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Should you invest in Real Estate Now?

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Flight #8 – Should you invest in Real Estate Now?

Podcast Transcription:


 I’m excited. Real estate rentals. This, this is a topic that comes up all the time. Yeah.  

Charlie: Yeah, it is. It’s awesome. Right? Can be you see my sign on the back? I’ve got here. Can you all read that? I love real estate. I line through it. Yeah. It has an extra, for some reason. Anyway, I I’ve been a real estate investor, all my adult life. 

I can’t remember where the first time, not really intentionally, you know how it is Rob, you move around in the military, you end up keeping a house that you lived in, you end up renting. So that just happened to me a lot. It seemed like, and most of the time it worked out okay. Sometimes I made a little money and sometimes I lost some money. 

So we’ll talk about those today. Yeah. Yeah, exactly. But we’ll, we’re going to talk, you know, maybe if I could do my three point thing here, like we’re taught to do Rob and the air force three, three talking points, you know, the investment, you know, what is the in real investment? Most people don’t. Properly analyze this investment. 

So then it’s like poker or blackjack. You walk away from the poker table, the blackjack table. And you’re like, man, I really, I think I actually made money or there, I really believe that I made money. You know, I came in with a thousand. I only left with 200, but you know, I made money somehow. And you know, we, we kind of lie to ourselves a little bit. 

So that’s the blackjack mentality that happens in real estate. So we’re going to talk about how to properly analyze real estate investing so that you can make a great decision on whether it’s right for you or not. We’re going to talk about some tax pros and cons, and then we’re going to talk a couple other items, like maybe a LLC trusts. 

Self-directed kind of stuff in, uh, although I’ll lump those three topics into one point I had to only have three, so that’s okay. So we did that. You liked that very  

Rob: quick. All right. Yeah.  

Charlie: So what do you all think? I mean, I didn’t fall asleep on you. Yeah. You weren’t paying attention. Do you all want to, uh, What do you think about real estate before I jump into this diatribe that I have and do all this talking? 

Yeah. Give me some inputs. Yeah. And  


Rob: the millennial perspective?  

Ben: Well, I mean, you get on Tik TOK or Twitter or Instagram. I mean, you hit  

Charlie: on Tik TOK. I know. 

Ben: I, uh, I downloaded it and then I deleted it within maybe 10 minutes of down there, but I do, I do see a lot of videos and, and a lot of them are about how it seems like it’s millennial focus or something, but about how, you know, it’s a second stream of income, you can get, get rich, quick doing real estate somehow. 

Um, you know, here’s all the tips and tricks to real estate investing and it’s exciting. I mean, it’s definitely something that I’ve always been interested in and, um, I want to participate more and do some rental. Yeah. Uh, uh, or some real estate investing. But, um, it, as far as the millennial perspective, it seems like it’s just a thing that right now people are just talking about like crazy, whether it’s, uh, with Airbnb being a huge, uh, uh, another driving factor of, of real estate in general. 

But, uh,  

Rob: you know, well, the market’s been such still great since, uh, 2008 there, right. Or 2010 issue. The market’s just been hot. So. No wonder everyone’s jumping on, but it won’t always be hot. I can  

Charlie: guarantee you that that’s right. Yeah. This is like our last podcast where we talked about the recency bias or at least I think we did because you know, prices are high right now. 

Everybody’s making money on real estate. Yeah. But like you said, Robin’s not always that way. So we got to look at the entire body of evidence and not just the last couple of years, because we know that’s a, that’s a fallacy that leads us down the wrong path. So we’re going to today, we’re going to talk about what are the real estate like big picture. 

Should you do it? Should you not? So, um, like I told you guys before we got on here, don’t let me get too negative. Okay. Cause I just, I just came out of a bad relationship rental relationship, but we’ll talk more about that in a minute, but there’s some really good things. Let me talk, start off with some good stuff. 

Okay. You get, uh, you get the advantage of leverage. Most likely, most people were going to buy rental real estate using leverage. Um, you also have an advantage. In rental real estate where you do not have the market. And that’s what I call the informational advantage, you know, in the stock market, we really don’t have. 

In fact, there’s a strong argument that says no one has an informational advantage unless it’s inside information, which is illegal. But if you’re doing rental real estate investment in your local community, you have the ability. I have an information advantage. You could know that market. In fact, Rob, you will know the Colorado Springs market better than I know the Maryville, Tennessee or Knoxville, Tennessee market. 

You will know that, you know, you will have the information advantage, right? So you can profit off of that. And, and, and, oh, by the way, if you’re willing to get in there, if you’re handy, if you, if you can do some, you know, sweat equity, there’s an advantage there. Uh, I can’t do anything, so I gotta pay somebody else to do all that stuff and I don’t want to do anything. 

So those things all go into this decision, but it can be a great thing. Also, it’s a diversifier, you know, it’s a different type of asset, which we love. Um, and there’s a huge behavioral advantage and here’s what it is. You’re not going to see the daily price of your rental real estate fluctuate wildly like you do on the stock market. 

In fact, you know, unless you, you know, even if we have 2008, the great recession, you’re not going to see. I said, unless we have that, because you did see those values decline drastically, but, uh, except for extreme scenarios like that, you’re really not going to see the daily fluctuation. You’re going to treat it, you know, like a hate, just an income producing thing. 

I know it’s probably going to average three to four to 5%, you know, um, uh, appreciation and that’s it. So there’s no, I’ve got to sell it. It’s down. I got to sell it. It’s up. There’s no, there there’s none of that stress. What do you all think so far?  

Rob: Yeah. Yeah. Uh, I think, uh, you know, it can be good. It can be good. 

I’ve got obviously being in the military, we’ve got tons of buddies who’ve done really well. Uh, lots of buddies who haven’t done so well. And, and I would, you know, just my small sliver of the pie seems about half and half. Yeah. Uh, on those who’ve done pretty well. And those who haven’t the one thing that, that I know you’re going to get into is, is the time and the pain that, uh, having the rental comes up becomes  

Charlie: yep. 

Cost to that.  

Ben: Yeah. And just that, that PA that extra passive income I think is, is just a really nice, you know, freeing feeling that you’d get from, from having real estate, you know, just a little something else that, again, even if it’s just basically, you’re, you’re only getting the appreciation on the, the real estate itself, just to having that extra monthly stream of income and letting it pay for itself. 

I think that’s kind of, uh, something that’s interesting to me and,  

Rob: yeah, and it’s a diversifier, like you said, the only, the only thing that comes to mind is, you know, the, you have, when you have that leverage and you have the opportunity to have that upside, you have risk. And sometimes that risk you can’t see coming, uh, you know, your roof and all the different maintenance costs that come with having a house and having renters. 

Who’s, you know, they’re living in your property. It’s not theirs. They don’t treat it like you would. So you’re going to obviously have some more costs with that. Yeah,  

Charlie: you’re right. And like we said, the leverage is a benefit, but it can also be a disadvantage 2008. Again, the great recession is people were over leveraged. 

Big time. People were not putting any money down. They were doing interest only loans. So we learned the hard way there. What happens when we all do that? A lot more to that story. We won’t go into that, but let’s talk about some numbers. So I kind of did a case study all, just we can talk to it and we can address a lot of these questions that people have and the reality of their investment return or how to analyze it. 

So let me start with the first rule of thumb, the 1% rule, and, and you all may have heard of this. Your monthly rent should be equal to, or greater than 1% of the total purchase price of the investment. For example, I buy a rental real estate investment property for 250,000. My monthly rent needs to be 2,500. 

Now I’ll be honest with you and in our area and maybe different in the Springs and in Denver. That’s a lot. I think that’s very high. I think that would be really tough to achieve. And I looked at some properties in this area before we got on the call here. That’s really challenging. In fact, I think it’d be closer to 0.6 to 0.7% versus one. 

Nonetheless, that’s going to vary greatly and it’s not a disqualifier. Um, yeah, if you, if you don’t meet the 1% rule, there’s a lot of variables there. Uh, the other rules of thumb, another really challenging one. If you want to make money real estate, here’s, here’s the three things you got to do sounds early elementary, but it’s really challenging. 

You got to make money when you buy, you’ve got to make money when you rent and you got to make money when you sell again, those sound like no brainers, especially the last one. I’ve got to make money when I sell. But a lot of times people do not make money when they buy. Because they overpay and just like stocks, we do not like to overpay for stocks because that means your future expected return is lower. 

That’s a big deal. So you better find a deal. You better be good at negotiating, or you better have some sweat equity that goes into that. And then making money when you rent is a big one, you know, you all know, and Rob, you fly with a lot of folks. Like I did that say, Hey, I’m trying to lose money on my real estate property. 

Oh, I’m like, why? Well, I want to pay less taxes. Well, don’t ever lose money on anything. You know, that doesn’t, that just doesn’t even pass the, um, the sniff test there. The common sense says, but we hate taxes so much, again, another behavioral bias that we addressed last time. So I’ve talked a lot there. You, I’m going to be quiet for a second, but those are some rules of thumbs. 

They get people going. Those are  

Rob: super important. And even, you know, we talked about, you know, you’re looking at the numbers and there’s so many terms that so many numbers you want to be looking at. That you want to be familiar with and really get into the, you know, first rule or one of the rules of real estate investing is cap rate, cap rate, cap rate, which is the capitalization rate. 

What are you, what are you doing with, uh, you know, how are you making that money? Which is, you know, basically it’s your net operating income divided by the purchase price. It’s just one number out there to help you, you know, figure out if this, this real estate is better than that real estate. Uh, but there’s a lot of terms out there. 

A lot of different, uh, markers that you should look at when you’re looking at this kind of stuff. I think the other one that I would definitely throw out there as the cash on cash return, which is your annual cashflow divided by the initial cash out of pocket. You’re going to want to know those numbers. 

If you are, you know, set on getting into this and again, just realize you do have, if you’re leveraging, you have the opportunity to make some pretty good money on these. If you’re in the right market, can you guarantee you’re in the right market? That I don’t think anyone can guarantee, but you can obviously have some informational advantage there. 

Charlie: Right? Bob and Ben, I know you’ve got something to say, but as soon as here in a minute, we’re going to talk about those ROI numbers and how to calculate them and what they should look like. And we’re going to go into more detail, but Ben, what you got.  

Ben: Yeah. Um, I just think, um, when you’re going into real estate, especially getting started in it, um, you know, I, I just think you need to find somebody that’s got some experience and maybe partner with them to, to get really into it. 

Um, you know, there’s so many different factors whether it’s buying the house that, you know, is, is the property going to be kept up? Is it, uh, you know, is the roof going to leak? Is it you’re going to have to replace the foundation? Do you have to get a good inspector? You have to know the area. No, no. What rent prices are typically got and then know how to work the bank as well and how to get the best rates you can. 

And if I’m going into a, uh, uh, real estate investment, I’m, I’m going to want some, somebody that knows what they’re doing to go in with me and partner with just because I don’t trust myself in making that right. That necessarily the best decision. I think that’s where that overconfidence bias may come in play. 

You may say, Hey, I know my neighborhood so well, I know this and that, but. You know, you got to think there’s so many real estate investors out there that are ready to make moves on houses. Why maybe haven’t they bought the house yet? So that’s another thing that I try to think about, think about what could go wrong, um, as well, but partnering up with somebody with experience. 

Rob: And when you partner with someone, you know, sometimes people partner with realtors and that can be good. That can be bad. Depends who you’re working with. But I almost think, you know, the realtor sometimes is you’re paying 7% to sell a house. Um, yeah. And I kind of think of that. I’m wondering what you guys think about this, but I kind of think about that is, is a bit ask, you know, spread, if you will, almost, you have to cover 7%, you know, off the top when you’re selling, just to kind of get back to even, I don’t know what you guys think. 

That’s a good analogy on that.  

Charlie: Yeah, I think it’s, I think your point is valid in that. It’s a cost, you know, when you, and when you partner with anyone, especially in real estate, because what value are they bringing to the table? You know, if I just partner with you, Ben, for knowledge, how do I pay you? 

What’s it worth? And how much does it cut into my profit? You know, so those are tough in the real estate world. Those are very difficult things to quantify. So I’ve seen real estate partnerships really struggle because what value is it that you’re bringing to the table to me? How do I pay that? And does it, does it reduce that hurdle rate, Rob, that you talked about my return on my investment because it will, the real estate fees will do it. 

In fact, let’s go ahead and transition into the numbers into my, into my supposed case study here and the RA and Ben, I’m going to pile on what you said there. You got to know, you know, you talked about knowing the financing, knowing this and knowing that, but what I learned as a real estate, uh, landlord, and not everybody. 

It was going to be a landlord. You don’t have to be a landlord to be a real estate investor, but most will, if you hold on to it, I learned how to deal with renters. I mean, I went into the deal like, oh, here’s a contract. I pulled it off the web. And, uh, see, uh, when the rent’s due, not really, really, I mean, you gotta, you gotta really be involved. 

You gotta really pay attention, detail, be directive, all those things up front. And I guess we call it operations, but you need to think really thoroughly and do your homework about the expectations you’re setting for renters. Otherwise you’re going to get burned, you know, and, and again, depending on who you’re renting to, you better be ready to either a, be a parent along with an investor, or, you know, if it’s a, maybe a higher income and then maybe less so, but you’re going to pay for that too in a different way. 

So let’s get into the numbers. Um, first of all, Rob, you nailed it. Before we got on this is just a risk return profile decision. You know, again, these questions do I use leverage? Do I use all cash? Let’s talk about it. Well, I’m going to use leverage if I need a higher return on investment, but I might use all cash. 

First of all, if I have it. You know, it’s not easy to throw down a couple hundred thousand on a property, but I do get a higher, you know, I get a higher, a clear, a higher cashflow. I get more cashflow subdued. So it’s just like a stock. Do I want appreciation? Or am I interested in cashflow? Most? Let’s just say most airline pilots, most professionals working now, they don’t need extra cash flow. 

In fact, they’re trying to minimize that because it’s just going to be taxed at the highest marginal tax rate, right? A 32% probably for, for a lot of the folks we’re talking to. And so maybe I don’t need cashflow. Maybe I just want to break even I want to appreciation. So that’s going to dictate what kind of property you buy. 

You better buy. If that’s what you want, you better buy a quality property in a quality neighborhood. You’re going to pay for that. You know, uh, if you want higher cashflow, Ben, like you were talking about, well, then you do what I did and I kind of do this by default. That’s my excuse. I didn’t do this intentionally, but I own two, I own two trailers. 

I had Charlie’s trailer park. That’s what I called it. I was a mayor of the trailer park. Yeah, that’s right. It was exciting. Uh, we’ll share some stories in a minute about the time that I had to evict of seven cats out of one of the residences while the kids were watching and crying and screaming for her mother, why is this man taking our cats? 

But anyway, uh, uh, allowed them to have one cat and they had seven, you know what the heck it’s the way it goes. But anyway, so that is a high yield bond because I didn’t pay much for those. I didn’t pay much for those properties, but they, I could charge a higher rent. And so my yield was phenomenal. 

However, you know, it was painful. You going to tell, I ain’t gonna lie to you. It was painful. Um, People threatened to burn them down and you know, all kinds of stuff. So that’s some good stuff. Good fun. Um, so that’s what you need to think about and Rob, you nailed it. Risk return. What do you want? What kind of property are you handy? 

Well, then go get something and fix it up. I flew with one, one pilot. He actually built his own rental properties, which I thought was genius because he was good at that. He could build them specifically to rent, which means they had concrete floors, very durable walls. And so, you know, that that was a pretty, a profitable thing. 

I believe. What do you have?  

Rob: Uh, just on something like that, you just want to make sure you have the right insurance. If you’re building a property, obviously you’re insured. If things don’t go quite the way you want them to, because we have professional builders, you guys, I don’t know if you guys have been a new house, I’ve been new houses where these professional builders to get in and they’ve messed all kinds of things up. 

It’s building the house. Isn’t exactly. It’s not rocket science, but it’s not exactly easy either. Yeah.  

Charlie: Yeah. That’s right. So think about, you know, when you’re looking at rental, what do we want? So in our case study today, we’ve got a $250,000 property, three bedroom, two bath, 30 year mortgage. Oh, by the way, as a, as a non-owner occupied property, you’re going to pay a higher mortgage interest rate. 

In fact, the going rate right now for a second property rental property is 3.5 to 3.75. And you could probably get a whole point lower than that. If you’re owner occupied. You’re also going to put more money down. You’re probably, I don’t think you can get away with putting less than 20% down on, on a rental investment property. 

That’s just my latest, uh, look at it. I don’t know. Have you seen  

Rob: anything different? The only exception there is, if you were in the military or whatever you were, you moved in, you owned it, bought it occupied and then left obviously,  

Charlie: right. That’s a good way to do it. Yeah. Um, you know, I looked around at our local area and I’m telling you $250,000 property getting more than about $1,700 a month in rent is a stretch. 

Uh, and that’s only 0.7% that doesn’t even make meat, our 1% rule. So there we go right off the bat. We’re a little bit behind, but you know, that’s not the only factor. Um, my income rental income, um, what’s a 1750 times 12. It’s about 20 grand. If I’m not mistaken. Cause somebody do that math. I did a different kind of math on that one. 

Great math anyway. Um, so, so basically we’ve got some income, you know, 18 to 20 grand. We’ve put 40,000 down. And so man, we’ve got some good income and let’s see what our mortgage would be about. I think I put mortgage in here somewhere. It’s about 1200 bucks a month. No, 11 1122 a month. Yeah. So yeah. So once you get your, your more, you know, your, uh, income minus your mortgage, you’ve got a pretty good rate of return there. 

In fact, you’re probably approaching the double digits or more, you know, I didn’t do the exact math, but let’s just say we’re in the, in the low teens. Okay. However, here’s where it gets. Here’s where you got to do the real analysis. Like you’re talking about Rob and the return on investment. If you’re having someone manage it 10%, it’s $180 a month. 

If you’re, uh, you will be paying some maintenance costs, you know, we’ve replaced roofs, air conditioners, septic systems, somebody decided to flush Snuffleupagus Snuffaluffagus. Down the toilet stopped up the entire septic system and in the rain, you know, we’re out there digging up a separate system and then I had to put them in a hotel. 

So there are some expenses you’re going to have. Yeah. And, um, so be ready for that. Again, usually a couple, like 2% might be a rule of thumb to use. You’re going to have some vacancy. You got to plan for that. You’re not going to be rented a hundred percent of the time. You know, you’re even in a good scenario, you’re going to miss a month or two a year, even just in the turnover. 

You know, if you’re getting one renter out and one end, you need a few weeks to get it ready. So that’s at a minimum. What is your time worth? What are you spending on these rental properties? Now I will tell you if you want to pass the real estate professional test, which we’ll talk about in a minute, you better be at least spending 15 hours a week. 

That is one of several tests. So if you’re a high income earner, I don’t know somebody can do that. Math for us. Let’s say you’re, you know, the average CFO makes, I don’t know what, 130, 140 bucks an hour average captain makes 240 bucks an hour. That’s pretty doggone expensive. Now. I’m not saying you’re going to do that because most people can’t. 

And so therefore you’re not going to be a real estate investment pro professional, but nonetheless, let’s say you spend four hours a month. And that’s probably about what I did. You know, there’s some bookkeeping involved. Even if you use a management company, you’re going to get calls. You got to make some decisions. 

You got to go visit, you got to do stuff. Well, that’s about 800 bucks a month and I just kind of averaged, you know, some hourly internet airline rates there. Yeah. So now we’re, we’re, we’re, you know, if you’re a rental real estate investor, you better be tallying up these numbers that I’m talking about it and I’m not done. 

I’m only halfway done. So now we have property taxes, usually about one to two, actually closer to 2% of the value. In this case, 375 bucks a month. Insurance, homeowners, insurance, uh, that’s going to be paid in escrow, probably about a hundred bucks a month. Mortgage interest. You’re paying interest on that investment you made and there’s turnover fees. 

If you change renters, you got to clean the place you got to clean carpets. You might have to paint you better average, you better be ready to spend about a thousand bucks every time you change renters. So put that in the formula. Okay, so now we’re going to talk in general. What is my average ROI after taxes, insurance, and expenses. 

You’re probably in the high single digits. You know, which is not bad, right? I mean, 8%, let’s say I get 8%. That’s not bad. However, the only reason I’m there is because I use leverage, right? One of the only reasons is, um, um, I’m leveraging and that might even get me to the low teens, mid teens if I use leverage. 

But think about that. We’re not, you know, when we go think about the investment, my alternative is to go into the stock market and buy real estate investment trust without leverage. And that’s been one of the highest, uh, performing asset classes. The last 20 years, probably high single low double digits. 

If I, you know, I didn’t look that up before the, before the show, but so now again, we’ve got to come, we’ve got to analyze it appropriately with all the numbers I’ve just talked about and we’ve got to compare it to alternatives appropriately. Okay. I’ve talked to,  

Rob: yeah. So just to summarize that, it sounds like Charlie, uh, to wrap it up a little bit on, on this part, If you’re not using leverage, your returns can be okay again, you’re buying, you know, maybe one, two, three houses, and those risks, you know, associated with buying one house. 

If anything happens to it, if the soil is bad, if the water’s bad, all these different things that can happen, the roof goes back, you know, you can be out some pretty good cash with that. If you’re in it. And this is just all non leverage. If you leverage, you can get into some pretty good money. Again, the risk is higher because you’re leveraging, but the return on investment can be a little bit, a little bit more. 

Charlie: Yeah. Yeah. And I’ll tell you, Rob personally, I would not even do it without leverage. You know, it’s, it’s, it’s a lot of work. It’s some headaches. Some people are really good at real estate investing, you know, there’s no doubt. And like I said, I don’t want to get too negative on this, but I just want to be fair on how you analyze this. 

But some people are really good at all those things we’ve talked about so far. They know how to manage renters. They know how to buy, they know how to sell, you know, they’re really good at it. They treat it like a real business. We have clients that treat it like a real business. They do a great job and they probably have, uh, returns, um, because they’re leveraging of mid to low teens, you know, maybe even low twenties, but that I would not mess with this. 

If, if I didn’t get at least a double G in fact, my hurdle rate, if I was going to do it would be at least 12%. Otherwise I’m going to put my money in a REIT, um, you know, publicly traded REIT real estate investment trust, and I’m going to just. Let it go. I don’t have to do anything, pay anybody or worry about somebody sticking their stuffed animal down the toilet, you know,  

Rob: and a lot of this too can be, uh, you know, there’s some information, uh, bias that you have, I guess, and in a lot of it’s luck, where do you live? 

If you live in California, you can be doing really well. But if you live in Ohio where I live, maybe not so well, you  

Charlie: know, places, and even within those, even within cities, there’s these micro markets, you know, even in a certain part of town, you can really be profitable, you know? Uh, but  

Ben: yeah, and on that Charlotte, like I was going to say like the, the, the, there’s some units in a building right next to me that they’re selling for $500,000, two bedroom. 

That’s going, you know, the rent is, uh, maybe $1,800 a month. So, I mean, talk about the 1% rule that’s blown out of the water down here. So. You just did it definitely depends on what area you. Yeah.  

Charlie: Yeah. Yeah. And I, you know, let me summarize that return on investment equation, because I just talked about the things you better be thinking about, but here’s the equation, you know, it’s annual return, you know, in other words, the rent that you take in minus your expenses, including your mortgage payment and all the expenses I just listed, uh, divided by your total investment, which is the cost of your property. 

So that’s just the formula, you know, and again, we just talked about some rules of thumbs, some things to think about, but make sure to fairly analyze your real estate investment and treat it like a business and do not try to lose money on purpose. A lot of S and I’m going to throw the CPAs under the bus. 

Kevin is a CPA and, uh, I’m going to throw them on the bus. Cause they say, Hey, you need to go out and buy our property because you pay too much taxes. It’s like, holy cow, that’s a terrible reason to buy a property, never buy at any investment. It’s strictly due to taxes. So anyway, we’ve seen that. I promise you and, uh, Real estate can be great, but don’t do it just for taxes, which probably is a good transition. 

Rob: There will always be that Sarah alive, uh, skid way back with Steve Martin. He’s the doctor. He’s like, I recommend you. You do some bleeding, bleeding already. Exactly. Who’s the doctor here. That’s  

Charlie: right. That’s what this is for bleeding is a good analogy.  

Rob: Sometimes, you know, I hate to, I guess I watch too much TV, but, uh, the other thing that this reminds me of is the back to the future. 

Am I going to be back to the future too? You guys remember that where he goes away and he comes back, uh, and the image might be an alternate universe, but the nice cush neighborhood, the neighborhood to live in all of a sudden. It’s not the nice neighborhood. And I think we’ve seen that in a lot of, a lot of cities around the world. 

So just because you do think the neighborhood is nice, you have a risk that, that, you know, some kind of regulation, uh, some different politics gets involved, get involved and all of a sudden it’s not the nice thing. So you  

Charlie: have that risk. Yeah. Just be ready. I think too, you know, people say it’s good. 

Passive income. Well, I don’t know. That’s debatable even though it’s maybe classify that as by the IRS. Um, Hey, I’ll tell you what, let’s talk taxes. It’s always fun to talk taxes, taxes, and real estate because that’s why people get into it. Right? Hey, your CPA says, I should, you know, I’m getting paying too much taxes. 

I need to buy some property. Well, let’s talk about that. So the biggest advantage tax advantage for real estate is depreciation. And so depreciation is exciting, right? We get to it’s, it almost creates, you know, re uh, real estate properties. Almost can be like an investment inside of an IRA because the depreciation allows me to defer my either gain or I can even defer some income. 

Right. So that means, right. It’s almost like tax free growth, right? Well, that is the one advantage as really pretty good. But, but you gotta be careful because once you start making $150,000 or more, you lose the ability to deduct passive losses against your active income. Okay. So now if I make a 500 bucks a month in rent, uh, then I can deduct that rental income. 

I can deduct my expenses and depreciation against that income, right? Because that’s passive income, uh, that I’m, that I’m getting rid of with my expenses from the rental property and appreciation. However, let me transition into this one. This is what most people want. I want to deduct my rental expenses and appreciation against my airline income. 

No, no, that’s a no-no that’s not going to happen. And let me explain the rule. For real estate. This is right out of IRS publication, nine 25. If you’re going to do rental real estate, read that publication and get familiar with it. So here’s the deal. If you make less than 150,000, then you can take up to $25,000 and let me correct that a little bit. 

It starts to phase out at a hundred. So the phase out starts at a hundred thousand of adjusted gross income, and it ends at one 50. So you make less than a hundred thousand. You’re able to take 20 up to $25,000 in losses in your real estate and deduct them against your passive income. Excuse me, against your active income, your airline income, your whatever you’re doing. 

That’s tremendous. However, above a hundred thousand, it starts to phase out above 150,000. That’s gone. Now, if you have losses, you can roll over those losses. There’s a more technical word for rollover losses. I can’t think of it right now. Kevin would know. Yeah, you can roll them over and definitely into the future. 

So that one day, when you make less than that limit, you can then take the losses. So what a lot of people try to do and way before I move on, are y’all tracking with me so far. I’ll try to throw out some tax stuff there and it gets convoluted at times. Am I being clear so far? Yeah. So the crystal crystal that’s right. 

Um, so that’s the holy grail, right? People want to deduct their rental law. That’s why I want to lose money, man. I got to lose money so I can do it. I pay less taxes on my airline income. Well, it’s not going to happen pretty much unless you’re making less than a hundred grand. Now you can roll over those losses indefinitely in the future. 

When one day you might make less than then you can use them. So how can I, is there a way to possibly take these losses against my airline income and you have to be a real estate professional to be able to do that. That means you’re. Active in the business, you are a real estate professional. Then you could take your real estate, losses and deductions and deduct them against your airline income. 

That’s what most people are trying to get to or think that you can get to. So that’s, that’s where some confusion lies, and that’s also where the opportunity lies as well. If you’re willing to go down that road.  

Rob: Absolutely. I think that, uh, Charlie, that the term we were looking for there was you can carry forward the losses carry forward. 

That’s it? That’s the,  

Charlie: that’s the phrase. Thank you. Not roll over. Carry forward. Thank you very much. Um, so, so I know you all are dying to know. Right. You’re dying to know how do I become a real estate professional? Aren’t you done to know that? Of course, we’ve got to know how to just do it now. Let’s just end the podcast there. 

That’s it. All right. So last night we were talking at our meeting. Ben, me, you and Kevin Rob didn’t show up, but anyway, so we’re talking about being a real estate investment professional. And Kevin had the good quote and, and, uh, he said the, uh, help me out ban the trail to real estate professionals is littered with bodies of, uh, tax, fraudulent people that have tried to cheat on something he’s like doctors, lawyers,  

Ben: pilots. 

So it’s  

Charlie: littered with those people. Yeah, exactly. Oh yeah. That’s  

Ben: the, like, that’s the main story they talk about. Uh, they talk about that story all the time and like every CPAs, uh, conference, they always get the final story of somebody getting, getting in trouble, claiming their real estate. Oh yeah.  

Charlie: So it’s pretty, you know, it’s interesting if you go online and you, you Google, I would Google. 

If you’re going to be a real estate investor. Or farmer pretend I’m doing air quotes for farmer. Cause we have some real farmers, but we have some fake farmers as well. And um, if you want to do that stuff, go Google court cases and look at how some of these people got, uh, kinda got burned. In fact, let me give you an example. 

One court case was, I don’t know how to say it. Edgar E G E R Gregg Egor versus the United States. First of all, do you want to, do you want to go to court against the United States that even if you win, is it really a win, but anyway, maybe if you want to stick it to the man, you could, but basically all of his deductions, all of his care for losses were disallowed by the us government because, because he didn’t pass the test of actually. 

And this is not just being a real estate professional. This is the very first test of, is it a rental property or not? You’ve got to meet some tests there that you’ll find in publication nine 25 as well. But basically he did not forego his ability to use his own property. So therefore they disallowed it as a rental. 

They said it was yours. You had access to it. And he had to essentially pay up, I guess. And again, when you’re going to court in the first place, that’s really, probably not where you want to be, but you can go on laundry, all kinds of court cases and of what not to do. Um, one, one story real quick is when I moved into our last place, it was 12 acres. 

We had a horse barn, we had a couple of rentals and we had a couple of chickens. Somebody said, Hey, you’re a farmer. I was like, really? I’m a farmer. You got two chickens, you’re a farmer. You collect some eggs, collect eggs, dude, you’re a farmer. You can deduct all this stuff. And that’s, that’s brilliant. So I’ll go to Google being a Spartan dude that I am, I go to Google and guess what? 

I find a court case or a pilot claimed he was a farmer because he had chickens. Ah, so I was like, no, I think I won’t deduct those costs of the chickens Charlie’s trailers and chicken or yeah, there you go. Or, or the tractor, I think I’ll just pay the taxes, you know? So anyway,  

Ben: oh, you got two chickens and you’re trying to deduct a tractor. 

That’s that one’s going to be hard to pass.  

Charlie: It makes perfect sense. Yeah. I need that tractor for those chickens. Um, but anyway, so yeah, you get the idea of, we’ve got to be careful. We don’t want to go to court with the U S government, even if we won, I still don’t really want to do that. All right. So faster funnier, as we say, the holy grail is being a real estate professional. 

Here are the, you know, some of the requirements. 15 hours a week and that’s actually 750 hours per year. I just said, Hey, 50 weeks, you know, you’re going to get a couple of weeks vacation, but you be able to better be able to show that you’ve got to log it. Um, that’s not terrible. Hey, 15 hours a week. 

That’s not much right. Well, now there’s the 50% rule I’ve got. Uh, you know, let’s say I’m an airline pilot and I fly our work. I don’t know how you quantify this, but I work a 40 hour week. Then I’ve got to be doing 20 hours or more of rentals, real estate activity. So there’s a 50% rule, more than half. I’m going to read it because I may have been confused, but more than half of the personal services you performed in all trades or businesses during the year were performed in real estate trades or businesses. 

So that’s a big one. These are big hurdles. And then like I kind of alluded to in that court case, it must truly be a rental. You know, in other words, if you’ve got certain access to the property, it’s not really a rental and those are losses will be disallowed. If you get audited by the IRS. Yeah. What now? 

Rob: A place you want to be. Yeah, that’s a lot of work that looks like a lot of  

Charlie: work, right? It is. And in this publication again, it’s some really good reading in here. There’s a lot of stuff. Hey, there are ways to, again, to be very profitable, but, but again, you also gotta be careful not to open yourself up to court cases and, you know, audits and you know, people say, well, can I do this? 

Can I do that? And Kevin, and I will say, you can do anything you want. Is it legal? Is that really what you’re asking me? No, you can’t do that. You know, but, but people say, well, I can do it unless I get audited. Right. So I don’t want to go down,  

Rob: not down that path. Don’t  

Ben: most people want this as a, you know, rental real estate. 

I mean, I guess obviously the returns, but the passive, the passive income. So if, if all of a sudden you’re having to create. A side business or, or do a side business just to get this passive income. That’s really active that you can then deduct against your airline income. I mean, it’s just, isn’t really think about what the point of getting into it in the first place. 

You want to have to have a second job just to get the, save some taxes. I don’t  

Charlie: that’s right. And how many days you go fly? Like a, you know, I pretty much calculated that, Hey, I’m going to get rid of these two trailers. I’ve got to get rid of Charlie’s trailer park and the chickens, chickens get eaten, by the way. 

I’m very sad to say, um, not about Hawks coyotes Bobcat’s, but anyway, um, I would just, I was flying at the time. I was like, I’m just going to fly a two day a month. You all and get rid of all this stuff. So anyway, that’s something to think about, right.  

Rob: Something to think about for sure. Yeah. Now speaking of, uh, you know, flying and 401ks and IRAs. 

How does this play in to a, an IRA or a 401k? Can you, can I take this and just go, go crazy with my 401k woo. Go into real estate. Wow. At least at Southwest airlines. I know that. Yeah.  

Charlie: Yeah. Ben, you T you, you had some great points at the beginning, you know, about. This topic, what were you saying? Those are, well,  

Ben: I don’t know if they were great points, but I appreciate you. 


Charlie: they were mediocre. Sorry. They were very mediocre at best.  

Ben: There we go. There we go. Um, yeah, I mean, I, I’m trying to think of where I started this, uh, with those points, but, but basically you can invest in, in real estate, in a self-directed IRA. Um, you know, that’s a big thing. I’ve seen it. There’s a lot of stuff out there right now about it. 

I don’t know if it’s just some kind of a trend or some tic-tac video must’ve gone viral or something talking about it, but, but yeah, you can, you can. Um, but it’s, it’s very complicated. And as we talked about with that, the real estate professional. Tax advantages that you get there. I mean, to, to get the advantages of, of investing the self-directed IRA, and I guess really the advantage would be that you get to use your money, that, uh, from your retirement accounts to invest in real estate, but there are so many rules that you have to follow to be able to do this. 

Um, and you, you can get in trouble very easily by doing this the wrong way. So if you did want to invest in, in an alternative investment in your IRAs, it’s definitely something you want to, you want to think about a lot and, and consider all the alternatives. Um,  

Rob: and one of the biggest things I think about is the lack of leverage. 

You can use it going back to, uh, those points. Charlie was making them about. You know, if you’re just buying a cash, which in a self-directed IRA, you got to have that you got to pay for a cash, you can’t use the leverage. So you, you kind of forego all the higher return on investments that you could have, uh, if you’re leveraging outside of the software. 

Ben: Right. That’s and that’s where I had heard, like a lot of people trying to do the real estate and self-directed IRAs, at least from my, my understanding is that, uh, you know, if you can, if you can just get traditional loans from the bank or access to, to leverage through the banks, then you really don’t need to do the self directed IRA, uh, rentals in there. 

But it is a good, maybe it’s a good way for people who don’t have access necessarily to traditional leverage, maybe you’re you’re young, or you’re just trying to start out and invest in, uh, in real estate. You can’t get the loans, then maybe it’s an option. I know people will go around. They find other people to help buy into the, put money into the real estate, but. 

But, yeah, it definitely seems like a lot of work. Um, you know, I did, I did think about as well, just as far as diversification, you know, we talk a lot about that. Um, obviously real estate, you already having that in your IRA. Um, I like to think of my IRA is diversifier having it in, in equities. If you want to invest in real estate, you know, don’t spend all your money in your IRAs to, to invest in real estate when you can do that with, uh, with your, your own cash. 

Uh, I don’t  

Charlie: know if that made any sense, but  

Rob: yeah, I think too with that is, that’s just talking to IRAs when you start talking 401ks. I don’t think there are many 401ks out there, Charlie correct me if I’m wrong, but, uh, I don’t think there’s many 401ks that allow you to do what you can do in the self-directed IRA, which is use it for real estate. 

I don’t think you can do that many 401ks. Yeah.  

Charlie: Yeah. You’ve got to kind of do like an individual 401k, which we love individual foreign case for self-employed people. And if you’re a real estate professional, then you, you could open an individual 401k. And so there’s some things there, but, you know, uh, you know, I think the big P there’s a lot of complexity, you know, a little bit of nuts and bolts on these self-directed IRAs, lot of complexity, a lot of moving parts, you better cross your T’s and dot your I’s because in other words, you go to pay for a maintenance cost, you know, on your rental property. 

How do you do that? You know, do you pay for it within the IRA outside of the IRA? Is it a qual? Is it a non-qualified withdrawal? Are you going, gonna be penalized? Um, again, very, uh, very, um, you know, you get kind of highlighted when you do stuff like that with the IRS. So it better be advantageous. I think the biggest point is what you said, Ben is, Hey, wow. 

We need diversification in our 401k. We need diversification in our IRAs. Do the real estate stuff outside of it, because that’s the whole purpose is diversification. You get to use some leverage, you get some, some built-in tax deferral through the depreciation. If you get to take advantage of it. So going inside your IRAs or even an individual 401k is, you know, I don’t think that’s a, may not pass the sniff test for most people. 

It can be done. There’s higher expenses. So a lot of, uh, a lot of pros and cons just like anything else, but the man, I have a hard time finding, you know, a lot of good reasons to do that. Quite honestly, just my opinion and the other.  

Rob: Yeah, absolutely. The other thing I think of too is. Uh, when you’re, when you’re thinking of your overall investment strategy and your risk analysis, and we can help you determine what that is, but you want to think about where you’re living. 

Are you already, do you already have quite a bit of money in the place you live or are you already invested quite a bit in real estate in your hometown? Uh, REITs are great. You’re not using leverage leverage for REITs, uh, but they can be a great investment. That’s inside your 401k, inside your IRA. It’s a lot easier to take advantage of, and you’re not betting the bank on, you know, what Denver, Colorado, or any certain town you’re, you’re you’re most of those REITs are diversified in some or even overseas. 

And you can take care of, you know, you can invest in those a lot easier and diversify away that risk. And, uh, in a, uh, perhaps smarter, you may not get the returns on investment. You could, again, if you’re, if you’re just taking the risk with one, one town or one city or one house,  

Charlie: Definitely. Yep, absolutely. 

Yeah. A lot of, a lot of good stuff there. Um, you know, in the end, uh, again, I don’t want to beat up the rental stuff too much because it can be a good thing. Just know what you’re getting into, know if, if it fits your, you know, if it fits your preferences and I’ll be honest with you, I’m done with, I’m done with it. 

I don’t want everyone. And we moved and I’m like, it’s so nice to work on my own house. Even if it needs lots of work, at least I’m working for me, not somebody else, that’s just going to trash it. And, uh, but again, that was my experience. I did have some other experiences with higher income rentals and they were less maintenance, but I made less money, you know? 

So, um, so it just depends, but yeah. Pros and cons just like any other investment pros and cons.  

Ben: Yeah, definitely. This one’s a little more hands-on though, than some of our other investments, you know, a little, a little more hands on than some stocks and bonds. So  

Charlie: definitely it’s a big,  

Ben: I don’t know. You definitely have to love it. 

I would  

Charlie: say.  

Rob: Yeah. Yeah. You’re going to want to totally in there and get familiar and getting a mentor. Like you talked about Ben and yeah, that’s really important. I think when you get into this is having people who’ve been there done that can walk you through and sidestep those politics,  

Charlie: right. Leading edge is a good, good mentor. 

We can tell you, uh, give you some pros and cons and talk. Make sure you’re doing a realistic analysis at least.  

Rob: Absolutely. Yeah.  

Ben: We’ll definitely make you reconsider it. 

Rob: Well, think about it each their own. Some people really love it. Some people hate it. Like there’s just no, what you’re doing before. Yeah. Before we get into it. Anything else? Anything before we wrap it up?  

Charlie: That’s it  

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this Podcast will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any information or any corresponding discussions serves as the receipt of, or as a substitute for, personalized investment advice from Leading Edge Financial Planning personnel. The opinions expressed are those of Leading Edge Financial Planning as of 03/31/2021 and are subject to change at any time due to the changes in market or economic conditions.