Do you own an investment property valued at $1,000,000 or more?

Do you pay federal income taxes?

Do you operate a corporation or entity that is for-profit?

Are you planning to the hold the property for more than one year?

If you answered yes to all of these questions, you are eligible to enter a raffle that will be held at the end of this article.

Just kidding. But you are eligible for major tax benefits, so keep reading.

You already know that real estate is the best industry to be in, but  you’re about to learn that it’s even better than you thought. Why? Because of all the tax perks that come along with it.

What is Depreciation?

It’s one of the best gifts Uncle Sam gave to property owners and real estate investors. Depreciation is a special tax deduction based on the concept that the more something is used, the lower its value goes. When you drive a new car off the lot, it immediately goes down in value. It’s the same with real estate. Every year, the IRS allows you to take a deduction of the property value against that loss in value. (This does not include the value of the land, which doesn’t depreciate each year). But here’s the best part — this applies even if your property value is appreciating each year!

Related: How to Use Cost Segregation to Increase Annual Depreciation (& Save Money!)

Simply put, depreciation is a paper write off for real estate.

OK, so I understand what depreciation is. And I know that a residential property is depreciated over 27.5 years—and a commercial over 39. But what does it mean to accelerate that depreciation?

These are very long periods of time. To make the benefits of depreciation more tangible, the IRS established shorter “lives,” as follows:

  1. Five years for personal property within the building (flooring, boilers, etc.)
  2. Fifteen years for ‘land improvements” outside the building.
  3. The standard 27.5/39 year rate for the structure of the actual building.

What does this mean for you? You can depreciate the value of the first two categories of assets at a faster rate and start saving on taxes during those first few years after purchase. These savings you can reinvest in other ventures.

How Much of a Property Can Generally be Re-classified Through Cost Segregation?

Usually between 10 percent and 30 percent of the property value.

OK, so let’s make sure I understand this completely. What are some examples of five-year personal property?

Flooring, carpeting, wall coverings, appliances, furnishings, special purpose lighting, special purpose plumbing, special purpose electric, and much more.

What are examples of 15 year property  land improvements?

Asphalt, fencing, landscaping, signage, etc.

Wait. So, all these years I’ve been willingly lending the IRS my money when I could have possibly lowered my tax liability to ZERO?

Umm…yes. But you can stop today!

Now comes my most important question:

Why Didn’t my Accountant Tell me About This?

A CPA isn’t qualified to perform cost segregation. Tax knowledge is not enough. You also need to understand engineering to calculate how each structure depreciates. That’s why there are cost segregation firms – which employ engineers that are trained in the tax code and tax experts who work together to conduct the cost segregation study.  

Your CPA can certainly apply the results once the cost segregation study is complete. But the IRS recommends (not requires) that those “competent in construction methodology or techniques” perform the actual study determining how much you can save.

Who Works at These Firms, if Not Accountants?

The firms hire engineers that are trained in the tax code and tax experts, and they work together to conduct the cost segregation study according the Cost Segregation Audit Techniques Guide from the IRS.

But you can’t just make claims. Everything has to be documented: what you built, when it was built, and how much you paid for it. The construction budget or the AIA (American Institute of Architects) documents will be used during the study.

Does This Mean That Certain Materials and Building Methods Can Save me More Money?

Yes. The materials used and how they are affixed make a difference in whether the property is considered a five-year property. As we said above, if something is part of the main structure, it is not personal property and can’t be accelerated.

What Are Some Common Examples of Things That Could be Eligible if Done Properly?

Floor coverings — if it’s affixed with permanent adhesive, nailed, or screwed, then it’s considered part of the structure.

Not eligible: ceramic tile, marble, paving brick, or permanent wood floors.

Eligible: strippable adhesives such as vinyl-composition tile, sheet vinyl, carpeting, and floating hardwood floors.

Should I Have Cost Segregation in Mind Already as Soon as I Start Building or Renovating?

You should. A savvy real estate professional will keep this in mind.

Related: Your Tax Write-Offs Could Affect Your Ability to Get a Loan: Here’s How

What are Other Examples of Things That Could be Eligible?

  • Mirrors clipped to the wall instead of glued on.
  • Portable air conditioner units that plug in instead of being hard wired.
  • Demountable walls. These have become a very common trend in corporations, educational institutions, health care, and government organizations. Such walls, in addition to making customizable work space easy, can bring in major tax savings as they are not considered a structural component.

Are There Other Benefits to Bringing in a Cost Segregation Expert in the Planning Stages?

Yes. Cost segregation engineers can review the construction contract and identify the line items that need to be priced out separately. Knowing the actual costs will allow for a much more accurate report than having the engineers estimate the cost down the line.

When Does the Property Begin to Depreciate?

Depreciation begins when the property is “placed in service.” For a new construction, this is generally when the property is advertised as “ready to move in,” or when monies have been transferred to a permanent account.

When Doing Renovations, What Needs to be Capitalized and Depreciated — And What Can Just be Deducted as an Immediate Write Off?

If the property is rehabbed before being put into service, the rehab expenses should be added to the basis. If rehab work is done while in service (tenants are still there), you can fully expense an item that would normally be capitalized if it’s less than $2,500.  

You can only fully expense those items (it’s called de minimis safe harbor rules if you want to get technical) after the property is placed into service. Where the expenses were incurred before the property is placed into service, then they almost always have to be capitalized.

That’s the technical answer.

Does This Put me at Risk of an Audit?

If the engineering report is well-documented, the cost segregation is not only a permissible depreciation method, but it is actually the preferred technique under the internal revenue code. However, if a CPA uses ad hoc calculation, or relies on a contractor’s guesstimations of cost, it is a surefire way to fail in the event of an audit.

Are There Any Other Advantages of Doing a Cost Segregation Study?

If a building component subsequently needs replacement and a cost segregation study was done on it, taxpayers can write off that component’s remaining tax basis.

Example: A cost segregation study showed the carpeting to be initially valued at $100,000. Two years later, when the carpeting has an adjusted tax basis of $80,000, it needs to be replaced. The taxpayer could deduct an $80,000 loss. Without a cost segregation study, though, no loss could be taken because the carpeting and building tax basis would remain intertwined.

What is 100 Percent Bonus Depreciation?

A new law that took effect on September 28, 2017, determined that any five- or 15-year asset placed in service (by you) for the first time — whether it was just constructed or newly acquired — is now eligible to depreciate the entire value of an item in the first year. With this law, it is more important than ever for real estate companies to use qualified cost segregation experts to maximize their savings and be eligible for 100% bonus depreciation.

What is the Biggest Fear When Discussing Accelerated Depreciation?

Depreciation recapture. When you sell a property, you must pay tax (capped at 25 percent) on the amount that you took depreciation deductions. So if you took $100,000 of depreciation deductions, you will have to pay $25,000 in tax upon sale of the property. This is only if you sell for a profit. However, the amount of personal property depreciation that was taken is taxed at your ordinary income rate.

Can This be Avoided?

With a 1031 like-kind exchange (details in another article) you can defer these taxes even further.

If I Accelerate the Depreciation on my Five-year Personal Property, Will I Have to Pay Taxes on All of That When I Sell?

It depends. Consult your CPA or tax adviser to learn about different strategies.

“You were right — I really did win a lottery. I’m going to cash in on it now!”

Do you have questions about cost segregation?

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Are you curious about investing but not sure if it’s right for you? I used real estate investing to pursue financial independence, but I had some doubts along the way. Personally, I have only done flips and buy and holds, but here’s what helped me figure out if real estate was the way to go:

1.  I Laid Out My Intended Role

A fantastic first question to ask yourself is: How much or how little do I want to be involved in my investments? Real estate can serve many purposes in many different ways. For example, real estate investment trusts are almost entirely passive. No middle-of-the-night phone calls, no managing, no nothing. You can also hire (competent) property management companies to take care of your properties. This way, you can stay as involved or uninvolved as you prefer.

If you prefer to manage yourself, you absolutely can. I personally invest in three different markets, and I manage about half of my portfolio right now. A company manages the other half, and I keep tabs on them. Prior companies I’ve trusted my properties and money with have made accounting errors and placed poor tenants in my property without my consent. That was a costly mistake that only I was responsible for. As a result, I tend to be really involved in my properties.

The major question is, how involved do you expect to be? To what extent can you trust and delegate to others? To what extent are you capable and confident of learning the laws regarding tenants and landlords? Many people invest and realize it’s more intensive than they want it to be. For me, it’s really not a bother to manage my properties. I’ve had a few late phone calls over the years, but I have an amazing team that helps tenants whenever they need it — and that’s key.

Related: Keep it Simple! 3 Ways to Launch Your Real Estate Investing Business

Not only that, but what is your temperament like? Are you able to provide a customer-oriented service that is also stern when necessary? I tend to be softer than I should be. For example, we just had vacating tenants who had things nailed into every surface of the wall they could find. They asked for the paint color so they could pass the move-out checklist. I gave them a paint color I knew to be close but not exact, advised them as much, and told them they needed to be sure it matched before proceeding. Well, they didn’t, and I had a cheetah-print light gray on slightly-lighter-gray condo when they moved out. I charged them minimally from their security deposit because I felt bad for not providing the correct paint color. A week or so later, I woke up and realized, hey—that’s not my fault! Please feel free to give me a tough time over that. My point is, even a few years in, I still find myself being a little too soft. I’ve successfully put my foot down on a number of items (such as lease breaks) without problem, though.

2.  I Determined My Goals & Priorities

What purpose is investing in real estate going to serve you? I figured out my financial blueprint from Secrets of the Millionaire Mind and found a way for rental properties to serve it. My goal? Financial security and financial freedom. Funny how those two words work together when we talk about money, eh? If your priorities are set and you are driven to work toward them and real estate can serve them, you’re likely going to be able to tolerate the ups and downs associated with real estate.

3.  I Learned to Let Go

Give yourself room to grow!  Not everything will go your way. I’m a very type-A person, unfortunately. This works to my advantage in many ways, but it has also allowed me to become more stressed than needed in some cases. I’ve grown into a much more relaxed person when things go wrong. Like when someone in your condo building accidentally sets their condo on fire. Or when a contractor suddenly gets arrested and goes to jail. I laugh at these two items now, because they have legitimately happened to me, and it makes it look like I run a circus of a business. I promise, I don’t. But there are always lessons learned along the way.

You can plan, and vet, and plan, and vet, and things still may not go your way. I am a very active person, and I usually have quite a few things going on in my life. Major appliances and other big repairs tend to need attention the moment I arrive in a faraway country half a world away. But that’s OK! That’s life. And things work out one way or another if you have a good system set up.

4.  I Taste-Tested It

No one is going to force you to become a legitimate real estate investor. Once I started blogging about this on my personal page and whatnot, I became the point person for friends and friends of friends regarding real estate, financial independence, etc. A friend of mine recently relocated for work and decided to try renting his house out rather than selling it. Sure, the market can fluctuate during that time should he decide against landlording, but it’s a risk he’s willing and able to take (key word: able).

Related: 10 Lethal Mistakes to Avoid on Your First Real Estate Investment

5.  I Learned More & Built More

Lazy people are the best, right? They think efficiently. I wouldn’t say I’m lazy, per se, but I definitely don’t like to spend time doing menial or pointless tasks. Neither do other successful business owners, which is why the Pareto principle is a thing! If you think spending time on whatever real estate task is too much, is there a way to bring that down so it’s tolerable? If it’s worth paying someone else to do it, can you delegate it to someone else? Do the numbers work on these properties you’re considering? Learn more before diving in, and take a calculated risk if you’re willing and able.

Once I started gaining more properties, my initial investment was paid back and profits were being rolled into new properties. I enjoy finding properties that give me a 30 percent ROI. That’s quite a bit more than the average of 7 percent over the stock market’s lifespan. I like being in control of the company’s decisions and installing environmentally-friendly showerheads and other low-flow appliances to save water.

Conclusion

I’m not saying that you absolutely should invest in real estate, but you definitely need to consider what you want from these investments and what you’re willing to do in order to reach your goals. You may have a bad experience here and there. It happens. And it has happened to me and many others. But for me, any time I need to do something real estate related, my average hourly rate is well above anything I’d make in another highly skilled job. I’m not working 40 hours a week, but I’ve cut my spending drastically (lower than Mr. Money Mustache even!) to a point where my properties can fund my way of life. That’s the dream I set out for myself, and as I sit at home during the day petting my dog and writing blog posts every now and then, I think I made the right choice.

What steps have you taken to lay the foundation for your real estate career?

Share them below!





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After Tuesday’s Case-Shiller report showed a 6.4% increase in home prices, experts in the housing market indicate wage disparities and lacking inventory as critical motivators. Keller Williams Chief Economist Ruben Gonzalez predicts that home prices will continue the upward trend, largely due to consumer demand.



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Today, S&P Dow Jones Indices released its results for the Case-Shiller Home Prices Indices, which showed an annual increase of 6.4% in April 2018 for national home prices. Seattle, Las Vegas and San Francisco continue to have the highest year-over-year gains among all 20 cities.



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Today the question is this: How do you know if you’re investing in the wrong market? 

I’m probably going to sound like a broken record here, but it is very, very important that you build trust and relationships with the key people who are going to be involved in your real estate ventures. For example, you need to have a good real estate agent, property management company, accountant, and possibly attorney. You need to have contractors, a rehab crew, a title company, advisors and mentors. You need to be part of a real estate club, and you need to be part of an online community. Don’t forget your network equals your net worth. 

Success won’t happen overnight. It is going to take five, 10, or 15 years to build a lasting portfolio that will be able to offer you financial freedom. You also want to work with people who understand what delayed gratification is and what planting a seed now and reaping the harvest later is.

So how do you know if you’re investing in the wrong market? My experience has led me to believe that I should forget about all the online stats and demographics. As I mentioned to you, the team is by far the most important thing. So, let’s just hypothetically say that you have found the right team in a particular market that you have researched. Then, you need to get down to the fundamentals. That means cash is king and cash flow is queen, and you can forget about appreciation because that is a crystal ball analysis. We do not know what tomorrow brings, so you cannot include any appreciation estimates into your calculations.

Related: Here’s Why the Market is Exactly Where It Should Be

You may think what I’m going to share with you won’t work in your market. Look, I understand because I attend a lot of conferences nationwide, and a lot of these institutional companies and buyers are talking about a lack of inventory in markets that have a seen big appreciation. I get it. Well, then don’t invest in that market. It’s as simple as that. Invest in a market where the numbers make sense and just focus on the cash flow. That is my belief, take it or leave it, but I do not believe in appreciation. I do not believe in speculation. I believe in the core fundamentals of a deal as it lies today.

For the Hands-Off Investor

In order for a market to make sense, you’ll need to follow the numbers. If you are not getting numbers that work, then you are in the wrong market, period. If you are buying turnkey or buying a renovated property through a real estate agent, it is my belief that unless you are making 8 percent in net cash flow, then you should not do the deal and you should not invest in that market. Again, 8 percent net return on investment. I also want you to include a margin of safety where you are overestimating your expenses like maintenance and vacancy deductions. What are some of the deductions when you’re calculating your ROI? You have hard costs like property management fees, insurance, and property taxes. Then the unknowns are the maintenance, vacancy, and CapEx, unless the property has been recently renovated, and then you can include those costs in there too.

The rule of thumb is to overestimate your expenses and underestimate your income. Once you have done that and the numbers on paper produce less than 8 percent net return on investment, don’t touch the deal. That is my honest belief. You’ve got inflation coming at you at 2-3 percent every year, so you want to be making some kind of money. You still want to minimize your risk as much as possible or you might as well take your money and put it in an index fund. If you want to be as hands off as possible, you need 8 percent net. Unless a market offers those numbers, forget about it.

Related: Why “Overpriced” Markets Like San Francisco May Be Healthier Than You Think

For the Hands-On Investor

Next, if you are like me and are happy to get down and dirty and do deals, then begin to hustle and negotiate. Also, send out a lot of yellow letters and not buy properties on the MLS. Try to keep rehabs to a minimum. Personally, I would not get out of bed unless I am making a 15 percent net return on investment. Those are the numbers that I do if I’m buying and holding for my portfolio. I encourage you to reach out to me because I am happy to show you the numbers that I am doing in my market. Again, that’s going to come down to finding a property and buying it cheap because you make money when you buy, not when you sell. You want to buy it for as cheap as you possibly can. Remember, rehab always goes over budget.

So, I buy cheap and I negotiate well. Then, I rehab to an average standard and have my property management company to manage. Remember, I won’t do the deal for my own portfolio unless I am making 15 percent net. A lot of people ask me what I’m doing in Toledo. I say I’m here because the numbers make sense, and I moved here from Australia because it was a once-in-a-lifetime opportunity. I just don’t know of any other market where I can find a better return on investment. It’s all about the Midwest, period. That’s where the deals are and where the cash flow is. Forget about appreciation. Focus on the core fundamentals of that particular transaction as it lies today.

If you live in an expensive market where you can’t find these numbers, move to market where you can. I did it. It’s a sacrifice, but nothing comes easily, especially if you want financial freedom.

Hate it or love it? I welcome your criticism. I welcome your comments. Please feel free to comment below.

Am I right? Am I wrong? I’d love to hear from you.





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Wealth is not an accident, it’s a choice. And on today’s powerful episode of The BiggerPockets Podcast, you’ll learn exactly how to make that choice each and every day. We’re excited to bring back two return guests, Hal Elrod and David Osborn, to talk about the choices that wealthy people make to ensure they stay focused on reaching their goals. You’ll hear about Hal’s recent battle with cancer and the mindset that allowed him to overcome the odds and live. You’ll discover how your diet can make you wealthy and how to command your day from the moment you wake—even if you aren’t a morning person. And you’ll discover the powerful concept of having an “air game” in addition to your “ground game”—and how understanding the distinction can make you wealthier than you have ever dreamed. Packed with wisdom, humor, and incredible insight, this show will leave you pumped up and ready to choose wealth.

Click here to listen on iTunes.

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We just waRealtySharesnted to give a shout out to our podcast sponsor on today’s show: RealtyShares. RealtyShares is a crowdfunding platform that allows you to invest in professionally managed properties without leaving your living room!

Learn more by visiting RealtyShares.com/biggerpockets!

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In This Episode We Cover:

  • Hal’s cancer survival story and the Miracle Morning movie
  • David’s latest updates
  • What their miracle mornings look like
  • How Miracle Morning for Millionaires came to be
  • Overcoming the “but I’m not a morning person” objection
  • How to own your agenda
  • Choosing to be wealthy
  • How to find the right group of people
  • The thing that’s more effective than work ethic
  • Tips on self leadership
  • How to develop unwavering focus
  • And SO much more!

Links from the Show

Books Mentioned in this Show

Tweetable Topics:

  • “It’s not about overthinking things. It’s about finding things that work and putting them into action quickly.” (Tweet This!)
  • “There’s no way you win in life without having your agenda and being purposeful towards your agenda.” (Tweet This!)
  • “The economic downturn was my lucky break.” (Tweet This!)
  • “Work ethic is not enough.” (Tweet This!)

Connect with Hal and David





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Chris and Debbie Emick have two daughters—AND are well on their way to financial independence through a combination of local and long distance real estate investing coupled with frugality and conscious spending.

Chris and Debbie are everyday Joes living the dream in small-town Colorado. Debbie home schools their two daughters and manages their rental property business from home, after her 14-year career in teaching. Chris is a passionate leader to his team of network engineers by day and organic gardener/personal finance extraordinaire by night. Their home base is rural Southeastern CO, where they can go for dirt-road runs and trafficless drives while still being able to make quick mountain trips for hiking, backpacking, and skiing.

This is the first in a periodic series of interviews with families who are on the path to financial freedom.

Click here to listen on iTunes.

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Help us reach new listeners on iTunes by leaving us a rating and review! It takes just 30 seconds. Thanks! We really appreciate it!

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The all-new FreshBooks is accounting software that makes running your small business easy, fast and secure. Spend less time on accounting and more time doing the work you love.

For a 30-day unrestricted trial, go to FreshBooks.com/bpmoney

In This Episode We Cover:

  • Chris and Debbie’s personal finance journey
  • Debbie’s autoimmune disease diagnosis
  • Lifestyle changes and adjustments they made to achieve their objectives
  • Using the YNAB app to budget their money
  • How they track all their spending
  • How their budget works
  • Why they invest their money in real estate
  • The very first property they purchased
  • Properties they have purchased since
  • The cash flow they produce from their portfolio
  • Household and quality of life improvements
  • Their goals for the next few years
  • What the cash flow quadrant is
  • And SO much more!

Links from the Show

Books Mentioned in this Show

Tweetable Topics:

  • “You find what you are looking for.” (Tweet This!)
  • “If we can do it, they can do it, too. It is just a matter of taking a look at priorities.” (Tweet This!)

Connect with the Chris and Debbie





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I’ve seen all the latest updates on the #TimesUp and #MeToo movements, yet it somehow manages to shock me each time I hear of something new happening. On a recent National Association of Real Estate Investment Trusts panel, real estate investor Sam Zell made some shocking comments. So when is enough going to be enough?



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The majority of individuals on BiggerPockets are investing in real estate because they want to create financial freedom. Blog and forum posts often touch on the fact that building out a real estate portfolio will allow you to achieve financial freedom. And I certainly agree with this notion. But what I’ve come to realize is that financial freedom isn’t what it’s all about.

Few people actively write about building a lifestyle. True, there are many blog posts that touch on lifestyle by roughly saying, “I invest in real estate so that I can eventually do these additional things that I love.” The focus is on building a real estate portfolio with the lifestyle as a result. And that’s the problem.

Today’s article is going to focus on building a lifestyle with the real estate portfolio or business as the result. What will be notably different in my article is that your desired lifestyle is the objective, not a number of units, not a “cash flow per door” number, and not even a “financial freedom” number. I want to turn the formula upside down.

We’re not investing in real estate and as a result, going to live an awesome lifestyle. Instead, we’re going to live an awesome lifestyle and as a result, invest in real estate.

Lifestyle is Secondary—Or is It?

There can be a high price to pay for financial freedom, especially if your means of getting there is investing in real estate or starting a business. Stress is high, money is tight, and your tenant just didn’t want to pay rent this month.

How many times have you met a business owner or real estate investor who is earning gobs of money yet openly complains about their lifestyle? With further prodding, you learn that these poor souls work insane hours, are always on call, and live in a constant jet stream of stress. But they earn $500k! Surely they are just cynical, as anyone earning that much must be happy.

Trust me, as a CPA who interacts with and provides services to plenty of folks earning much more than $500k, money quickly loses its value in regard to happiness. Money has a diminishing marginal return, meaning that after a certain point, each additional dollar you earn brings less happiness than the dollar before it. Research suggests this “peak” dollar figure is $70,000 annually.

tenant-screening-tips

Related: How to Use Lifestyle Design to Create an Ideal Retirement Driven by Passive Income

An example of diminishing marginal return: You order 10 cheeseburgers (you freakin’ love cheeseburgers!), and you eat them all in one sitting. You haven’t eaten in a while, so the first one is delicious. It truly hits the spot. The second one is also delicious. It’s cooked medium rare, nice and juicy, perfectly seasoned. The third one is good, but you are starting to get full so it’s not as good as the first two. By the tenth cheeseburger, you’re so full that the sight of it repulses you. That’s diminishing marginal return in a nutshell. Each cheeseburger is the exact same, but their value steadily reduces as you consume them.

I’m always curious to hear the backstory of these folks who earn plenty of money yet are seemingly unhappy. Unsurprisingly, the stories are all relatively all the same: “I dreamed about living ‘X’ lifestyle in the future, so I started this business/ invested in real estate to hopefully get there.”

On the flip side, I also have clients earning a high amount of money who are perfectly happy. They love what they do, and more importantly, they love their day-to-day. When I ask them about their backstory, their stories generally go like this: “I had a lifestyle that I wanted to live today, and this business was what complimented that lifestyle.”

And that, my dear readers, is the key difference between living a life of full of wealth and happiness and one of just monetary wealth.

Lifestyle Starts Today

I learned this rather quickly in my career so I’m quite grateful: Lifestyle starts today, not tomorrow.

The key point I want to impress upon you throughout this entire article is that you don’t have to wait 15 years to achieve financial freedom and then begin living your desired lifestyle. Instead, I want you to think about the desired lifestyle you want to live right now and figure out what steps you can begin taking to implement said lifestyle immediately.

I’ve never met someone who wanted to be unhappy—yet many people are unhappy. And if you look closely, most of them have a common theme running throughout their life: Their desired future lifestyle dictates how they live today. They are sacrificing their present time for future happiness.

Now, I’m not suggesting that you drop everything and put forth little work or that you don’t think about the future lifestyle you’d like to achieve. What I am suggesting is that you begin implementing the lifestyle you want to live today and build everything else around you to supplement that lifestyle.

You’re still going to sacrifice plenty. You’re still going to stress and wonder if you’re doing the right thing. But the key difference is that we are focusing on crafting your lifestyle today, rather than setting a target number in our minds and saying, “Once I hit that, I’ll begin to live the lifestyle of my dreams.”

save_money_invest_lifestyle_design

Where Do We Start?

Frankly, I don’t really know. I’m a CPA, not a guru trying to sell you my coaching program for $20,000 (I take check or credit—just kidding, of course).

What I do know is that crafting a lifestyle that I’ll enjoy on a day-to-day basis has been my goal from the get-go. I don’t want to wait 20 years to “retire” and live the lifestyle of my dreams. I want to do that today.

So I’m going to walk you through my logic of how I built assets around me to supplement the lifestyle I wanted to live. Hopefully you’ll be able to take something away from this and implement it in your own life.

The first step is to define the lifestyle you want. After my first few months working for a Big 4 accounting firm, I decided that the corporate lifestyle was not for me. I didn’t understand why one must commute to an office for work that could easily be done in the comfort of my own home. I thought the whole “dressing up” thing just got in the way of providing high quality work. The last time I checked, a suit and tie, while studies suggest makes you more confident, don’t improve your intellect nor work product.

Worst of all, I didn’t understand why people of high integrity and character were required to show up a 9:00 a.m. every day. If the deadlines are met, the quality of work is high, and the client is happy (the most important thing), then why does it matter when someone walks into the office? It seemed the performance measurements were backwards.

I disagreed with the values of the corporate lifestyle, how they held individuals accountable, and how they measured performance.

So I began to sketch out what my ideal lifestyle looked like. I knew that I wanted the flexibility to work in my pajamas at home. I knew I wanted to be able to work anywhere in the world seamlessly while traveling. And I knew that I wanted my performance to be measured by something other than whether or not I billed 1,800 hours out of the 2,080-hour work year (that’s called “utilization” in the accounting world).

I determined the best thing to do was to build assets around me that allows me to accomplish these things. The two asset classes I chose were real estate and a professional services business. But the key for living my lifestyle would be a laser focus on implementing systems that complimented my lifestyle.

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Building Assets and Focusing on the Systems

When people focus on a number to achieve their desired lifestyle, the business systems get put on the back burner. Instead, you should be focusing on the systems you must implement in order to live the lifestyle you want today.

As I mentioned, I decided that investing in real estate and running a business would both complement the lifestyle I desired to live. The problem was that real estate typically requires a hands-on approach, and professional services firms usually have offices that clients can walk into—both of which go against my desired lifestyle of working anywhere in the world.

The real estate solution was rather simple to figure out. I knew I needed properties that cash flowed quite well, as I needed all of my expenses to be covered. The cash flow would allow me to “buy” teammates on the ground and put the asset in auto-pilot mode, allowing me to be 100 percent virtual. I could invest in areas I visited frequently or wanted to travel to once a year, and I’d require that my property manager send me a video walkthrough of my units quarterly.

Related: How I Saved $20,000 in 2014 and Used it to Invest in Lifestyle Design

On the buy side, I’d research the city’s economics like crazy to make sure the local economy was growing and not subject to undue risk. I’d use Google street view to explore neighborhoods. I’d place offers sight unseen and only travel to the property post-inspection.

Using these “desktop” methods, I’ve picked up two 3-unit properties. These two properties cash flow well and cover most of my monthly living expenses, though I don’t actually use the cash flow for my monthly living expenses. The point is, if the going gets tough, I can rely for a short amount of time on these properties.

The business solution was a bit tougher. When I hammered out what I wanted my lifestyle to look like, I knew there were very few corporate jobs that would support it. The next step was to start a business, and since I had a CPA, I naturally started a CPA firm.

It was tough to figure out how to build a CPA firm that would support my lifestyle. My biggest obstacle was the preconceived notion that clients would want to walk into a CPA’s office and shake his/her hand. But I knew the lifestyle I was crafting so I laid out the ground rules for my CPA firm:

  1. I will not meet clients face-to-face. Instead, we’ll hold meetings over the phone or video calls. This goes for local clients as much as non-local.
  2. My marketing will be content rich. I will develop awesome content that people derive massive value from. A potential client will read my articles and “test me out” prior to ever scheduling their first consultation.
  3. I will develop business systems that will support a virtual practice. Document sharing must only be done in the cloud. I will not accept paper documents.
  4. I will hire employees and not require them to be local to me nor come into an office. They will enjoy the same lifestyle I do. This means they have to want to live the lifestyle I’m living. I will also need to develop metrics that focus on results, not the amount of time an employee works.

With that, I was off to the races. I started making massive strides to get content out there, and I used BiggerPockets as my growth platform. It was tough and took a lot of sacrificing, but two years later, I have a firm that supports my desired lifestyle.

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Conclusion

My point in telling you this is that I didn’t say, “I want my lifestyle to be ‘X’ in the future, so I must build a business to reach ‘$Y’ in annual revenue. At that time, I’ll be able to live the lifestyle I want to live.” Instead, my method of thinking is, “I want to live ‘X’ lifestyle and I’m going to build ‘Y’ assets and systems that complement the lifestyle I want to live.”

With my way of thinking, you won’t be putting your desired lifestyle off into some distant future point. Instead, you’ll start thinking of ways you can move toward living your desired lifestyle today. Sure, it takes sacrifice and hard work. It took me two years to get my business to a point where I could actually live the lifestyle I was actively trying to build. But in those two years, I had a laser focus on building a business that complemented the lifestyle I wanted to live. My virtual lifestyle was the objective; the real estate and the business were the results.

Many people make the mistake of letting their lifestyle be the result and their investing or their businesses the objective. Don’t do that. Focus on building a lifestyle portfolio and business. You’ll be much happier in the end.

We’re republishing this article to help out our newer readers.

How are you designing a lifestyle that works for you? Do you agree with the above philosophy?

Let me know your thoughts with a comment!





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Most consumers do not grasp the difference between the price and the value of a product or service. Price is simply the amount of money paid or charged for something. When we focus on price, we are focusing on the short-term acquisition of a product. Value, on the other hand, focuses on the long-term aspect of the purchase.

Price is what a buyer spends, and value is what they receive in the transaction. When a buyer has received more value from a product than what they spent, this purchase is viewed as possessing great value. If a buyer values your product and can find a solution to his problem with your product more than he values his money, then he will purchase your product. People who focus on cost focus on the total cost of ownership, but people who focus on value focus on the total picture and how the product will create a solution.

Now, how can we compute value in real estate and specifically multifamily real estate? There are basically three methods of calculating real estate value: the cost approach, the sales approach, and the income approach. The sales approach is widely used in valuing single family homes, and the cost approach is utilized for properties that have few comps and for new properties (such as a church or school). Let’s focus on the income method, which utilizes the net operating income and cap rates to determine the property’s value. This is by far the best method to analyze apartments.

Hyperbolic Discounting

Before we dive into analyzing the value of a multifamily property, I would like to discuss the term “hyperbolic discounting” and why I think a significant amount of investors shy away from investing in multis. I was introduced to this term by Gary Keller while reading the book The One Thing, and hyperbolic discounting states that the farther away a reward is, the less motivated an individual is to achieve it. If I have a choice of earning $100 in two weeks or earning $500 in 18 months, most people will choose the present reward over the future reward overwhelmingly. This impulse of instant gratification is becoming evermore popular within our society.

This may explain why strategies such as wholesaling and fix and flipping are extremely popular to investors. These strategies employ much shorter time horizons than multifamily investments. A wholesaler can earn a profit in a matter of weeks, while a multifamily investor usually needs to dedicate a much longer time horizon to execute his business plan to generate his return.

There are other challenges that investors encounter when deciding upon multifamily investments, such as lack of capital or lack of experience, but I feel that not being able to focus on the long-term dissuades many investors from multifamily investing. I sometimes wonder if our society is losing the willpower and the persistence to see things through.

If you understand the value and the various benefits that multifamily offers, the decision of delayed gratification will be a no-brainer. So what are the benefits of multifamily, and how do we determine the value?

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Related: The 4 Phases of a Real Estate Cycle (& When to Buy a Multifamily for Maximum Profitability)

6 Benefits of Investing in Multifamily Real Estate

Here is a list of benefits:

  1. Cash flow. Apartments generate monthly income, what I like to refer to as wallet money. I compare cash flow to dividends paid by stocks. The money rolls in every month.
  2. Control. You are the captain of your own ship. You have the ability to control every decision that affects your investment.
  3. Tax advantages. It’s not what you make, it’s what you keep that’s important, and real estate offers tremendous tax benefits. Why would the government create advantages for this tax class? The government realizes it does not have the ability to deliver affordable housing, and by offering these benefits, it is trying to stimulate the private sector to step in and fill the void.
  4. Economy of scale: This is a huge advantage when trying to scale your business. I find it much easier trying to collect rent from 30 tenants in my apartment building rather than running all across the city to collect from my single family homes. It is easier and more cost effective to have more units under one roof.
  5. Ability to force the appreciation: The value is not as reliant on comps as it is your ability to increase the value through growing the NOI.
  6. Velocity of money: This refers to the ability to refinance a property, withdraw the equity, maintain control of the asset, and invest the refinance proceeds into another property. Banks are the ideal example of “velocitizing” money. They borrow funds from their customers and lend the proceeds out to individuals looking for loans. The faster the money moves, the wealthier you become.

Multifamily Valuation: How to Calculate Value in Multifamily Investing

Now that you’ve seen the incredible benefits that the multifamily space provides, how do you calculate value? In multifamily investing, it is all about the net operating income (NOI) of the property and the fact that the investor is purchasing the property based on an income stream. Let me provide you with a few definitions:

Operating Expenses

Costs that are incurred to maintain and run a property. Some examples include trash, snow plowing, and pest control.

Capital Expenditures

An expenditure for an asset that will improve or extend the useful life of an existing asset for a period to exceed one year. Some examples include water heaters, driveways, roofs and A/C units. I like to set aside $250 per unit per year in a cap ex account to address these “repairs.”

You may have to set aside a larger amount, depending upon the age and condition of the property. The cap ex figure falls below the net operating income, so it does not affect the value of the asset, but it will certainly affect your cash flow, i.e. the money you put in your pocket!

Net Operating Income

Annual income generated from a property less total operating expenses.

Cap Rate

The rate of return on an investment property based on the income. Cap rates are specific to a market and are affected by the type of property class (A, B, C, D) you are investing in. A broker should be able to tell you the cap rate in his market.

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Property Class

  • A Properties: Newest, shiniest asset. They contain many amenities and cater to white-collar workers. Expect low cap rates, around 2-4. This class of asset is poor at cash flowing but has the ability to appreciate greatly. I tend to think that investors choose A properties to maintain their wealth, not create it.
  • B Properties: Built within the last 20 years, this class caters to a mix of white and blue-collar workers. This type of property may show a bit of deferred maintenance, but overall, it has a nice mix of cash flow and potential appreciation. Look for cap rates around 5-7.
  • C Properties: My first real estate brokers defined C properties as “crap” properties, but loved their ability to generate substantial cash flow. I tend to agree with his candid analysis. These properties are usually 30+ years old and have deferred maintenance issues. Cap rates hover between 8-10 on these properties.
  • D Properties: The lowest class of property. They are usually located in inner cities where it’s difficult to collect the rent and vacancy rates are high. These properties are highly management intensive, and the tenant base is often difficult to deal with. Investors get lured into investing in these properties due to the low prices, but soon realize they got more than they bargained for. 

The goal is to increase the NOI by either increasing revenues or by decreasing expenses. You are trying to force the appreciation of the asset by increasing the NOI.  The term that is thrown around to accomplish this task is “reposition.” When you reposition an asset, you are adding value by changing the appearance of the property or the operations of the property, all to increase the NOI. You are focusing on the value-adds to a property.

Related: The #1 Thing Newbies Should Do to Get Started With Multifamily Investing

Example of a Successful Multifamily Reposition

Let me give you a quick example of a reposition on one of our assets and different types of value-adds we instituted. We purchased a property that had rents that were well below market, and many units that were vacant. Our goal was to address desperately needed deferred maintenance, while filling the vacant units.

We eventually filled all the vacant units and increased the rent rates on the current tenants from $450 per month to $625 per month. In a span of 12 months, revenue exploded from $53,000 per month to over $90,000 per month. In this example, we were able to increase the value of the property from $4.1 million to just over $6.3 million in only 12 months!

Examples of Value-Adds

Potential value-add items might include:

  • Adding upscale touches, such as two-tone paint and upgraded kitchen floors
  • Offering amenities, such as a fitness center or clubhouse
  • Instituting Ratio Utility Billing System (RUBS)
  • Changing the zoning on a property to a more favorable use
  • Generating new sources of revenue, such as laundry, pet fees, late fees, application fees and storage fees
  • Renovating a property to allow the owner to increase rents
  • Increasing the quality of the tenant base
  • Repositioning a C Property into a B property

All of the value-adds listed above need to focus on either increasing the revenue or decreasing the expenses. If you decide to install granite countertops, but you realize that this upgrade has failed to increase revenue, this would NOT be a value-add. One of the biggest mistakes investors make is to over-improve a property without focusing on the ability of the improvement to increase revenue. (I’ve done that a couple of times. OUCH!)

This is the beauty in multifamily real estate. You have the ability to increase the value of your asset by employing sound management principles to increase the NOI, thereby increasing the value.

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How to Calculate Multifamily Value Using Cap Rates

Now let’s tackle how you calculate the value of a property using cap rates. You would take the NOI of a property and divide it by the cap rate.

NOI/Cap Rate = Value

For instance, if the property had an NOI of $150,000 and the cap rate was 6, the property value would be $2,500,000 (150,000/.06). If the NOI increased to $180,000, the value would increase to $3,000,000. A $30,000 increase in NOI generated a $500,000 increase in value.

Cap rates have an inverse relationship with market value. When cap rates compress, as we are witnessing in the current real estate market, the value increases — and vice versa. It’s fantastic when you own property and cap rates are falling, but a real bummer when you are trying to invest. The formula for cap rates is:

NOI/Price = Cap Rate

For example, if the property had an NOI of $50,000 and was listed for $500,000, then the cap rate would be 10 ($50,000/$500,000).

Our strategy is to purchase assets based on actual numbers. We ask the seller to provide us with the last 12 months of income and expense figures, as well as the rent roll. Once you purchase on actuals, your job is to go to work on the NOI. In life, it’s not what you buy but what you pay that is critical to the success of any investment.

My goal in this article has been to describe what “value” is, why some investors are hesitant to jump into multifamily investing, the benefits of investing in this asset class, how to analyze a multifamily property and how to implement value-adds to an investment. Remember, at the end of the day, it’s all about the income versus the expenses.

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Related: Thinking About Buying a Multifamily? STOP! Wait Until You Read This!

Your Task

Decide now that you are ready to invest in apartments. Seek out websites, such as BiggerPockets, to begin your education. Immerse yourself in podcasts and books that focus solely on multifamily investing. Learn how to properly underwrite (another fancy word for analyze) deals.

Begin to visit websites that list multifamily properties, such as Loopnet, Costar, and Realtor.com, to become familiar with your market and the “players” in the market. Start networking with these individuals and ask them to start sending you deals to analyze. Expect to receive subpar deals in the beginning, but don’t quit. Tell them why these deals don’t work for you, and continue to analyze more deals. Formulate a business plan and strategy on how you will create value once you begin investing.

We’re republishing this article to help out our newer readers.

Investors: Do you choose to invest in multifamily real estate? Why or why not? Any questions about the valuation process?

Leave your questions and comments below!





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