227: Ask Buck Part 3
Buck: Welcome back to the show everyone. So without further ado let’s get to our first question. You know and these are you know these are from a while back here because we have quite a few questions so they might be a few weeks old. We have a couple questions here recorded from Srinivas one of our very active investors.
Srinivas: Hi Buck this is Srinivas. I wanted to thank you so very much for your podcast, the guests that you have and all the work that you put into it. I also wanted to thank you for the Wealth Formula Network and the excellent investment opportunities that you’ve presented to myself and others like me. My question is really more of a comment obviously. The Covid pandemic has really opened my and a lot of other people’s eyes to the risks associated with real estate syndication investing one of the risks that was apparent to me only now is that the limited partner to me really seems at sort of the end of the line so when the Covid pandemic started and it really affected real estate starting in March. It seemed that most sponsors were really doing everything that they could to not only preserve the wealth and equity of the asset but also to preserve the income stream for everyone else except for the limited partners. So obviously they were making sure to still be able to pay taxes to be able to pay the mortgage but also they were still making sure to still be able to pay the workers on the property to pay the operation fees and to pay the asset management fees but it seems to me that the one fee or cash flow that was disrupted and is being held is the distributions to the limited partners. A lot of syndicators are sort of holding those distributions to be paid at a later time and I just sort of wondering if this is what we can expect sort of going forward that is the limited partner investors seem to be the ones putting up the vast majority of the capital but when any problems arise they seem to be the ones who are suffering first from a lack of cash flow as opposed to all of the other players in the deal just wanted to see what your thoughts were on this. Again, thanks so much for all of your help. I really appreciate it.
Buck: It’s a good question. It’s a probing question so let’s put it into context okay. So let’s start with this idea any investment relies on the ability to make a profit after expense and so in this sense you are absolutely right, you’re going to pay the mortgage, you’re going to pay the taxes, these are very large assets, there are a large number of employees that need to get paid and managers that need to manage those employees and so remember the employees and all the other things are not making money as investors but rather again as employees of a business because every one of these assets is really fundamentally a small business you know in our opportunities in specific you know the general partners are on the same level as the limited partner in the sense that if distributions are not being made to the limited partners distributions of cash flow are not being made to the GP either. Now that brings up another issue that is important to understand and I’ve said it before and I’ll say it again, just because you are not getting distributions right now, as I know you’re not, that doesn’t mean that you’re not making a profit. You are making a profit, specifically, especially in the opportunities I know that you’re involved with. Think about it this way, if you yourself owned a building by yourself okay let’s not put it into a syndication context you’d still be paying a mortgage with principal interest you’d still be paying property taxes you’d still be paying your property manager and maintenance employees and then in that case again when do you make a profit well you only make a profit after all those expenses get paid right but you know given the financial uncertainty that we’re in with the pandemic and an upcoming election which is typically very, very disruptive to any economic scenario, even in the scenario where you had your own building and you were still making some profit right now and you were getting these checks from the manager into your bank account, your operating bank account, you might be a little bit reluctant to spend that money right away, right? I mean after all what if we had a bad month? What if all of a sudden everything went into lockdown again? So wouldn’t it be nice to be capitalized and feel like your capital is secure and I’m guessing the answer is yes because no one wants to go crazy with you know spending money that they don’t know for sure that they’re going to get to keep. So if the money though is in the bank you’ve already been paid by the property manager you own the building, is that your money? Yes it is your money, you’re just not spending it. So basically that is no different with what’s happening in the syndication scenario that you’re in right now. In most cases as you know our offerings are exceeding pro forma and we’re doing quite well. You and other investors certainly in our group are making money, are making a profit and you will see that on K1s. Furthermore, your basis of value in the sense of you know creating equity continues to go up meaning that your equity is growing, your money is still your money right, the profit is still your profit it’s just in the bank right now and it’s in the bank to you know to help keep your principal as safe as possible. Now think of it as an insurance policy basically right when this covid thing is clearly under control you know you’re very likely just going to get a great big check representing multiple quarters as I know you know your equity is growing too at the same time. Now let me give you an example. One of our first group investments was a property in Mesa Arizona that we had planned to do our first refi you know around 24 months which would have been right about now for about 70 percent return of equity but right now refi well they’re very difficult to do first of all because of banks are requiring significant principal and interest in escrow because they’re kind of bracing for the potential worse too but if in doing so you would also end up taking away you know capital reserves of the of the asset which in this situation is really not that smart. Listen these are all small businesses and small businesses the most common reason for them to go out of business is to be under capitalized. So bottom line is again you the investor are making money it’s just either sitting in a reserve account right now or growing you know with the appreciation of the asset or both. By the way you know I know again you’re invested a number of these things through Western Wealth Capital stuff, I would highly encourage you to look at the basis of value numbers on your reports. Some of these returns are already looking I mean absolutely huge after 12 to 18 months and I don’t know how closely you look at that but I would encourage you to do that it’s a lot more you know I think the mistake that people are making right now is thinking that if their syndicator is not making distribution somehow the property is struggling and that’s just not generally the case. In fact you know I don’t know about other syndicators but I will say in general there is not a lot of distress in the system right now. So apartment apartment investors are generally doing pretty well so hopefully that answers your question and let’s go to your next one Srinivas because I know you had a couple here.
Srinivas: Hi Buck. This is Srinivas. I want to thank you so much for all of your advice on the podcast and for the great opportunities to invest through the Wealth Formula Network. My question is a little bit of a technical question that pertains to preferred returns on the waterfall that many syndicators offer my question is this: do syndicators often also return a portion of the capital that’s invested by limiting partners as a way to decrease the amount of distributions that they have to give to limited partners based upon this distribution waterfall? So for example keeping the numbers easy let’s say that the syndicators raise an investment and a limited partner contributes a hundred thousand dollars and then let’s say after year one the syndicator returns ten thousand dollars of that initial investment that is at the start they raised more than what was actually needed and then let’s also say that there was a 10 preferred return as a part of the distribution waterfall so after the first year based on a initial hundred thousand dollar investment the investor would expect to get ten thousand dollars in that year but then in the second year based upon a 10 distribution waterfall because 10 percent of the cap of the initial 100000 capital was returned in addition to the percent return the investor investment is only ninety thousand dollars so in the second year by a ten percent preferred return the investor would only get nine thousand dollars. Sorry for this long explanation but I’ve heard that this is a way that some syndicators can kind of dupe investors into thinking that their preferred return is based on their initial investment as opposed to their investment throughout the deal. Again thanks so much for your insights as always and I was wondering what you thought of this technical question. Thanks again. Bye-bye.
Buck: Another probing question there Srinivas, you know without getting too much into the weeds, you are right. There’s a lot of complicated various waterfall structures that can be used by general partners to make more money and as you’ve said it to make it seem a little bit deceptive. Here’s what I would say my primary advice here and as you know in general this is kind of what we do in our group is stick to really simple structures where you’re getting access to the upside and or aligned with the GP. I think the challenge is when you get into these you know waterfalls these constant shifts I think you know a lot of those kinds of things that you’re talking about are possible, it becomes very convoluted. That’s why, for me at least, you know the way that I have generally tried to look at things and certainly present things sometimes is in terms of annualized returns because for me that’s kind of the easiest thing to understand. Sometimes you can really be fooled into thinking that you know you’re getting something better than you are by the way somebody says it, I mean somebody says I’ll give you 25 you know cash on cash on your investment, you’re like wow that sounds great 25 cash on cash, but then all of this then you realize that the investment only lasted for four years so you know the next thing you know you’ve made just your capital back and you’ve made no money on top of that, that’s obviously not you know necessarily something that you’re you’re seeing but you’re going to see variations of what I’m talking about people in this space like in any space they are good at trying to push the buttons on what what less sophisticated investors might be looking at. My advice again is really to focus on annualized returns because annualized returns typically are going to give you a little bit better of an idea in terms of you know what the true return on and on a yearly basis is expected to be. People get caught up in this preferred return things which is in my view the concept of preferred returns is totally overrated. People get excited about preferred cash flow returns because they think it they they think that it somehow suggests some kind of guaranteed return which which as you know it really is not it’s funny you know with one of the models that I know you’re you are familiar with there is no preferred return and I get this question from new investors all the time well why is there no pref and I said well there’s no pref because there is no money that’s you know no cash flow or capital gains that are going to the operator until you have 100 of your capital back and so in that regard it’s not a preferred return or you can say it’s a preferred return that is you know infinite until you get your money back but these whole preferred returns are you know in my in my mind a little bit misleading too because in most cases the preferred return is also incumbent on the you know the asset itself actually producing that much cash flow so at the end of the day I don’t think you know that much about preferred returns. I like to focus on what is the split what is the alignment between the limited partner and the general partner and ultimately looking at pro formas you know once once you realize you know if the performers are realistic trying to get a sense of what an annualized return projection is anyway that’s pretty simplified answer but I think the moral of the story is for me is simply just to keep it simple.
Okay next question from Tuan. This is a written question. Hi Buck. I am a high W-2 healthcare provider. I wanted to start investing in buy and hold rental to generate passive income and benefit from tax breaks but I just found out that I can’t use any of the tax benefits to offset my active income. Is it worth it for a busy health care provider to start a portfolio of small multi-family or would I be better off investing passively into syndications?
Well let’s start with the issue of you not being able to use your losses well unfortunately you are right there, you cannot write off these wonderful real estate losses against your W-2 income and that’s why people do things like have their you know spouse quit their job and become a real estate professional so that you know the real estate then when you’re filing jointly some of those losses can actually offset your W-2 income. If you’re not going to do that, if you’re not going to find a new spouse to do that or whatever it takes to get the real estate professional status, the goal ultimately at that point is to create a robust flow of passive income where you can use those paper losses right, I mean that’s the name of the game. So sometimes the reality is that people have lots of passive income but they don’t even know it and let me give you an example okay, a number of our investors physicians and such have ancillary income in the form of surgical centers, hospitals, maybe they have dialysis centers whatever, and I’m not talking about a few bucks, I’m talking about hundreds of thousands of dollars that their CPAs are not considering passive income for some reason. If you are one of those people who can identify or even create these kinds of robust flows of passive income then you can use those big losses from real estate you know like bonus depreciation et cetera to offset that income. I’m not a CPA but I’ll tell you that’s what I know. Okay now as for this question of direct verse direct investment versus syndication, it’s a slightly different question it’s a very different question of course and for most people in our high income cohort the only reason really to invest directly into real estate in my opinion is because A you like being a landlord, and most people realize they don’t like being a landlord they like real estate but they really like what real estate does for them rather than you know being a landlord or you want to get the real estate professional designation which we’ve talked about before and you know for one of the spouses in a marriage for example and then you can potentially use those passive losses get applied to your W-2 income. I mean that is you know that’s sort of the holy grail, if you can do that now if that’s not possible if that’s not the goal my opinion and again it’s my opinion is that you’re much better off spending your time finding you know the right operators to invest with passively okay making material money in real estate you know and doing it consistently doing it well it takes time, it takes effort and that’s just a fact there’s no denying that people sometimes think that they’re gonna make more money if they buy properties themselves instead of going through syndications and in my experience that generally ends up not being the case you know for a number of reasons I mean not excluding the fact that people don’t often have the expertise or time to do it but if you look at like you know my personal investments that I have as a passive I mean I’m consistently yielding well over 20 annualized I’m not talking about anything that I’m doing I’m talking about my limited partnership investments that I have in my portfolio so I’m consistently yielding 20 annualized or better now most people can’t do that well on their own because they again they don’t have the expertise to optimize the profitability of the asset and even if they do pretty well they often find themselves putting a lot of time and effort into these properties which you may or may not like doing. Now with regard to time and effort remember your time is actually worth something as well especially if you’re a high paid professional and if you’re spending 10 hours per month even on real estate the cost of your time has to be factored into that ROI so you know bottom line is you know if you are one of those individuals who whose hourly is like 400 an hour well if you’re spending 10 hours a week on real estate you better you know you have to make 4 000 a month more from your active activity compared to what you would make as a passive to make it actually make make sense right so bottom line is for most people choosing the right the group or operator might be a better option you know especially if you’re a busy person and that’s of course you know I’ll put a shameless plug in again there for our Investor Club which you can sign up for at wealthformula.com if you’re accredited.
Next question is from Cindy. Hi Buck I have a simple question. I’ve often heard that rich people don’t gamble their money in stock markets since they have other investment tools that offer higher returns at less risk, however, I also heard in the news that all this stock rally this year only benefits the rich since the poor do not own stocks these two sentences sound contradictory so are we talking about two different groups of rich people here? Well thanks I love listening your podcast as always and learn from them. Well thank you Cindy. Listen I think the quote about rich people not investing in the stock market is first of all it’s not true and who are rich people anyway? Are we talking about you know people who make a million dollars a year is that rich people? That’s not what the people who are making 10 or you know 20 million a year or worth 100 million they don’t think of the 500000 to a million dollar people as rich people but you know listen I think the point is that you know when you’re talking about wealthy people in general I think the idea is not that they don’t own stocks I think the point is that their entire portfolio is not sitting in a bunch of mutual funds with huge fees inside of an IRA you know the wealthier people generally you know they obviously do have significant stock portfolios but also remember that they are usually people with a lot of direct investments as well so a number of real asset investments or you know you see a lot in wealthy people you see these products these life insurance products like Wealth Formula Banking or Velocity Plus type things which you can check out at wealthformulabanking.com. You know listen while most everyone I know who is wealthy owns a substantial amount of real estate I would not say that they do not own stocks as well so I think that’s the bottom line. Personally you know I like the idea of owning equities if there are guard rails similar to the ones you see in something like Velocity Plus which again is that you can see a webinar on that at wealth wealthformulabanking.com and something that actually allows you to take the upside and leverage it but allows you to skip you know a year that actually goes negative. I mean those kinds of products are used by the wealthy all of the time and they’re called generally speaking they’re called you know premium finance IUL’s or you know LIRPs which are Life Insurance Retirement Plans those are things that you know the ultra wealthy are really into. Bottom line is you know these statements I think they’re too generalized and you know it’s just that the wealthier you are generally speaking the better you are at you know taking or your advisors or whatever it is or at you know making sure that you maximize your profits and mitigating your losses. Well that’s quite a few questions here so I am going to take a quick break and we’ll finish up when we come back.
Okay welcome back everyone the next question here is from Aneesh. Aneesh says, high Buck. I’m a soon to be PGY2 resident physician in other words that means he’s almost in the second year. In recent months I’ve been getting into personal finance and ideas for financial independence. I came across your podcast. I’ve enjoyed listening to it. Just wanted to get your take as a resident with nominal income and time at hand, are there things you think I could or should be doing aside from maybe a Roth IRA over the next few years to lay the foundation for building this wealth and getting to that next step? Okay well listen Aneesh that’s a good question and I will just say something that goes against the grain of all of these probably all these other you know physician bloggers and stuff like that honestly as a second year resident I personally don’t think it makes any difference what you do right now. Residency is weird. You get paid pretty much nothing for a few years then suddenly you had a huge raise and if I were you I’d spend all of your resources right now on education, financial education and trying to understand how you can position yourself when you do have the money when it starts coming in. I think the idea of you know you know trying to do too much with as little as you have in terms of time and money it might just be a waste of time you know I’ll that’s my honest opinion on that but again it’s just my opinion. One thing though I will say that that I would consider if I could go back and doing it, and it sort of depends on where you live and stuff, if you really want to get started on something in real estate and the market seems like you know that it’s possible for you do you could look at one of these FHA loans where they have you put down three percent and specifically to buy a multi-family you know like a four unit or three unit building it’s up to four units residential. So what’s cool about that is that’s actually something where you don’t need a lot of cash to put down and it’s something that you might be able to do with your limited income and then build equity while letting the other tenants pay for your rent. So that’s like the one thing I think if I was going back I would be thinking about you know retirement accounts etc I think that’s fine I mean you know what money are you gonna put in a Roth right now five grand a year how far is that gonna go? Is it gonna be meaningful? I mean I guess it would, I just don’t think it’s something I would spend too much time thinking about.
Anyway okay so next question what are your operators of course talking about the different partnerships we have in Investor Club he says what are your plans or strategies if no more Covid payments are made from the government to tenants so we’re talking about apartments obviously well first I think it’s extremely unlikely that the government stops paying tenants because you know essentially that would mean they’re like eliminating unemployment which isn’t going to happen. Also remember we are in working class apartments so you know generally speaking we’re in areas that the cost of living index is not very high so their rent is not that high for how much money they make even if they’re on unemployment and then the next major issue there is that the majority of our tenants currently are not unemployed so and I don’t see unemployment getting worse at this point either. However to answer your question about well what are your strategies, I mean what are you going to do to make sure or to mitigate the risks? The biggest thing we’re doing is being well capitalized so that again that goes back to Srinivas’s questions about well why are we not getting paid or you know we’re whatever listen we’re just staying capitalized so that we can weather the storm. There’s just money sitting in the bank account it doesn’t guarantee that we’re going to be fine. Nothing’s guaranteed in life. Your stocks aren’t guaranteed that’s for sure. However there are thousands of owners of these kinds of apartment buildings who I can pretty much guarantee you would lose their properties before our partnerships and our in our operators and the reason for that is capitalization we are very very well capitalized and you know as for this idea of you know all of these buildings getting foreclosed on etc and taken back I just don’t see Fannie Mae or Freddie Mac letting that happen. They’re not in the business of taking back apartments that would be an absolute disaster for them and for the economy and so if a scenario like that happened I’d truly believe we’d see a huge bailout of some kind for our industry but listen, the best we can do is what we’re doing right now and you’ll be happy to know that we’re actually doing really really well, our portfolio right now is performing at you know Covid levels or better so you know listen we just need to keep staying ahead of the curve and as long as we do that I truly believe we’re going to be just fine.
The next question is from Christian Schultz. Okay so Christian asks Buck, perhaps this is one that can be raised on webinar but Western Wealth Capital relies heavily on upfront depreciation, raising the cap rate through improvements and then refinancing of the resale. What are the implications to this model if Biden wins the White House and democrats take the senate as well? Is there any indication that they would do away with depreciation allowances or change the tax loss surrounding multi-family real estate if the ability to take maximal depreciation up front were done away with the market for multi-family real estate could dry up. Thoughts? No I don’t think so, actually at all, for one thing remember that idea of you know the market you know the ability to take that maximal depreciation upfront is only like two years old I mean so I don’t see any indication of that drying up at all you know listen, so the only real change that sounds like from from my understanding of the Biden laws in terms of us really relate to people who own real estate there’s challenges to potentially to 1031s etc. I don’t think it would affect us because it sounds like what it would affect is mostly the elimination of bonus depreciation with cost segregation analysis which is set to sunset anyway in 2022. So let’s just review that real quick because a lot of people may not even know what a cost segregation analysis is but a cost segregation analysis is basically an engineering study done by you know an investor to segregate the property into what is considered real property which is like you know the land and this the big old building that you got there versus chattel or personal property which is like stuff you can pull out of it cabinets or you know whatever washer dryers et cetera real property is depreciated over 27 and a half years so that’s mostly if you do nothing if you do know you don’t do a cost segregation analysis in apartments it’s going to be a straight line but if you do a cost segregation analysis the personal property part can be depreciated over five years and that is the exciting thing because in apartments it ends up being sometimes that about 30 percent. I’ve noticed on average of apartment buildings end up being considered the acquisition price considered chattel or personal property so you could depreciate that over five years and that has been the rule of the land for years and years and years it’s been a great tax advantage to real estate investors for a very very long time and to be clear there is nothing in the Biden plan that suggest any challenge to these elements of the tax code. Now bonus depreciation use with cost segregation analysis was, as I mentioned this was new, I mean this started with Trump with the tax code that allowed you to take that five years that I just mentioned of accelerated depreciation and hyper accelerate it into all into the first year so if you were either a real estate professional or have a lot of passive income like we talked about maybe of a surgery center or whatever that was a huge huge advantage and it is a huge huge advantage and it will be until it’s not anymore so take advantage of it if you can. But you know the reality is for most people investing passively it’s not going to make much of a difference either though you know so bottom line is I don’t think limited partner investors have much to worry about frankly, but I will say if you’re benefiting from bonus depreciation ride that baby as long as you can.
All right, last question here and it’s from Cindy. She says we are all familiar with Robert Kiyosaki’s famous saying “your house is not an asset” and from financial perspective I totally agree especially since I live in a state where housing is expensive, however renting has its own limitations, for example we can’t design the house we want, tiles, paint, etc. We also can’t dictate how long we want to stay in the house. If the landlord decides to sell a home while renting. May be easy for young folks with no kids. Those of us with kids might find the potential instability quite a bit of downside. So what’s your view on taking out as much HELOC, home equity line of credit on the primary residence as we can to invest in opportunities that generate a higher return than the interest that we need to pay the bank. It’s not perfect since most banks would only allow a certain percentage of the loan to value but would that be a good compromise to this question? So there’s no real perfect answer here, right, there’s two ways I would look at this question and then I’ll leave it to yourself to determine what you think, but first there’s the question if you look at it purely from the math and the math answer is quite simple right? If you can get returns higher than the interest you’re paying on your HELOC then the math is easy and you should maximize that home equity line of credit to the hilt right and invest it. You should do that if it’s purely a mathematical question. Also in benefit of that argument of doing that remember equity in your home is really just dead money. It’s not doing anything and it’s also a big target for creditors and you know mortgages and HELOCs are if you think of it that way are potentially the best asset protection you can have on your house. And the final thing in favor of doing the HELOC maximizing leveraging is that the truth of the matter is that the banks are far less likely to foreclose on a home with no equity. So they might be willing to work with you more if you stripped out all the equity from your home, got yourself in trouble, again that’s the math side of this but at the end of the day when it’s your personal residence, there is a psychological element to this as well which I understand and appreciate. You know there is something to me well and to a lot of people that is psychological about not having to worry about paying a lot of money to stay in your home. So bottom line is I don’t think there is a black and white answer here and as long as you know the specific issues you need to do what you need to do to feel feel like you can sleep that night. Now one last compromise that I’ve heard particularly in Wealth Formula Network which I think is really really smart is okay maybe you don’t keep a lot of equity in your home but you’re keeping you know you’re keeping an equivalent amount of equity in some other you know in some other place where you can access it. So for example maybe you’ve taken a hundred thousand dollars of equity out of your home but you have a hundred thousand dollars accessible to you in a Wealth Formula Banking policy that’s thrown off five and a half percent compounding. Now the advantage in a situation like that is well when can you not access your home equity line of credit? Well unfortunately usually it’s when you really really need it right so if your credit is gone or all of a sudden you lose your job that’s when you’re not going to be able to you know get a home equity line of credit. So some people that I’ve talked to have said well what I’m going to do is I’m going to strip out the equity put that equity into something like a Wealth Formula Banking policy where it’s better for me to keep it and I know the banks won’t lock me out of their system when times get tough. Anyway that’s something to consider.
We’re gonna wrap it up here we’ve been going for a while and that actually wraps up three sessions of Ask Buck and I hope you enjoyed it. Again if you like this kind of stuff, join us in Wealth Formula Network go to wealthformularoadmap.com. This is Buck joffrey with Wealth Formula Podcast signing off.