot of discipline to stay on track for 10, 15 or 20 years. It takes a lot of focus to zero in on your action plan and not get your head turned by the trendy investment strategy of the month. It takes clear milestones along the way to show you where you’re supposed to be on every stage of the journey.

Without a thoughtful strategy and an accompanying plan of action to execute, it’s impossible to reach that critical mass, acquire the discipline and the focus and establish those clear milestones that are critical to success. In the wise words of Warren Buffett: An idiot with a plan can beat a genius without one.

Bonus: The Blueprint Annual Review Process

As part of our Blueprint plan, we do an annual review with our client, I’m working on one such review for a client meeting so I thought I’d share that process with you in hopes that you find it helpful. During this annual review, we go over 3 key questions:

• How did last year go? Here we look at the targets we set last year. Did we accomplish all we set out to achieve. If yes, we celebrate the win. If no, we need to find our what happened and learn the lesson for the future.
• What do we know today that we didn’t know when we prepared the plan? In other words we look for new information that we can use to course correct, if necessary.
• What do we need to accomplish this coming year?

https://youtu.be/nouSkGNRL5Y

When I posted a video on how to decide if you should pay off debt or invest earlier this week, a friend (and past client) commented with the following question:

What’s the best way to maximize the returns on investment for your stock market and 401(K) investments?

The answer may surprise you.

First let’s consider the following facts:

Over a 10 year investment timeframe 85% of mutual funds underperform the market. Extend the timeframe to 15 years and 92% of mutual funds underperform the market. In a nutshell, the overwhelming majority of funds underperform the market over the long run and charge you higher fees for that privilege.

But before you say: “You’re saying there’s still a chance …” you have the understand that the 8% that do outperform are not always the same funds. Meaning, a fund could outperform this year but underperform the next.

At this point I want to share one of my favorite quotes ever from Warren Buffett’s long time partner, Charlie Munger:

It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.

That idea is as profound as it is clever. Most “wounds” in the financial realm are self-inflicted. How else can you explain the fact that while the market averages 10% returns over a period of time, investors average 4%.

So what should you do instead? Focus on what you can control: Costs and not doing anything stupid!

The impact of costs on performance is incredible.

Let’s look at a scenario to illustrate it: If you invest $100k earning 6% interest for 25 years with no costs it will turn into $430k . Same scenario but with 2% annual costs and it only turns to $260k.

2% costs = 40% less principal

Let that sink it for a second. That 2% cost may not seem like much but it can devastate your portfolio’s performance. Or put a different way, your fund’s superior strategy would have to outperform the market by 40% just to offset the effects of its fees on your portfolio.

Simple Stupid-Free 3 step strategy to maximize returns in your stock market investments:

1. Invest in index funds and ETFs that mirror the market at the lowest possible costs.
2. Automate your investments
3. Leave them alone

401(K) accounts are a little trickier due to “pay to play” dynamics. That is, the fund has to pay in order to be part of the lineup of funds offered within the 401(K) plan of a corporation. Those fees paid are then passed on to the customer (you) through higher fees charged by the mutual fund.

However, many 401(k) plans have been adding low cost index funds and ETF because employees have been asking for them. So my advice on your 401(K) is to look at your current holdings as well as the other lower cost options within the lineup. Even if your 401(k) isn’t offering the lowest cost funds, you can still dramatically reduce costs and get an allocation that more closely mirrors the market.

“Cash flow vision” is a common blind spot among real estate investors who “worship at the altar of the cashflow” (as my good friend Jeff Brown would say).

It’s a tendency to ONLY pay attention at the cash flow produced by the property on an annual basis. For instance, an investor will run the Year 1 numbers on a rental property to calculate the cashflow for the year. Rent minus expenses minus mortgage payment equals cashflow. Then they divide the cashflow into the amount invested in the deal and calculate the cash on cash return. This return is then compared to an arbitrary return benchmark and a decision made.

Cash flow is nice, don’t get me wrong. But cash flow is not where the MAGIC happens in real estate.

The MAGIC is in the long game: Where you invest $37,000 into a rental property and net 3.3x that amount 10 years later.

The cashflow is the dividend you get every year and it makes you some money. But the growth over time is what makes you a fortune.

How do you decide between paying off debt vs investing in it real estate or the market?

A client asked me this exact question last week and I want to share with you the thought process I used to arrive at a good decision. The client has received an end of the year bonus at his job plus they had some additional money in savings. The sum was large enough where both investing and debt payoff were viable options.

The way this question is typically answered is by comparing the cost of the debt (interest rate) to the expected rate of return on the investment. If the rate is rerun on the investment is higher than the interest rate on the debt then you should invest. And vice versa. But is that really true?

Let’s say you have credit card debt at 16% interest. When you make the choice to pay off the credit card debt, your “rate of return” on that move is 16% (same as the interest rate) for as long as the debt would have been outstanding if you hadn’t paid it off.

Even more importantly, that rate of return on paying off debt is GUARANTEED. The moment you paid the debt off, you earned that return. On the other hand, the expected return on the investment is an estimate. An educated estimate if the analysis was done properly but an estimate nevertheless. So, it’s not correct to compare the returns in each move apples to apples. Instead, the expected rate of return on the investment should be adjusted down to account for the possibility that it won’t materialize.

Another benefit of paying off debt (in full) is that it frees up room in your income statement for you to save the payment you used to make toward investment capital in the future.

Not only that but it also frees up borrowing bandwidth for your future investments. Did you know that when you pay off a debt that has a $500 monthly payment, it adds roughly $80,000 to your borrowing capacity whenever you make your next investment purchase?

So, what was my advice to the client:

• Defer investing for a year
• Use your bonus to pay off some credit card debt and the remaining balance on one of the car notes
• AutoTransfer the payments to savings
• Purchase 2 properties next year