How to Understand Infinite Return through an Example Deal

hi it's Ken macwhirr again I am very excited to talk to you about infinite returns and I'm not going to talk to you today about theory because I did that a little bit in the first piece of this video but what I'm gonna do is I'm gonna walk you through a real deal something that we've done here at MC companies through a lot of hard work through our employees this is a real deal that we still own today and I figured that it'd be better to go over something like that then something in theory because this you can do and replicate over and over and over and over and over and we've been doing it for years so the first thing was back in 2005 we bought a property in Flagstaff Arizona in 2005 we found this property and we decided to buy it for 19 million dollars so this was the price or the value at the time and what we were able to do was figure out again talking about over here is what the cash flow was so I didn't have the down payment for this property and so I knew that I was going to have to raise the equity for that and so we went to the bank and we said if we buy this property for 19 million dollars how much of a loan will you get me and the bank said you know what I think that we can loan you 15 million on this deal and I say great ok so the bank now said we're gonna loan you 15 million ironically this was Lehman Brothers and back in this day the the rate was pretty high I think it was in the in the 6% range today rates her in the 4% range but back in 2005 it was quite different this is before everything blew up in 2007 2008 so what I knew is that I was going to have to generate equity I was gonna have to go out and raise money from investors in the form of equity and so I was going to need four million of equity and so what we did is we put together a whole business plan on how to how this property would perform from a cash flow standpoint like I just talked to you about a minute ago so again how did the bank decide to lend us fifteen million dollars well I touched on it a little bit and that was with our Noi and the Noy at this property was about 700 K at the time in other words it generated about seven hundred thousand dollars annually from income and expenses and so when the bank is sitting down looking at how much they're going to lend you this is the number that they're looking at they're looking at the 700 thousand dollars every single time so if it's 800 you're gonna get more of a loan if it's 600 you're going to get less of a loan and of course if it's 600 then you have to raise more equity so so all of that factors in to what the bank gives you now the reason I like this property is because we had a plan for it so every single time we buy a property we're trying to create massive value in the property and so for this one we had a $700,000 and a y but this property had lots of opportunities it had it was 20 years old and needed a paint job needed roofs it needed parking lots redone and it had it was lower than the market yeah in the all the rents were lower than the rest of the market because of those things because it was a little tired the other thing is is it didn't have any washers and dryers in there it was close to university so we really felt like this particular and a wide number could be increased by increasing the income and there also were some expense savings so that was the primary reason we bought it we said okay if we buy this thing today for 19 million dollars and the NOI is seven hundred and we can get fifteen million dollar loan what can we with it later so that was the strategy in the very beginning and so what the bank said is that you know the the loan payment so the the payment was about four hundred thousand a month on the loan so what that generated for us with what's called a cash flow of three hundred okay this is the most important thing that you can remember now if you take three hundred thousand and divide it into the four million dollars you'll come up with your cash on cash number so I think it's around seven to seven and a half percent so now through a little bit of due diligence we were able to say to the investors we need four million we think that it's going to generate about three hundred thousand dollars a year and that's about a seven percent return very simple but the bigger issue was that we think that we can grow the ANA Y here which we ended up doing so this is how the deal was when we bought it and what we're trying to do is grow the and why because then I can go back to the bank and get more alone and that is the whole game what you're trying to do is hold the property and use debt we're trying to again have an infinite return so how do you generate an infinite return give everybody their money back tax-free and have massive cash flow so that's what this lessons about the other very interesting piece that a lot of people don't talk about is depreciation so depreciation on this property was about five hundred thousand dollars and how you get depreciation for multifamily is you basically take the value that you paid deduct the land and divide that by twenty seven and a half years the reason you divided by 27 a half-year because that's what the IRS tells you to do so that generates your depreciation number and for us depreciation is five hundred thousand and why that's important is because what we're actually doing is we're actually reporting a loss of two hundred thousand to the investors so imagine this imagine you invested four million dollars you get three hundred thousand back annually but you report a two hundred thousand dollar loss so essentially this three hundred thousand is tax-free that's the most important piece it's already tax-free because of your depreciation so now how do we accelerate that how do we get this four million dollars back so the question is how do you get this four million dollars back that's my only focus how do I return the four million dollars back to the investors so fast forward to 2009 we increase the Noy to 1 million dollars now you probably asked how do you do that so this property it was two hundred sixty seven units and when we put the washers and driers and started increasing the rents we increased by in four years we were able to increase every single unit on the average about a hundred dollars a month now the most important part that you don't need to understand is that we knew we were gonna do this before we bought it that's the most important thing I knew that I was going to be able to increase the rents by a hundred dollars a month on the average I wasn't quite sure how he's going to get there because we have one bedrooms two bedrooms and three bedrooms so the three bedrooms were a little bit more than one bedrooms were a little bit less but on the average it was about a hundred dollars per unit per month now if you think about that that's about twenty six thousand dollars a month was 12 you already see how we grew the enna why right because over here we're growing the income all I'm doing is growing the income by a hundred dollars a month over a period of four years so we were able to grow the income by about three hundred thousand dollars so that's how we grew the Noy and we knew this before we bought it so we go from seven hundred to a million by just putting washers and dryers fixing up the property and increasing the rents over a long period so then we take that 1 million dollars and we go back to the bank and we say ok you can see that we've grown we've increased our cash flow substantially so what what kind of a loan would you give us now and so the bank said based on the 1 million dollars we think that the property is now worth 25 million based on the new Noi and so I said ok great so how much would you loan on the 25 million dollars and they said we'll give you 20 million dollars so imagine this so I already I'm looking for at least a 20 million dollar number for a loan so I I went ahead and did this deal also the most interesting thing and it was completely luck was that rates went down from 2005 to 2009 because as I mentioned earlier they were in the 6% range and by 2009 they were under 5 that's luck you cannot guess on interest rates but in this particular case I got really lucky so my cost of debt went down from in the sixes to the fives so the best part about the 20 million dollars and this is the this is what we're trying to get out the 20 million dollars loan I first pay off the old loan of 15 then I give back the investors their money the 4 and in addition to that I have an additional 1 million here so now in four years I've given the investors their entire investment back I've paid off the bank I have a new loan and I've increased the value by six billion dollars now what I still have here is I still have five million in equity my payment went up to six hundred the reason it went up is because I borrowed another five million dollars even though my interest rate went down my payment still went up but my cash flow went up to four hundred my depreciation stayed the same because the way depreciation works is it stays the same for twenty seven and a half years it's five hundred what I report to the investor what I want to want to import report to the IRS is a negative 100 so let's just analyze what happened this is called a cash out refinance you don't pay tax on this you don't pay tax on debt the reason you don't pay tax on debt is because you owe it back so this technically is not money that you have to pay tax on until you sell the property so I used because I still owe the twenty and I was able to pay off the original fifteen I'm also able to pay off the equity that I got initially plus I gave everyone back a million bucks which I participated in so very good deal so now these investors are very happy at this point I am a hundred percent infinite okay the investors have no Oh equity in this deal at all they're getting 400,000 in cash they just got another million and they're reporting to the IRS a loss of a hundred thousand sounds like a great deal right well we did it again so this again this is a deal I still own today so in 2014 again going back to here we were able to grow the Noi to 1.4 million now what happened during this period of time because we didn't do a lot but this is a five year period so what happened from here to here is our rents went up a lot so this was a time where the economy a lot of people had fallen out of their homes and they were going into apartments and there were no new apartments so see we had a lot of homeowners going into rentals and so what it did is it pushed up the rents for the whole market so right now the apartment market in flagstaff is in the mid to high 90s and rents are very high and there's no new construction in sight in fact they have a building moratorium in Flagstaff and they're not going to have any more rentals up there for a while so what that means is if Flagstaff grows as a city it's going to become less and less affordable from a renter standpoint so the rents and Flagstaff happen to be some of the highest in the state of Arizona as a result of this because the one thing that throws off rents are more apartments or big job losses so in this particular case there's neither and the rents continue to go up so in this five-year period rents went up and we were just lucky in the right place at the right time occupancy is very high lots of renters and every single lease that we turn in every single apartment the rest just continue to go up and up and up so now the Noy over here has gone up to a million four so of course it did the exact same thing I went back to the bank and I said what do you think the property's worth now and he said it's worth about thirty-five million today now we're not going to talk a lot about this but the reason is much higher is because capitalization rates are cap rates went down so when you take the lower capitalization rate and divide it into the 1.4 million you get a higher value now capitalization rates are something that you really got to follow they can go up or down in strong markets they're really low and weak markets are really high when we bought this it was low and right now currently today cap rates are very very high which was why we got the high value but what we decided to do was not take a lot of loan against this property because now we're already out we're already infinite so so I get a twenty five million dollar loan from the bank and now keep in mind now I've got ten million in equity in this property so this property I have ten million in equity I got a twenty five million dollar new loan and I'm very happy so now the property is increased in value by sixteen million dollars it's all very strategic some of it was luck the interest rates went down we had a really strong runner you know market in in the renter's which we still have now but what happened was my payment went up to eight hundred but which was fine because now I took the 25 million I paid off the twenty now keep in mind I don't know any equity at this point so now that's another five million so now I've given the investors back six million more than they gave me they gave me four plus I gave them another six so this property has produced ten million dollars through a cash out refinances of two which we did one in 2009 a next one in 2014 the property cash flows today over 600,000 depreciation is that 500 still but now I have a positive 100,000 that we owe so the investors now are positive when they when they turn their K ones which they call which we call for all the investor returns they show a positive $100,000 but what they've really gotten was ten million dollars back their original equity of four million back there infinite here and they only pay tax on a hundred thousand dollars even though they're generating over six hundred thousand so we're giving the investors annually $50,000 a month and they're paying tax on a hundred thousand a year so that's why we're doing this is what you're trying to do is you're trying to borrow borrow correctly raise the equity pay it back and today this property is wildly successful we have over 10 million in equity we degenerates well over six hundred thousand dollars a year the investors got their money back over seven years ago and they're infinite and so the only problem that we have at this point is if we sell if we sell all this goes away it's called depreciation recapture and that's why we don't sell and that's why we don't flip and that's why we invest for cash flow for the long-term and not for capital gains because once you get to this point you should be generating wild amounts of cash flow and replacing your income for life at this point you don't have to work you want to work because this is fun and if you can understand it at this level there'll be hundreds of investors that will give you money if you can if you can return it like this tax-free and you can do this too thanks for listening

Channel: Ken McElroy

Views: 250,806

Keywords: Rich Dad, Entrepreneurship, Investing, Personal Development, Get Wealthy, Earn Wealth, Ken McElroy, Entrepreneur, Rich Dad Advisor, Success, Business, Self-Help, Coaching, Real Estate, Real Estate Entrepreneur, Real Estate Investing, Freedom, Lifestyle Business, Hustle, Infinite Return

Id: MhSDeX491ps

Length: 20min 6sec (1206 seconds)

Published: Mon Jun 17 2019