Buck: Okay, welcome back to the show, everyone. Without further ado, camilla is going to start asking me questions. The first one is from Amy.
Camilla: If I sell my pharmacy business and keep the building, I have the opportunity to lease it out to a buyer of the business. The question is, do I pay off the building and take the cash flow, or do I reinvest the money in new cash flowing opportunities, creating more debt because this new tenant will pay off the building? Anyway, thank you so much.
Buck: Great question. All right, so as you know, Amy, there’s no definitive answer to this, okay? There’s no definitive answer on what you should do. And whoever you’re going to ask, they’re likely to have different opinions on this. So, in effect, what we’re talking about is you’ve got a pharmacy, you own the building, you’re going to sell both. Are you going to sell the pharmacy or you’re going to sell the actual business and then you’re going to keep the building? So the question is, do you pay off the building or do you leverage it out? Essentially, my personal view on this is that there is nothing like creating wealth through good leverage. It’s so critical in many ways. And I would say that you cannot really build significant wealth without utilizing leverage to a certain extent.
So this is a classic example. I mean, yeah, you could have the cash flow, but if you leverage that building and you have a bunch of other cash that you can deploy into another asset, as you said, you’re going to pay this building up over time with the renters money, and then you’re going to have that other money to create an entirely different asset. So if you think about the Wealth Formula. The mathematical Wealth Formula, that’s a major component of what it is. The mathematical Wealth Formula is what we call wealth is equal to mass times leverage times velocity, where mass is the amount of money that you are actually deploying because you got to deploy money in order to make it. Then you have velocity and how quickly you get that money back. But a big thing that makes it different from investing in anything else is the leverage. And so, again, from my perspective, a big ethos of the Wealth Formula concept and the math is using leverage. So if it were me, that’s what I would do. I wouldn’t pay it off and just enjoy a bunch of extra cash flow that you may not even need, frankly, because you probably have plenty of other money to use. All right, very good.
So next question is from Marina Kamala. Do you want to read that?
Camilla: Hi, Buck. With the mortgage rates rising, can you please comment how Western Wealth Formula investments may change in the next couple of years? For example, my guess is that refinancing will be rare and the focus will be more on operating and reselling properties versus refinancing and reselling. I’m also guessing more properties will be held longer. Is that your expectation that the velocity of money will slow?
Buck: So, yeah, that’s a very good question, Marina. Here’s what I anticipate. Obviously, I don’t have a crystal ball, but what’s happening is because rates are going up and we bought at a certain period when rates were low, refinance are not making sense right now. Right. Because basically what you’re doing is what’s the point? You’re just basically cutting out cash flow and making an asset more risky if you leverage, because you don’t know for sure if rates are going to continue going up or not. Now, the good news is about this is that multifamily assets are the best hedge against inflation there is. So that if inflation continues to go up, which will be reflected in rates going up, we’re going to be able to keep up with that. And so from that perspective, I’m not concerned about the properties at all in the long term. So for those properties that we can’t refinance, you’re right. I think the velocity of money slows down a little bit. However, I do think that what we’re going to see is as soon as the lending market stabilizes and there’s a bunch of new buyers in the market, you’re probably going to see a lot more disposition, certainly from our portfolio. And we could do that now, but I just think that the reason for doing it is we don’t have to, and we really want to be in a seller’s market when we’re doing things like that. That’s that.
Now, in terms of long term, how does it affect the business model? I actually don’t think it affects the business model very much, because if you think about it. Now, say we’re making acquisitions. We say we have a new baseline of sofa, and it’s pretty stable, right? At that point, basically, you’re buying based on that particular interest rate, and then in effect, you’ve got a new baseline where you can refi from as well. So you don’t have moving gold posts. What we have right now is moving gold post. Rates are moving, and that’s what’s making the refinance difficult. If, on the other hand, the rates are a little higher, but they stay relatively stable over the course of a couple of years, which is what I anticipate, at some point we’re just going to normalize will be a little bit higher than we are, then the model should be back in full force. We should be able to refi based on where we buy, at what price we buy. And looking at the rates and continuing with that high velocity model of refinance and dispositions anyway, at least I think that addresses most of your questions. Hopefully, it makes sense.
All right, next question is from, let’s see, from Eric.
Camilla: Hi, Buck. Thank you for all you do. We spend all our time here discussing strategies to accumulate wealth. However, I have not heard any discussion about the next phase of life where we transition from our careers to retirement and where are we going to be living off accumulated wealth? Do you have any thoughts on where one would be wise to put their accumulated wealth in order to safely stop working and draw income reliably? By the way, I already have an LIRP to supplement my retirement income.
Buck: Okay. So, Eric, great question. So the evolution of my thinking and personal finance has been this. I didn’t think about it at all when I was a surgical resident and I was in medical school and all that stuff. And then one day I read a Robert Kiyosaki book, and I was so inspired, and anybody who looked at me and I would immediately get them to start thinking about cash flow and how you can have assets that essentially replace your income and make it so that your life is on autopilot, right? So replace your income. That was the idea. But here’s what happened when I actually try to implement this. It’s not that straightforward, right? And that’s where we get into what I would call sort of a wealth 1.0 situation where you realize. Hey. That cash flow model is great. Except even if you’re getting like, in which you’re not these days by the way, getting 10% cash on cash. It is going to take an enormous amount of money and time for you to deploy enough capital in order for you not to work anymore. Okay? So that was a revelation that I had a couple of years ago and where I was like, okay, actually, this doesn’t really make sense. What we really should be focusing on right now is the idea of building capital of having a significant amount of capital continuing to grow. And that’s what we do through these velocity models. Right. You mentioned somebody else mentioned Western Wealth Capital. The whole model there is to create value, create refi, pull out equity, deploy somewhere else, and turn hundreds of thousands of dollars, potentially over time, into millions of dollars. And we’ve seen that. We’ve actually seen investors do that.
Now, your question is, okay, what’s next? Well, I’m not there yet personally, because I’m probably too greedy at this point to stop this whole endeavor. But I will say this one point. The idea is that you will take this amount of capital, and then if you really don’t want to do anything anymore, you don’t want to invest, you don’t want to grow it, you don’t need to. Then you start taking the money that comes out of these high velocity equity growth models and you start going into cash flow, true cash flow type assets. Why is that significant? Okay, so if you didn’t do that, if you started from cash flow, say, for example, I’m going to use an example of an actual investor that I’m aware of who had deployed approximately $700,000 over the five, six years into high velocity models. If that guy had done that 700 grand initially, just expecting cash on cash returns of, say, let’s say it’s 8%, and that’s even pretty generous, right? So it’s 8% on $700,000. What is that? It’s about I think it’s about your brain is better than mine, maybe $56,000 a year, which is fine, it’s not bad. But somebody who’s deploying multiple hundred thousand dollars per year into this stuff is probably not going to live off of $56,000. Now, instead, what that guy who deployed that $700,000 did was he deployed it in these high velocity type models that we do. And that capital is now worth over $4 million. So now if you pull the cash flow trigger at that point and you got 8%, now it’s 8% on $4 million instead of $700,000, 8% on that $4 million is about $320,000 per year. And compare that with the $56,000 a year that we talked about before.
So that is something that there’s probably a pretty good chance that somebody could retire on. Listen, the numbers that I’m giving, our absolute numbers, but I think the thing to focus on is look at how much different that cash flow model is if you spend the initial part of your life or most of your life just accumulating growth of capital through reinvesting and refinance and that kind of thing. So hopefully that makes sense. And by the way, I think the LIRPs, as you mentioned, LIRP is short for those of you who are wondering what LIRP is. It’s life insurance, retirement plan. So it’s a lot of these things that we talk about, whether that’s premium finance, IUL Wealth Formula, banking, velocity plus. And also probably most significantly, and actually, Rod is going to answer a question about this in a minute. Is the Wealth Accelerator program? Anyway, hopefully that answers your question.
All right, next question is from Kelsey and Kelsey. Okay, here we go.
Camilla: Is it wise to invest using an entity? How much am I really exposed as an LP by keeping them in my personal name? Is it wise to use an entity? Is it wise to create multiple entities once I reach a certain number of syndication investments or dollar amount invested?
Buck: Lots of new words there, but you did great. Okay, so, Kelsey, let’s just go back and review what you’re talking about. Okay, so when you’re investing in a limited partnership, so real estate, syndication, and you’re investing in that, you are absolutely right in that you are protected from any kind of liability when it comes to the asset in which you’ve invested. Because by definition, that’s what a limited partner is. You have limited liability. And so you really don’t have any risk from the asset itself. So if that’s the case, why do many people, including myself, use an entity to invest out of? And the answer is, I’m not protecting myself from the assets that I’m investing in. I’m trying to protect myself from people who are suing me personally. Okay, so the idea there is to create some sort of wall. It’s asset protection between somebody who sues you personally and the assets that you own. So that’s why a number of people, including me, will use, for their limited partnerships and for their syndications, a single holding company that effectively deploys capital and then receives capital, and you can obviously make distributions from that as well.
But that’s the whole idea. The idea is not that the asset itself poses any risk, because in that regard, you can use your personal name. Now, there is one other thing to consider, too. As long as we’re talking about using a personal name versus an entity, if you are going to use a personal name, I highly recommend that you do it through a living trust rather than through your name. Without the living trust. Why is that? Because when you die, if you do not have a living trust, so will alone does not suffice. If you do not have a living trust, which is really cheap to get, just a couple of all of your personal assets will go into what’s called probate. Effectively, the courts deciding, even though you have a will, whether you can give that stuff away. And when you can and it’s very expensive. It’s very expensive. And it also creates a situation where if somebody dies and they have most of the assets, it ties up that money for several months, even up to a year in California. And so just words there is that if you’re going to skip an entity, certainly consider at least using a living trust.
Okay, next question is from James
Camilla: Can you please explain in general how it works with deferring taxes once investment with WWC ends and reinvest the profits on the same year, are the taxes deferred at that point? If we don’t reinvest, is there enough deprecation to cover tax liability so that we don’t have to pay capital gains?
Buck: Okay, good question. So let me summarize essentially what the question is. The question is basically, okay, so how does this hold deferring taxes, things work. We’re talking about specifically here of what, WWC, but we’re not going to talk about specific investments. This is how it works. Okay, so right now we have bonus depreciation and it’s 100% right now. So what happens is that every time we get a new property, we’re doing cost segregation analysis and then applying bonus depreciation. Okay, so what exactly is that? Okay, let’s start with the cost segregation analysis. Cost segregation analysis is separating personal property from real property. And it’s an engineering study and it’s significant because what happens is personal property is depreciated over five years, whereas in real property, multifamily is about 27 and a half years.
Okay. Now the tax law changed under the Trump administration, making it so that five year accelerated depreciation could all be taken in the first year. Visa, Visa, something called bonus depreciation. Now this is a big deal because for many of us, what ends up happening is that the amount of depreciation that we get nearly offsets the amount that we actually invested, right? So it’s a really good deal, especially for real estate professional types. So let’s mechanically look at what your question is. Your mechanical question is, okay, so now you have a divestment. How are we going to defer taxes on that divestment? And so that the capital gains aren’t something you are going to have to pay for that year. So let’s say you invested $100,000, then you had some depreciation there. And so maybe your basis is now $80,000. A couple of years later, the property sells. Say you get $200,000 back. Okay, so your $100,000 went in, you got $200,000 out. So out of that $100,000 of what we would call profit, I guess you’re going to break that down because part of that you’re going to also have to pay in recapture. So your basis was $80,000. So instead of paying just capital gains on the $100,000, you actually have to pay that $100,000 capital gains plus recapture on $20,000 that you took in depreciation. Okay, so now on surface that looks bad.
Now I’ve got capital gains and I’ve got recapture. So now what am I going to do, right? Because now I’m going to have to pay. Well, here’s the beauty is that when you reinvest that $120,000 into something else, you’re going to get a K1. Right? Now, these days the way bonus depreciation works, that nearly approximates the $120,000, which includes long term capital gains and recapture. So in some, you’re basically not going to end up paying much in the way of taxes. Now again, I’m not a CPA so don’t take anything I say as professional tax advice. I don’t want anybody trying to sue me for that or anything like that. But this is the way things work, okay? I’m around this stuff all the time and that’s the game that we can play, which I think our listener Tim Hambury is called the golden hamster wheel, which is something that right now real estate investors, we got the best deal in town, there is no doubt. Okay? And then so one other point that I’m going to make here is that you can’t use passive losses against active income, right? They’re different buckets and this is for most people who are listening and it doesn’t relate to real estate professionals but it relates to everybody else. This income that’s coming off of these things though, the long term capital gains, this is like long term capital gains on real estate. It is different. It is different from long term capital gains on portfolio income. Why? Because what we can do with the losses from our K1 when we reinvest is we can offset those passive gains from the divestment before in stocks. You can’t do that, you can’t use depreciation to offset stock gains. So that’s another huge benefit of investing in real estate.
Okay, let’s see, next question is from Yaron.
Camilla: Hi Buck. My question relates to how you envision the transition from cumulative investing approach we currently utilize going through to the retirement phase where we are going to need some funds to live on without burning through our capital. How do you propose restructure this so that our money is not stuck in a medium term investment but at the same time not sitting in a bank doing nothing?
Buck: Well, it’s a good question Yaron, but I think it goes back again to an earlier question about this shift. I think at some point in life you’re going to decide, you know what, I’ve made my 700 grand into 7 million and you know what, I don’t want to keep doing this. So maybe at that point you start looking for when things start coming out, you start buying assets that are more long term. Now the classic thing to do in real estate terms is to buy triple net property. So that used to be the way in real estate investors always did it.
There was this mantra buy, borrow and die. So you would buy a property, you would borrow against it by another property, borrow against it by another property and all along that way you’re taking depreciation and of course if you sell all of it you’re going to end up paying a bunch of depreciation, recapture and capital gains. But what if instead of doing that you said, okay, well maybe I don’t need to have annualized returns with 30% at this point on $7 million or whatever, 5% is just fine by me. Okay, so if you did that say you invested in some sort of triple net real estate. The prototypical triple net real estate is the Walgreens and all of a sudden you’re getting a 5% coupon on that and it’s a 30 year it’s a 30 year lease.
That’s basically what people do. They shift. They go to lower risk, highly stable assets that they don’t have to worry about. And so that may be a consideration for you depending on where you are in life. Anyway, hopefully that helps. But again, it goes back to the idea that at some point you start allocating money into things that are not just about reinvesting, but you’re going to need to invest, frankly, in real estate in perpetuity in order to not have to deal with the recapturing capital gains. Now I said buy, borrow, and die. And why do I say that? Because when you die, all of that recapture goes away, resets basis for your kids. And so that’s why real estate investors do this. They buy stuff, they borrow and then keep doing that. Maybe they just move to something that’s not going to require a lot of work and then they die. And then their kids have these assets basically tax free because the basis resets. All right, I have one more question here and I’m going to read that one. This one is actually was not written to me as an ask but question. It was written to me as an email, so I’ll leave the name out. But it was a good question, so I wanted to make sure that we answered it.
Okay, so here’s the question. It says, Hi Buck, I watched a video on this site and he’s referring to the Wealthaccelerator [email protected] And he says, I have to say it’s not clear at all how it works. And if someone is not very familiar with other Wealth Formula Banking velocity offerings, video seems like fantasy land. He says, you know, I’m a fan of yours and have invested frequently with you. I just don’t feel like this one was well explained. The video explains the type of returns you can expect and says that you use life insurance beneath it. But it doesn’t really explain all where the arbitrage comes from and how it can multiply so phenomenally. Maybe the idea was to give a teaser, et cetera. Anyway, scratching my head. And so at any rate, this is actually really good to hear this kind of question because I think I try not to, but sometimes I’m also guilty of sometimes assuming that people know certain parts that we haven’t necessarily filled in for them. Bottom line is the whole concept is driven by leverage. And I had Rod Zabrisky record an answer for us. So let me get that.
Rod: The next question. You saw our webinar on the Wealth Accelerator and had a few questions, including finding out where the arbitrage comes from and then secondly, how it can multiply so phenomenally. So just to really quickly get people caught up on the wealth accelerator. Is it’s using life insurance? Combination of whole life and indexed universal life. We initially fund the policies out of pocket and then as early in most cases beginning in year two, we continue to fund the policy, but through financing through a bank. So specifically what we do is we set up a line of credit using those policies as collateral. The cash value in those policies are collateralizing the line of credit, and then we just start funding and keep funding those policies through that line of credit. So the idea is that we’re building an asset cash inside of those policies. The asset is acting as collateral for this loan that we’re creating. And over time, we’re just going to create more growth in the policies than what we’re accruing an interest on the loan.
And that’s really, at its core, what those life insurance policies are meant to do in the way that we design them. They’re meant to grow the cash value at a higher rate than what regular interest rates would be through loans. So more specifically, we’ve done a ton of backtesting and predictably can create about a 2% spread. In other words, the growth in the policies versus the interest that we’re accruing on the loans, we can now pace it by roughly 2%. That’s that Arbitrage that Brent is asking about. So in the policies, we create growth with Whole Life. The growth is generated by a guaranteed interest rate plus a dividend. It’s not linked to the stock market at all. It’s influenced by interest rates. Interest rates rise. We are going to see a rise in the return of the insurance company, which means that dividend goes higher, they pay out a better return in the policy, interest rates go down.
You see, the opposite happened in the index Universal Life. The growth of the policy is based on a market index. The money isn’t actually invested in that index. So let’s say the S. Amp p. 500, for example. We’re not actually investing in the SMP, but we’re using it as a measuring stick to determine how much interest we earn each year inside the policy. When the market is up, we gain based on that up to a certain cap. In a year where the market goes down, that index loses value. We don’t participate in those losses. We just don’t earn any interest in that year. So on average, we’re going to create more growth in those policies than the interest that we’re accruing on the loan. Now, there will be years where we earn less growth than the interest on the loan, and there will be years where we do more. Historically speaking, when we have gone back and again done this back testing, there’s never been a 15 year time frame where we would have seen less than a 2% spread.
So that’s actually the number we use in our projections. We assume on average, 2% higher growth in the policies than what we’re accruing in the loan. So that’s where the arbitrage comes from. And the second question about how does it multiply so phenomenally? Well, we’re just jacking this thing up with a ton of financing. In other words, in the example that we showed on the webinar, we showed someone putting an initial contribution to $500,000 and then financing all future funding of the policy at $500,000 per year. And that doesn’t stop after five years or ten years. We’re just going to continue to fund that policy through that financing. And so in some of the other presentations we’ve done with premium financing, we’ve talked about a three to one ratio of for every dollar that they put out of pocket, we were financing $3. We’ve had other programs, nine to one. For every dollar they funded, $9 came through the financing. In this case, you think about it depending on the age of the person starts. But if we’re funding this over a 2030 year period of time, then it becomes a 20 to 130 to one type of ratio.
So as far as the question about how does it multiply so phenomenally, it’s that leverage, but it’s compounding at that rate. So when you think about the real estate that you invest in, and you put a down payment of say, 20%, and you finance the other 80%, well, you just used basically a four to one ratio and you create some really cool results from that compounded over years, especially. So in this case, it’s a larger ratio of the leverage that we’re using compounded over 1020, 30, 40 years. So that in that example, that initial 500,000 going in produced $25 million of income between the person’s age of 55 and 90. And then it also put out another $12 million in death benefit. And that doesn’t all happen upfront, right? The initial income was lower. But again, as we continue to fund the policy, finance those premiums going in, it just continues to ramp up that income. So that if at age 55, in this example, the income was about 23,000 by the time they’re 90 years old, it’s a million plus of income per year that they’re getting out of there. So it’s a mechanism of ramping up the leverage inside of there and growing at a compounding rate that just turns a relatively small number 500,000, not a small number, but relatively speaking, into 25 million plus 1230, $7 million worth of benefit coming out the back end. And that became the equivalent of about a 14% IRR on that initial 500,000 that went in. So the wealth accelerator is built to produce a double digit return in a place where we’re primarily using leverage to magnify what the life insurance policies are doing.
And I’ll also say this, it’s built four times like we’re in now. In other words, interest rates are going up right now. So we have a lot. Of people who have concerns about that, how’s it going to perform? Is it a bad time to get in? Well, at the end of the day, it’s not a bad time to get in, because these times are assumed that they’re going to happen. We know they’re going to happen. We structured it in a way to take on times like now and still produce really impressive double digit, tax free returns over a long period of time. Hopefully that gives you a little better feel for the Wealth Accelerator. If you haven’t checked it out already, go to Wealth Forming the Banking.com and take a look at the webinar to get maybe a little more of a base of understanding and then come back and listen to my answer again, and hopefully that will help expand on what you learned in the webinar.
Buck: Okay, there you have it. Rod, thank you for giving us a little bit more detail on the Wealth Accelerator, by the way, even though evidently we didn’t explain it very well, I really love that particular product. So check it out, Wealth Accelerator. Go to WealthFormulaBanking.com.
That’s all I have for this week of Ask Buck. I don’t have a lot of other questions, so unless you guys have more questions WealthFormula.com, that’s all I got. And we will be right back to close it out after these messages.