Why You’re Losing Money by Trying to Save It.
Today we have Eric Tait, MD, MBA, a physician and alternative investment expert. Beyond practicing medicine, Eric has analyzed, purchased managed, and developed numerous income-producing investment projects both domestically and now internationally.
He will discuss various ways you can invest your money and what he considers to be the best investment option to grow financially.
In this Interview Learn:
- Where most millionaires make and hold their wealth
- Why you need to be crystal clear before investing your money
- What the 1% Rule is
- A Simple formula to see if a property is a good investment
- The difference between price and value
I’m a fourth generation medical doctor. I did a dual degree MD, MBA program to learn business entrepreneurship along with medicine at Baylor.
I’ve always been entrepreneurial minded growing up. But one day my college roommate introduced me to Rich Dad, Poor Dad back in 1997. I started medical school in 1998. That book changed my worldview on money and business.
The MBA gave me the broad knowledge of what’s out there. How different businesses cater to different human needs. Through the traditional business education, we were taught about upper middle management or upper C-level positions. However, I was never really taught how to invest money wisely. So I went on a quest to learn how to invest my money in a way to give me more time in my life.
During Residency, I looked at all these different ways to invest money. Whether it be through trading stocks, being a long term buy and hold or even purchasing franchise businesses. But all of them required you to be very “Active” with every day management to really stay on top of it.
But once I learned the differences between active income and passive income, I chose the later. With active income, you have to put in hours and do actual work to earn your pay. Passive income takes a lot less of your time and you don’t actively have to be working to earn money.
For me, I found that Real Estate allows you to leverage the most of your dollar and create more free time for you to pursue the things you would like to do in life.
Why RE over other investments?
When I was trying to figure out what to invest in, I asked,
“Where do most millionaires and billionaires make and hold most of their wealth?”
The answer kept coming back to Real Estate.
I looked at all the different investment categories. Stocks can be great if you’re looking to trade, options, those kind of things. But what I consider investing to be is when your money is actually working for you. Stocks, mutual funds, 401K, IRA’s, etc, were unable to take me where I wanted to be.
Putting money into Stocks, the buy, hold, and pray model, didn’t work for me. It’s not that I did’t know how to invest in the stocks. I was trained in business school on how to “invest” in the stock market. But I chose a different, better alternative route.
If your money is not making at least 5% return, especially when you’re on a fixed income basis, you are actually losing money to inflation.
The point is not to save as much money as possible. The point of money is to be able to buy things that you need or want.
“Your money is always being eroded.”
It’s value continually goes down.
With the rate of inflation being about 4%, if your money doesn’t beat inflation in terms of return, then you’re really not getting ahead.
You’re actually losing money with it just sitting in your saving accounts. Sitting heavy in cash is one of the worst things you can do with your money in this economic environment.
But with real estate, it automatically fights against inflation. Inflation raises market prices, and if you invest in hard assets like RE, it will preserve and hold the value of your money.
Can you discuss active and passive income?
This is what I tell my investors. This is the most important thing that you need to do first. You must figure out what your investment philosophy is.
It all starts with you, you as the investor. What is it that you’re trying to accomplish? What is your investor identity?
How much time, effort, and resources do you want to put into accomplishing those particular goals?
You have to be very clear in your goals and what you’re trying to accomplish.
I’ll use myself as an example. There is this saying in medicine, “Medicine is a jealous mistress.”
Meaning, you’re not going to have lot of extra time to do other things while being a physician. Physicians can work anywhere from 60-80 hours a week.
This time limitation is also true for busy lawyers, accountants, and busy professionals in general.
For me, wealth is measured in time, not dollars.
Once you understand your goals, you can order and prioritize things in your life.
So you can begin to understand that you’re working to create active income. I’m going to work everyday to get a W-2 paycheck or a partnership income in a practice of some kind, whether it be law or accounting.
But you gotta understand that,
Active, earned income is what we call 50% money. It is taxed at the highest rate.
Pretty much if you’re in the top tax bracket, with federal, state, and other taxes, 50% of that money is being taken away from you.
So now you have to make a decision.
Do I do more of that? Try to build it up as fast as possible?
Understanding that eventually, you are going to have to work harder and harder as you get older, while making less and less in the future.
Or do I take that active income and move it over into portfolios to create passive income streams to lessen the burden of having to work that much harder later on?
Most of us make active income as we’re employed or own our own business.
But what do you do with that money you earned? Do you want to be an active investor or a passive investor?
Traditional investing is often seen in stocks. If you don’t buy and hold, then you have to actively manage and trade your stocks. So you can be an active investor in the stock market.
If you want to be a passive investor, you put your money away into bonds or IRA and hope somebody else will take care of it.
What about active or passive investing in Real Estate?
Now getting into RE, there is active and passive investing as well.
Active means you own a piece of the property yourself, whether you’re doing the work or hiring others, the final buck stops on you to make all the decisions on the property.
On the passive side, you’re pooling your money with other investors in commercial RE like hotels or shopping plazas. This is usually done behind a principal operator who finds and puts together investment deals. You don’t have to worry about making decisions on daily operations like hiring an electrician or doing maintenance.
Whereas if you own a single family home or a condo, you have to make those kind of decisions.
Passively investing your money in commercial RE is not the same thing as investing in a REIT. A REIT is a stock, it trades and performs like one. You don’t actually invest or own the property itself.
If you want to directly own RE, apartments, shopping centers, hotels, then you need to find an operator who puts those projects together. You can learn what they’re doing and take a ride with them. The passive investor gets behind an operator and gets a piece of the actual property.
What are typical rates of return in RE?
The US Federal reserve has printed 4+ trillion dollars last year. That’s money sloshing around the world looking for yield. Bond’s are not yielding anything, so there is so much money chasing a limited amount of deals. Demands for commercial RE projects are very high, so returns are not as high nowadays. Prices are going up because more people are paying for the same amount of assets.
So with Real Estate, there are 4 main areas you make money.
- Appreciation: price of property going up over time, or capital gains.
- Principal paydown: every month you pay down the debt, your equity on the property goes up.
- Depreciation: a phantom expense, tax free cash. It’s a tax write off for the income you get from the property. Even if the property is not making income, you can take the depreciation and use the tax write off on other sources of income.
- Cash Flow: Monthly income you collect from rent.
Again, before you start investing in RE, you must be clear on what you want. Are you looking for cash flow or appreciation of asset?
Anything you can do on the paper market in stocks, you can do with in RE.
So I would say about 8-10% in terms of total returns, from those four different ways mentioned above. Not all of it may be from cash flow or appreciation.
Can you go over different RE Asset Classes?
I’ll give broad buckets going from highest return to lowest return. I’ll tie them together with an underlying theme.
Don’t think about Real Estate on a national level. All RE is local. The real estate market in NY is completely different from the market in TX, which is different from CA, which is different from Beliz, which is different from China.
So #1, all real estate is local.
#2, it’s not a traditional asset class. in that you don’t interact with them. You can say you don’t want to own any stocks or bond. But you can’t say you’re not going to interact with RE. Because even the homeless person that sleeps under a bridge is still interacting with property. It’s not something that you can avoid interacting with.
If you’re just talking about asset classes within RE, there are SFR’s, condos, apartments, etc.
General Asset classes in RE from highest return to lowest goes as follows:
These are the Top Returns right now.
#1 Mobile home parks, manufactured housing. They have the highest rate of return right now. But they are very management intensive since things break down more often and the tenants are in the lower socio economic range. The rates can be anywhere from 10-20%, cash on cash return. (Cash on cash means, say you put $100k down, you’ll be getting $10-20k back every year in cash. This does does not take into account any appreciation.)
#2 Hospitality, Hotels and AirBnb. AirBnB in the right environment would be the next highest rate of return. But again, it is very management intensive. Next would be hotels, you can hire management companies to run it. Returns are about 8-12%, cash on cash.
#3 Retail shopping centers, not malls. Malls are having their individual issues now. Examples are your grocery stores, walgreens, CVS, etc. Returns are 6-8%.
#4 Multifamily Apartments. Now apartments used to be right below hospitality, but because there is so much money, pension funds and investors that want apartment complexes, their returns have been pushed down greatly in the market. Especially the A-class, those fairly new, built within 10 years time, which are highly sought after. Returns are about 3-6%.
The older the apartment complex, the higher the returns. But that’s because of the associated risks you take. Like now we have a 60 year old apartment we’re renovating and bringing in investors for. Our returns will be about 8-11% on it.
To get higher returns in apartments, you go for older properties and renovate when you can.
#5 Office buildings, similar to apartments. They are also highly sought after by institutional investors like insurance companies, big pension funds, etc. Return is about 3-6%.
#6 Industrial Warehouses. They are usually in longer periods of rental agreements. Again about 3-5%.
#7 Self Storage also has a lot of money being poured into it. It’s considered commercial, but if you’re not in a major city, you can get good deals in self storage, about 5-8% in those areas. In major cities, returns are much less.
Can you walk us through a formula you use to evaluate properties?
We have to start by understanding certain definitions.
Commercial RE is valued by the income it produces.
If you have two identical apartment complexes built by the same builder, but one is generating $1000,000 a year and the other is generating $50,000 a year, depending on the capitalization rate, the property with the higher revenue will be valued higher.
The Cap Rate is the rate of return you were to receive if you bought the property, all cash. Cash on cash return with no debt involved. Similar to the market multiple in stocks.
Net Operating Income (NOI) is the profit received after expenses are paid. (Does not take into account debt).
Revenue – Expenses = NOI
NOI / Cap Rate = Property Value
Ex. $100,000 / 5% = $2,000,000
On a 5% Cap Rate, any property generating $100,000 a year in net operating income, will be worth $2,000,000.
The Cap Rate is set by the market. You can’t control it. If apartments in the area give you 5% return, then it’s set. You can’t just go and say you want 8% return when the surrounding market gives you 5%.
But that’s the great thing about RE. You don’t ever have to buy, you have greater control in your investment. You can decide how much rate of return you want to make and then find the asset in an area that will give you that rate of return, which is determined by the cash flow.
This how you determine what properties will sell for and how you can price them out. The cap rate is very important. If you were a buyer, then you want a higher cap rate. If you were a seller, than you’d want a lower cap rate.
Cap Rates basically determine pricing of commercial real estate.
On the residential side, we have an easy 1% Rule.
The 1% Rule
If you have a house that’s worth $100,000, it should rent for $1,000 a month. If it does, you’ll make a decent return on it. 1% of the purchase price should be the monthly income.
If that $100,000 property can rent for $1,500, that’s above 1%, which will give you positive cash flow on the property. Anything above 1% is a great deal.
This is a quick and easy way to evaluate residential homes or condos.
Can you explain the Difference in Price and Value?
This is one of my favorite topics. This is what I try to get my investors to understand.
As Warren Buffet says,
“Price is what you pay. Value is what you get”
Price is what the market dictates. It’s the price you can sell the property for.
Value is determined by cash flow, or the revenue it generates.
It’s important to focus on the value rather than price.
If you focus on your cash flow, you will eventually get your price up. The market price can be very high or it can plummet. But if your cash flow is stable, that’s where the real value is. So you should always buy based upon cash flow. Don’t buy based on what other people are offering you at any specific point in time.
For example, if your 30 unit apartment complex goes down $1 million in market price, but your monthly cash flow is steady, you can pay down the note and still build equity. You don’t have to worry about prices going down. You can ride out the market with the cash flow, reinvest in your property, raise rent, and eventually the price will go up.
End Part 1 – Continue to Part 2 – “Using Debt to Create Cash”
ERIC S. TAIT M.D., MBA
Eric Tait is founder and fund manager of Vernonville Asset Management. VAM is a private investment firm that helps investors maintain their wealth through alternative investment strategies.
Eric has analyzed, purchased, managed, repositioned, and developed numerous income producing investment projects both domestically and internationally. He has personally overseen all aspects of the company’s day to day operations with help from trusted advisors and experienced contract professionals.
Eric is also President of Pinnacle Physician Management Organization, a Medicare Advantage partnership with Universal American Corp that has generated over $25 million in revenue since 2009.
Eric received his M.B.A. in entrepreneurship from the Jesse H. Jones Graduate School of Management at Rice University as well as his medical degree from Baylor College of Medicine. Eric is also a practicing physician in Internal medicine at a private practice in Houston, Texas.