The Real Estate Investor Radio Show – Single-Family Equity Capture vs. Multi-Family

Steve Davis on KSEV – Monday, August 24th, 2009
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Today we were going to discuss the differences or really compare single-family equity capture to the multi-family equity capture.

We’re also—if we’ve got time—going to talk about forced appreciation, the sixth way that every dollar you put into a piece of real estate makes you money that applies to multi-family. In other words you can actually change the value of an apartment complex by your actions.

Single-Family Equity Capture

Let’s talk about single-family first. And what I would like to do is take our standard bread-and-butter deal. We’re looking at a 80 to $120,000 3 bedroom, 2 bath, 2 car garage home, brick exterior, pitched roof, on a foundation, somewhere between 1500 and 1800 square feet. We’re talking about something that will lease at a thousand or less a month.

And right now, because of the foreclosures, we’re buying those things 30 and 40 and 50 cents below market — that means $100,000 houses selling for $60,000 at 40 percent below market. We’re then having to put $10,000 or 10 cents back into the deal for a total of 10,000 plus 60 is $70,000.

Then in many cases we’re paying high closing costs. And I’m going to use high closing costs even though for the majority of you you would not have to pay these high of closing costs, but I’m going to throw $5,000 in there for closing costs—again, a high number. That means all in including closing costs you’ve got $75,000 in.

Calculating Equity on Single-Family

The equity capture is the difference between the appraised value of that property, which was $100,000. All I did was go right in the middle of the 80 to 120, purchased a $100,000 house for 60. I made it completely perfect by putting what is a huge amount back into it, $10,000, to have 70 plus 5 in closing costs for a total of 75.

We’re going to say that out-of-pocket—even though for some of you the out-of-pocket would have been zero—some of you it might have been 12,500. We’ll say—I’m even going to go high on this — $10,000 out-of-pocket. $10,000 out-of-pocket. That leaves you with a mortgage of $65,000.

Net Worth Jumps

Now, what we then do is we look at that $75,000 you have in the deal and the $100,000 that that is worth. And what that does and what that means is that let’s say all you had in savings was $10,000. Your net worth was $10,000. You took that $10,000 and put it down on that property. Your net worth since you only owe 65,000 on that house just went to $35,000. Your net worth went to $35,000.

See, this one is a challenge for people because what people are used to doing, what most of you are doing is buying speculative things—you call them investments, but—and we’ll call them investments for this show, you buy speculative investments, buy low sell high, and when you take $10,000 out of your savings account and you go buy stocks, bonds, mutual funds for $10,000, guess what your net worth is when you’re done, $10,000 — if it’s not a bad day and it goes down in value that day.

We as real estate investors and you as real estate investors should be going out and buying stuff, true investments, that make you money the day you close that deal. When I take $10,000 and I put it into this deal, my net worth increases $25,000. My net worth—again, assuming you’ve only got 10 grand, on Monday you had $10,000 net worth, on Tuesday you closed the deal, you have $35,000 net worth, a thousand dollars a month more income to add to your personal income and a mortgage of around $800 a month.

So you’ve got about $200 positive cash flow off this deal. Of course it would be higher than that in this particular case, but that’s simply because of the investment. Remember our bread-and-butter deal has about $200 a month cash flow. There’s your equity capture in single-family, equity capture single-family.

Rates of Return

Let’s do the rate of return on that. If you put $10,000 into a deal and you instantly make $25,000, what rate of return is that? It’s a 250 percent rate of return.

Now, do you see why real estate investors—and this would work with any true business, but primarily with real estate—do you see why the real estate investor is getting wealthy so much faster than people who are in speculative things, gambling in the stock market, or mutual funds? We’re making 250 percent rate of return on our money the day we close the deal. That would be like you buying $35,000 worth of stocks for $10,000.

Now, there’s four other ways we’re going to discuss on single-family before we head into the multi-family that every dollar you have in a piece of real estate makes you money. There’s equity build up. There’s cash flow, there’s appreciation, and the tax advantage.

Cashflow and Tax Advantage

Let’s look first starting with the cash flow and the tax advantage together. The reason I want to do this is because first off how much tax do you owe on that equity capture that 250 percent rate of return? You owe whatever capital gains are, but you do not have to pay it—another powerful tool.

Let’s say you sold that property within oh, say a year and a half. You sell it a year and a half later. Do you owe taxes on that $25,000 profit? Yes. Are you going to pay it? No. Because what you’re going to do is you’re going to be following the golden goose rule that we’ve discussed so many times.

Are you going to pay taxes on it? No. Because you’re going to take that money like the goose — that’s the goose that—equity’s the goose. You never touch the goose. You only live off the cash flow.

You take that money and you 1031 it into more real estate, and it has to cost one dollar more. Now, of course you’re going to buy something that’s way more than a dollar more than you sold. But nonetheless, you owe no taxes on it.

ROI on Casfhlow

So let’s look at the next thing. We talked about the fact that your principal and interest, taxes and insurance payment are going to be right around $800 per month. You’re going to have a rent of $1,000 per month or $200 a month cash flow.

When you multiply that times 12 that ends up being $2400 per year profit. 2400 divided by the 10,000 you have into the deal is another 24 percent rate of return. Add that to the 250 percent rate of return you made when you bought the property, you’re up at 274. You’re headed towards a 300 percent rate of return.

Do you understand this? See, I don’t want anybody going, “I don’t see why real estate is that much better than the stocks, bonds, mutual funds.” It slaughters those things. Those things are not even comparable. And I know that this is harsh. Any incompetent financial planner, CPA that compares real estate investing to speculation is not qualified to be talking to you about investing. Period.

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