I read several books this year on real estate. I'm going to talk about three of them today.
#1 Raising Private Capital
One of the most interesting for me was called Raising Private Capital by Matt Faircloth. This comes from the Bigger Pockets folks and isn't actually geared at the investor, it's written for the syndicator. It is geared at the person who wants to invest my money in real estate. It was interesting because it gave me insight into the way these folks think or at least should be thinking.
I had to chuckle at one section though. The book calls the two parts of the party “deal providers” and “cash providers”, then gives advice on finding yourself one of these “cash providers.” Here are the six sources:
- Inheritance
- Savings
- People with retirement accounts that can be turned into self-directed IRAs
- People with home equity
- Savvy Investors
- High-income Earners
Guess which one most of you are? That's right, # 6. Here's what Joe says about you:
Most of you probably figure that people who earn a lot of money have a lot of money. This can be true, but it's not always the case. The could be living paycheck to paycheck; they just have more expenses to absorb all that income they have. There are other high-income earners who live below their means and have money to put to work but not the time to manage it. Some of my best investors are people who went through years of training to do what they do for a living and get paid well for doing it. Dentists and doctors are good examples of this. They went to school for more than ten years, in some cases, to get to their position. They are not going to leave that job anytime soon, but they get paid very well for doing what they do and are often looking for opportunities to grow their wealth. If you have a solid relationship with someone like that, he or she may even be willing to act as a sponsor for you on a loan.
Ha ha. Pro tip: If the person you're hiring to manage your money needs you to sign for the loan, that's probably a bad sign. But in general, the book talks about treating the passive investors well. That's a widely applicable business principle–you don't stay in business long by treating people poorly. Thieves just don't get that rich because they have no repeat or referral business and repeat/referral business is how you build a big, successful business.
I also enjoyed the section where he talks about structuring the deal, and how much of the profits go to the deal provider and how much to the cash provider.
There is a bit of an art when it comes to calculating how much of a deal to give to your investors and how much you want to keep for yourself. I find it helpful to approach this from their perspective and give them a return I know they will be comfortable with, leaving the rest for myself.
But he talks in simple terms about preferred returns, waterfalls, fees, IRRs and preferred equity. It is one of the best simple discussions of these terms I've seen. If you're sick of reading investing book after investing book that all say the same thing, you might really like this one.
Check out Raising Private Capital today!
#2 The Doctors Guide to Real Estate Investing for Busy Professionals
The second real estate investing book I read this year was written by everyone's favorite general surgeon turned author, Cory Fawcett. His fourth book is called Real Estate Investing for Busy Professionals. For those who don't know his story, a few years into his surgery career, he decided to start buying apartment complexes in his small Oregon town. By his early 50s, he was not only living entirely off the proceeds of 5 or 6 small apartment complexes, but he had automated the processes well enough to be able to really step away from them. In fact, he says he never once had that feared 3 am toilet call.
If It Doesn't Cash Flow, Don't Buy It
The book isn't super applicable to me, just because I don't plan to directly invest in real estate any time soon, but if you do, you should definitely read this book. At any rate, I thought one of the most important lessons out of the book was Chapter 7, titled “Cash Flow Method of Evaluating Real Estate Investments–The Gold Standard“. I think the lesson here is pretty obvious, but based on the number of people who apparently understand it, it isn't obvious at all. Let me quote from the book:
Cash flow is the only method I use to determine the value of the property to me and it is my decision-making tool. Cash flow is how I determine the price I'm willing to pay. It is the only way to fully evaluate the property as an investment, and it will take some of your time to compute. It also takes into consideration how the property is financed–which none of the other methods care about, but you certainly should. When I buy an investment property, the idea is to make money. That's the definition of an investment.: a place to put your money so it will make you more money. There are two ways real estate makes money. One is appreciation, which I can't predict well, and the other is cash flow, which is much more predictable. In order for you to compute the cash flow, you will need two pieces of information already discussed: income and expenses, which make up the [Net Operating Income] (NOI). The final piece of information is the financing terms…
It is very important that the money coming from the property, the NOI, can fully cover the mortgage payments…With an investment property mortgage, the property is responsible for earning the money to make the payments. You can then put the leftovers in your pocket: a positive cash flow….The cash flow calculations determine if you will have an investment that puts money into your pocket or takes money out….
Once you have calculated the estimated gross income and subtracted the total expenses, you will have the net operating income for the property. This is the amount of profit you would make if you paid cash for the property. Since it is less common to pay cash for this type of property, the NOI represents the total amount of money available to finance the property. For every property you purchase, you must have a positive cash flow. To establish what your cash flow from the property would be, subtract the mortgage payments from the NOI…
If you make the initial calculations and the cash flow is negative, you have at least three choices to turn it to positive. How much above your expenses , including financing, that you want it will be up to you. The more the better, but everyone will have a different comfort zone.
#1 Lower the Purchase Price: Knowing what NOI you have to work with, you can determine at what price you can afford to buy the property for it to be a positive cash flow.
#2 Make a Bigger Down Payment: [This still] gives the seller the purchase price she wants and gives you the loan amount you need based on the NOI.
#3 Get Better Terms on the Loan: If the seller won't come down…you can still swing the deal….if you can negotiate a lower interest rate on the loan.
Check out The Doctors Guide to Real Estate Investing for Busy Professionals!
#3 Do the Work Once, Get Paid Forever
The third real estate book I'll be reviewing today is called Do the Work Once, Get Paid Forever. The author is a, well, deal provider. Like so many of the investing books for doctors written by a financial advisor targeting doctors as clients that I have read and reviewed over the years, this one is written by a real estate deal provider who would love to have a bunch of doctors as clients. But it's a pretty soft sell.
The Case For PPMs
PPM stands for Private Placement Memorandum, the 100+ page document an accredited reads (supposedly) before buying into a private real estate fund or syndication. Like every one of his peers, he believes that these deals are much better investments than stocks, REITs, and direct real estate investing and tells you not to worry about the fees and just concentrate on whether you like the person putting together the deal. To make matters worse, he uses all kinds of analogies to doctors which sometimes make sense and sometimes don't.
But once I got through that, I really enjoyed this very short book. White coat investors are always asking me two questions:
- How to evaluate a sponsor (aka deal provider aka syndicator aka fund manager) and
- How to evaluate a deal
This book doesn't really get into # 2 much, but it does get into # 1 very, very well.
How to Pick a Sponsor
He actually gives some really specific information about choosing a sponsor. Now, that isn't all that different from the books that tell you how to find an advisor that basically describe the advisor writing the book, but I still think there are some pearls there, so I'm going to list them:
# 1 Make sure the sponsor is using a recourse loan. That means the sponsor is personally on the hook if the deal doesn't work out. It also means the sponsor is wealthy, or the bank would not have approved the loan. Both are good things for you.
# 2 Beware of rosy projections and high leverage. Avoid people using more than 75% leverage.
# 3 Make sure their money (or that of friends and family) is in the deal
# 4 Make sure they're at least in their 30s and preferably 50s (and in their first career)
# 5 Make sure they're crazy transparent.
# 6 Make sure you're directly connected to them without a middle man
# 7 Make sure they're motivated by making deals, not just money. All the best ones already have plenty of money already, so that can't be the only motivation.
A Few Interesting Pearls
If you want to learn more, check out Do the Work Once, Get Paid Forever today!
If you're interested in looking at private real estate syndications and deals, I would encourage you to sign up for my real estate deal introduction list, one of the free email products we have here at The White Coat Investor. It's free and you can discontinue at any time. If you're reading this in your email, there is a link at the bottom of this page that will add you to the list. If you're reading this on the web, sign-up for our free newsletter here.
What do you think? Have you read any good real estate books this year? Which ones? Do you invest in real estate? Do you buy properties yourself or invest in PPMs? Comment below!
This is one of my favorite weeks in the WCI empire. I always pick up a few good books from this process. I like the terminology of Fawcett favorite surgeon. I recently listened to a podcast interview he gave on “Doctors Unbound.” I learned about owner financing and how it makes sense for an owner to do that. His book has been on my radar, and I’ll go through your link to pick it up to support the site, its charity, and to a lesser extent the WCI home renovation. Get Fawcett on your podcast if you can too. Totally agree about the cash flow concept. I have always thought appreciation is more of a euphemism for negative cash flow and hopeful gambling. I appreciate the book recommendations. Although off topic, one you might enjoy is Christine Maslach’s book “Burnout: The Cost of Caring.” There is nothing like hearing if from the master as she focuses on practitioners in the caring professions. Finally, good use of the word “principle” vs. “principal.” In the past you have commented how that was one of your personal bugaboos.
Maybe I should engrave your name on the firepole. Maybe I should auction off the right to put listeners’ names on the climbing holds too! The house The White Coat Investors built.
Hopefully I’m finally getting the hang of principle and principal, but don’t hold your breath.
Great read and positive cash flow is the goal however I think the rental income contribution toward the mortgage should also be considered. Few small scale individual investors will be privy to the really sweet deal. I have in fact made an above average rate of return while diversifying my portfolio on reasonably priced rental acquisitions in solid, appreciating neighborhoods that initially yielded only a few hundred dollars of positive cash flow per month which has generally covered repairs. Although this wasn’t an initial consideration all of the rents have increased with tenant turnover and subsequently have a more favorable cash flow.
How many properties can you feed with your clinical income? Does it make you feel any better that some of that feed is going toward a mortgage? Probably not. If the property can feed itself, then it eats up none of your income and you can have an infinite number of them. Otherwise, the number is limited and probably a lot fewer than most think.
Agreed, I don’t take on a property if it doesn’t immediately yield some cash flow in terms of rental income however that is only one component of my consideration to invest. I am prepared that initially these properties may require money out of pocket for updates or unexpected repairs which also guides my decision to purchase. While perhaps flawed logic it actually does make me feel better to think my money is going toward a mortgage and since I only have 5 houses I’m coming from the little guy’s perspective so probably not your average audience member.
Initial upgrades/repairs should probably be considered part of the purchase price. And maybe you can be cash flow negative for a while and survive. But I wouldn’t recommend a long term plan based on negative cash flow. And this all of course assumes you know what you’re doing and actually counting ALL the expenses, not just the mortgage like many rookies.
The contribution of the renters paying off the mortgage a little each month is nice on paper but doesn’t affect my income. Though, that is how the mortgage is eventually paid off. But until I refinance or pay it off, there is no change in my financial situation other than my net worth is climbing “on paper.” Therefore, I do not use that in my decision making process. Only cash flow counts. I would never want to offset a negative cash flow by the positive effect of the principal portion of the payment. Like Jim’s title says; if it doesn’t cash flow, don’t buy it.
Agree your cash flow strategy is ideal but I didn’t have the luxury of a high income when I started purchasing real estate back in the late 90s. It was either take a chance on building equity and diversify or put all in the market which also isn’t contributing to my income or actually worth anything until sold.
I bought my first cash flowing property with no money down, so a high income is not a prerequisite to finding cash flowing property. It helps to have extra money to put into the deal, but it is not always necessary. The more money you can put into the deal, the more deals you can make cash flow. But you don’t need lots of deals, you only need one! Then you have started.
Impressive that you were able to secure one with no money down that also yielded positive cash flow. I figure they are few and far between. I did an owner financed deal years ago but the property needed significant updates which essentially negated the no money down component however it had a positive cash flow immediately upon renting.
As a physician or other high earner, you can take less risk and get to the same place. I’m amazed how much risk that some new real estate investors take, and sometimes they do blow up.
You can also take slightly more risk and get way ahead!
Will have my salary replaced in less than 10 years from cash flowing real estate – in my calculation appreciation is just bonus.
Index fund shmindex fund
justSayin’
medicine schmedicine
I purchased my single family portfolio with positive cash flow being the number one criteria. However after experiencing significant appreciation to the point I was able to do cash out refinances and get all of my original capital out; it really super charges your returns!
Thanks for your kind words about my newest book. With a little guidance, busy professionals with the desire to have direct ownership of investment real estate can make it happen. If I can do it as a busy general surgeon, anybody can do it.
Thanks for your support
“He also recommends you put 25% of your money into real estate, 25% into an index fund, 25% into paying down your debts, and 25% into cash.”
This is a very interesting diversification strategy. I might argue that 25% cash is excessive, and wonder what will happen with the 25% once debt is paid off, but I’m willing to bet that most people would do quite well if they went 37.5% real estate, 37.5% index funds, 25% cash. Would be interesting to see how that played out over 30 years. I’m guessing they are recommending the cash for liquidity on real estate deals?
Thanks,
I would assume so.
Hello,
Just a FYI, Raising Private Capital (published by BiggerPockets) is authored by Matt Faircloth not Joe Fairless. Joe wrote the forward to the book!
Thanks for your kind words about Matt’s book!
Liz
Sorry, of course you’re right. I’ll get that corrected.