February 7, 2013 by Dymphna

A Tale of Two Investors – Which Are You?

Today I want to talk about how you get started in changing your life for a better future with real estate…

I get quite a lot of emails asking me not just about real estate investing strategies, but also about getting to that place in your planning where you can begin to change your life to how you want it to be. To do, often that you first have to start doing things a little differently than you are at the present time in order to get different results than you’re getting today.

Think about the kind of deal, not the kind of property

For example, there are all kinds of real estate properties that you can invest in—residential homes, multifamily, industrial, offices, strips of shops and whatever else you can think of. But too often, people get tangled up in that snare of buying property without thinking about what they really want and need to do.

Students ask me what kind of property to buy, how many, and for how much, and all of that. But the type of investment property is really much less important than the type of deal that an investor puts himself into as it relates to his own personal financial situation and investing goals. Truth is, an investor’s time frame will be a big factor in determining the type of property he should buy.

Although every person’s situation is different than everyone else’s, there are two basic situations that apply to the vast majority of real estate investors that I talk to. And likewise, after years and years of working with all kinds of investors, roughly 75-80% of them fall into one of two broad categories of investors.

Investor #1

Let’s look at two common examples of investor types to show you what I mean…

Let’s say that Investor #1 has a steady job, earns around $75,000 per year as a manager at a company, has a $250,000 line of credit from her bank, likes her job, lives within her means and is looking for an investment property. Let’s also say she has a five-year time line to get where she can do whatever she wants to do. I don’t like to say, “retire” because retirement is such a dreary word and means a different thing to everybody. The reality is that, anyone can “retire”, in a short amount of time if they invest wisely.

Now, you might say, “well, that doesn’t apply to me. I make more (or less) that that, and my credit line is such and such. But it does apply to you; you’re just going to do things a little differently according to your own situation. So let’s just say that for Investor #1 to be able to what she wants with her life, living off her passive income, she has a five-year time frame.

With her $250,000 line of credit, Investor #1 can afford to look at quality properties in metro areas, in growth areas, even some very nice properties in the $1 million range, that she may be tempted to live in. But that’s not what she should be looking for. Investor#1 should be looking at multiple properties that are definitely not negatively geared (negative gearing keeps you poor your whole life) and at least neutral cash flow. By neutral I mean that all the money coming in is used to pay for the interest, the insurance, the management and the taxes on the property so it’s a net-zero for tax purposes.

Notice I didn’t count depreciation. That’s because I don’t view depreciation as a big factor in the overall process of cash flow. If you own the property in your own name, you might get some tax offset against your current salary, but I’m not keen about holding property in your own name for asset protection reasons I’ve talked about many times before.

So, a neutral cash flow property doesn’t cost any money on a cash flow basis.
Property design therefore becomes very important because Investor #1 will want to have multiple income streams coming from the same property so it reaches cash neutrality. It might be a house with a granny flat, a multifamily or blocks of units, or even a house where you can rent out each bedroom to students, for example, to give a higher yield.

The properties should be in a high growth area with a 7-10% growth rate and revenue neutral, with multiple streams of income from the property, whether it’s a resi-mercial (property that is both residential and commercial), or whatever type of property meets these criteria. In five years’ time, the value of the properties will have grown by quite a bit and rents will have gone up to where the properties are positive cash flowing. At that point, even if investor#1 hasn’t bought any more properties, she will be able to just live on the passive income if she so chooses. But of course, she should be buying more revenue neutral properties along the way, repeating the same process.

Investor #2

Now let’s look at investor #2, which I modeled after one of my students. He earns about $80,000 a year as an IT consultant, owns several negatively geared properties, and absolutely hates his job! What’s more, his negatively geared properties are absolutely killing him financially. He has a much shorter time horizon to pull the pin on his job, say 2-3 years at most.

He wants to be able to do what he wants to do with his life, such as becoming an artist, that doesn’t pay as much as his current job. In order to do reach that goal, Investor #2 will need to completely change his investment portfolio.

Investor #2 needs to concentrate on multiple, highly positive cash flow properties with the possibility of turning them into multiple income stream properties. He will need to focus on high demand areas like mining towns and regional towns, but it doesn’t really matter where the properties are located as long as they are providing high positive cash flow. Even with these criteria, he will also need to be able to manufacture value and income in those properties. It’s not important if his properties actually grow in value or not; rising income is what’s important for Investor #2.

Do you see the difference between the two types of investors? Your time frame is a big factor in which type of investor you are and therefore, which type of properties you should buy to realize your goals. Which type of investor are you?

The more you’re informed and the more you’re inspired to reach your goals, the quicker you’ll be doing what you want with your life. And really, life’s too short not to have choices, where you have to do something every day of your life, isn’t it?