REAL ESTATE RICHES

How to Become Rich Using Your Bankers Money

By Dolf De Roos, Ph.D.
(Warner Books, 2001)

Foreword: Rich Dad ... invest your excess cash and hold your wealth in real estate. It may not
be exciting, but if you invest wisely, it will keep you the most happy and secure.

Preface: I took upon myself to make a study of the rich ... they are not uniformly young or old,
male or female. I found only two things the rich have in common, almost without exception:
(1) The rich have integrity
(2) The rich either made their wealth or kept their wealth in real estate

CHAPTER 1: Why is Property So Good

Its not just a little bit better than other
Four Magic Questions: Assume you have
investments, it is tens and even hundreds
$100K to invest in securities or property.
of times better than other investments.
QUESTION #1: With $100K, how may
dollars-worth of stock can you buy? Property?
ANS: $100K worth of stock, and about $1 million worth of property (asset), with
rental income. If you bought wisely, rent could cover your expenses.

When you buy securities, you generally have to put up the entire purchase price.
When you buy property, lending institutions fall all over themselves to give you the money.

The above tells you two things:

(1) Property is considered a safe and secure investment.
(2) Leverage counts ... to buy property, you dont even need most of the money.

QUESTION #2: The moment you buy your stock for $100K, what is it worth? Property?
ANS: The stock is worth $100K. The property could be worth a lot more! It could
have been a bargain because of a divorce, ignorance (no appraisal), estate
squabbles, foreclosures, etc.

QUESTION #3: What can you do to increase the value of your stock? Property?
ANS: Limited options with stocks. With property, the options are unlimited (paint,
spruce-up, heating/cooling systems, bathrooms, kitchens, etc). For
commercial properties, find a tenant.

QUESTION #4: How can you enjoy the increased value of your stock? Property?
ANS: Sell the stock ... but pay capital gains taxes and reduce the remaining amount
that can earn further profits. Refinance the property ... pay no taxes, and you
still have the full, appreciating investment and growing rental income.
 Financial advisors have not yet figured out a way
CHAPTER #2: Conspiracy Theory
to profit from advising clients to buy real estate.
The mass media fails to represent real
estate investing fairly. They should:
(1) With asset values, compare
growth relative to the capital put in: Comparing the performance of $100K invested in money
markets to $100K invested in real estate is false. A 7% increase in asset value increases your
money market investment by $7,000. A 7% increase in your real estate value would be $70,000
on a $1M property purchased with $100K invested.

Leverage works both ways ... the downside is amplified like the upside. But have you ever
known real estate value to plummet by 60%, or 90%, or disappear entirely?

(2) With yields, compare income relative to the capital put in: The money market
account above yields 7%. The $1M property yields rental income (minus mortgage interest and
other expenses) plus as much as 4% on depreciation on the structure, as much as 20% on
depreciation of the contents, and the value of the property has changed.

Yield calculations on property investments are much more complicated than for bank
deposits, and the difference is a real eye-opener.

Real estate is the only investment where the

CHAPTER #3: A Taxing Issue
government will give you money when you
Many business assets go down in
make a profit ... not take it away in taxes.
value, or wear out, as time goes
by. Businesses are allowed to write-
off a portion of the assets value every year to help off-set replacement of the asset at the end of
its useful life. But, property tends to go up in value. Yet, the government allows you to claim a
depreciation allowance. Are they silly? No, the government knows it is not an efficient provider
of housing. It actively encourages private investors (like you) to provide housing opportunities.

Property is VERY tax-friendly. You can claim depreciation on a property

year-after-year, even though it may be consistently going up in value!

Example: $200K property (90% loan) $20K in annual rental income with $15K in expenses.
Pre-tax profit = $20K - 15K = $5,000
Depreciation = $9K
Net income = minus $4,000, to be applied against other income
At 40% tax rate, you save $1,600 in tax ... the government has paid you!
Yield = ratio of rental income to purchase price = 20K/200K = 10%
Pre-tax return = ratio of income to capital outlay = 5K/20K = 25%
After-tax return = (5K + 1,600)/20K = 33%

Never underestimate the benefits of property depreciation!

 Statistics are numbers looking for an argument.
CHAPTER #4: Beating Averages Easily
Stock market growth and real property
appreciation may have the same average. But stock market growth has a much higher variation.

For the investment sector ... fluctuation around the average:

(1) If you buy property, it is likely you will realize appreciation similar to long-term
national averages ... because the average is consistent, predictable, and even boring.
(2) If you buy stocks, you are taking a bit of a gamble. In any particular year, stocks are
less likely to mirror national averages.

For specific investments within the sector ... fluctuation around the average:
(1) If there are 100 houses in a development, and 99 have appreciated by 5%, it is almost
certain that the 100th has also appreciated by 5%. Properties tend to appreciate in unison because
buyers will compare units on the market and forego those out of alignment.
(2) If there are 100 stocks on an exchange, and 99 appreciate by 5%, there is no telling
how much the 100th may change in value. Companies come and go (and their stocks), but their
buildings and the homes of their employees, tend to stay around for a long time.

Knowing the average increase in stock values does not give us much information about how
a particular stock will fare. Its a gamble. Knowing the average increase in property
values gives us a good idea as to how much a particular property will fare.

Individual stocks vary wildly from national averages because there are so many variables
that distinguish one stock from another. Property varies much less ... there is only one
variable that distinguishes one home from another. Location.

What if your investment is taken out of circulation?

(1) Property ... it is rare (earthquake, fire, redevelopment, etc). But even when it
happens, the owner is compensated. Insurance is available and inexpensive.
(2) Stocks ... it is common (companies go under all the time). When they do, there is
nothing the owners can do about it. There is no insurance.

Beating the averages: I have yet to see a stock market investment strategy that beats the average
over the long term. I have a strategy to beat the real estate market:
(1) Invest in Geography ... where people go (climate, things to do, desirable places, etc).
(2) Invest in Demographics ... Boomers are retiring, and they live anywhere they want.
(3) Invest in the Seaside ... the allure is varied and deep-seated. Seaside real estate is
going to rise much faster than inland real estate.

Other investments may fluctuate by the minute. Real estate investments are
comparatively relaxed ... solid, consistent and sure.
CHAPTER #5: Yes, but ...

Impossible to get 90% mortgages:

Look around, they exist. Check out other banks and institutions. Check out the Internet. Private
Mortgage Insurance (PMI) is worthwhile, if it gets you a high percentage mortgage. Borrow as
much of the purchase price as possible.

Impossible to ask relatives for financial assistance: Ask the seller. An 80% first mortgage and a
30% second leaves 10% pocketed in cash ... deposit on your next investment.

Impossible to survive if I lose my tenant: Get a new tenant. Lower the rent, if necessary.

Impossible to get ahead by depreciating an asset, then paying depreciation-recovery tax: Dont
sell the property. If you sell, youve had an interest-free loan of hard (present-day) dollars that
youll repay with soft (future) dollars.

CHAPTER #6: Summary ... Why Invest in Real Estate?

(1) You do not need to have much of the purchase price ... borrow as much as possible.
(2) You can buy many dollars-worth more than you pay for ... leverage.
(3) You can greatly increase propertys value without spending much money ... improvements.
(4) You need not sell to reap the benefits of appreciation.
(5) You need not monitor your properties moment-by-moment.
(6) Property tends to appreciate smoothly and consistently.
(7) Property is very forgiving of mistakes.
(8) Property has exceptional tax advantages.
(9) Property appreciation varies little around the national averages.
(10) It is very easy to do better than the national averages.
(11) It is the simplest, most reliable investment vehicle to convert a little financial intelligence
into a lot of cold, hard cash.

Investing in properties is a numbers game.

CHAPTER #7: The 100-10-3-1 Rule

Look at 100 properties, make offers on 10, try to arrange financing for 3, maybe purchase 1.

The more properties you look at, the more efficient shopper you become.
You need perseverance to make this work.
CHAPTER 8: Finding Properties
There is no one magical source for great deals.
Classified advertisements: The small
column ad in the local newspaper is the
method-of-choice used by owner-sellers who are not using a real estate agent. Whats the
advantage of not involving a Realtor?
(1) Using their own resources, the private owner-seller may have under-estimated the
value of the property.
(2) There will be less competition for the property, compared to MLS, larger ads,
websites where any agent or buyer can find it.
(3) The owner-seller will not have had as many inquiries as when an agent is involved,
and offers may be more welcome.

Real estate magazines: The preferred source of listings, for two reasons:
(1) They usually include a color photo of the property. It will show the property in its
best light, but it is hard to be grossly misleading ... as it is with word descriptions.
(2) Looking in more detail normally means simply calling the real estate firm.

Real estate agents: They can offer an ongoing stream of good recommendations that are not
always out-in-the-open yet.
(1) Never stick to just one agent.
(2) Work with agents who are investors themselves.
(3) Interview them ... deal with a agent who can speak your investor language.
(4) A good agent will like to deal with an astute investor ... someone who buys often.

When agents are fast, knowledgeable and efficient, good investors are grateful for the ease
of getting the work done. When agents are lousy, poor investors pack up
and go away and the potential competition for properties is lessened.
The good investor wins either way!

Off-market sales: These are properties where the owner does not even know they want to sell.
The absence of a For Sale sign does not necessarily mean the owner does not want to sell.
Knock on the door ... no law against it. Youll be rejected more often than not, but an acceptance
makes all the rejections worthwhile.

Write your own advertisements: Why wait for someone else to put an ad to sell a property in the
newspapers ... run your own ads to buy. Let the world know you are in the market to buy
investment properties.

Other sources of listings: Once people get to know that you are a serious property investor, they
will catch some of your fever. People come out-of-the-woodwork to offer you deals, merely
because they know you invest in property!
 There is often an advantage in being from out-of-
CHAPTER #9: Analyzing Deals
town. Locals are affected by perceptions of what is
Terminology:
good or bad. You are interested in the numbers.
(1) Yield ... A snapshot of the
performance of the property. It is:
rental income
divided by the purchase price.
(2) Cash-on-Cash Return ... Another snapshot, but better than yield. It is:
rental income (less interest and expenses) divided by capital outlay.
(3) Internal Rate-of-Return ... A far more interesting measure, the motion picture of how cash-
flows and property values change.

Example: $100K property with 70% mortgage, after-tax cash-flow $1,000/yr for 5 years. After 5
years, the property will be worth $150K and owners equity may be $85K.
The cash-flow will be: (a) $ 30,000 in ... downpayment (equity) in the beginning
(b) $ 1,000 out ... received each year for 5 years
(c) $ 85,000 out ... equity at the end of 5 years
Internal Rate-of-Return: Interest rate a bank would have to give you on a $30K deposit
to generate $1,000 per year for 5 years and $85,000 at the end.

Software is available to calculate IRR. Once used, it is difficult to evaluate properties

without it. See www.dolfderoos.com.

Other factors to consider:

(1) Location ... subjective, but critical. Near good schools and shops (but not too near), with
good access via freeways and air.
(2) Property with a twist ... something to distinguish it from others.

Let your creativity and imagination run wild.

CHAPTER #10: Negotiations and
Submitting Offers

There are very few rules! I usually put these four clauses in a contract:
(1) Sign the contract As Nominee ... allowing freedom to assign to whatever ownership
structure is best later (my own name, company, family trust, etc.)
(2) Make the contract contingent on arranging financing suitable to purchaser.
(3) Make the contract contingent on purchasers attorneys approval as to title,
encumbrances, liens, easements, and other regulatory impositions.
(4) Secrecy clause ... keeps other competitors (buyers, sellers) from knowing your plans.

How to make your offer seductive ... staple your earnest money deposit to the contract!
 Buying property with Other Peoples Money
CHAPTER #11: Getting High on OPM
gears your investment through leverage.
Banks want to give you money ... let them!
Sources of financing ... numerous (banks,
credit unions, insurance companies, real estate companies, etc). It really doesnt matter where it
came from ... all that matters are the terms and conditions of the loan.

Should you pay off the mortgage? No, not on investment properties.
(a) Take the money you would have used and purchased another leveraged property.
(b) Paying down principal reduces your interest payments (lessens tax deductions)
(c) Your IRR on the property investment goes down

Closing thoughts on mortgages:

(1) Buy property to acquire debt. The amount of the debt decreases slowly while the
asset increases in value. Debt on appreciating assets is good. Debt on depreciating assets (cars,
stereos, boats) is bad.
(2) When you owe the bank $5,000, youve got a problem. When you owe the bank $5
million, they have got a problem. They have a vested interest in looking after you.
(3) Once youve shown yourself to be a successful property investor, banks will prefer
lending you money over anyone else.

You will either win or learn.

CHAPTER #12: Massively Increase the Value of
And you never learn less.
Your Properties (without spending much)

Example: Build a carport for $1,000 and increase

rental income by $20/week.
(1) The return on your $1,000 investment is about 100% per annum
But, theres more ...
(2) Get the property re-appraised. Capitalizing rent at 10%, the value of the property
should increase by about $10,000.
(3) Get a new mortgage for the higher value ... 70% loan puts an extra $7,000 in your
pocket and you pay $700/yr in extra interest.
(4) When the smoke clears, you have $7,000 tax-free in your pocket and $300 in
additional annual income ($1,000 - $700). All for adding a $1,000 carport.

How to increase the value of commercial property:

(1) The biggest way is to acquire it vacant and find new tenants.
(2) Subdivide a large property into smaller ones.
 Managing a property is like owning a pet.
CHAPTER #13: Managing Your
It is exciting at first. Then reality sets in.
Properties

Start by managing your own properties

because it is great training to understand the components of the process. Youll be better
prepared to turn the task over to professional property managers.

Tenant selection: This is the most critical factor in running your properties smoothly.
(1) Interview candidates ... references are helpful. Good long-term tenants dont mind
answering many questions about previous rentals, jobs, locations, etc.
(2) Visit candidates at their present home ... if circumstances permit.

Finding tradesmen: No magic formula.

(1) Ask friends and acquaintances.
(2) Join a local property investors association (if there is one)
(3) How to get a tradesman to do your job first, always ... pay him the same day you get
the statement. Word will soon spread!

Rule enforcement: The biggest mistake is investors trying to be too friendly with their tenants.
(1) Be firm, but fair ... friendly, but not familiar
(2) If tenants know you are fair, but you will take swift action on any breaches, they will
respect that ... and seek out a slower-reacting creditor to not pay when money is tight.

Accounting: The financial climate for property investing is so positive, dont even think about
any under-the-table transactions. Have a computerized system for accounting, and update it
weekly or monthly.

Evictions: One of the toughest things youll ever have to do

(1) Make sure you abide by all the rules and regulations for evictions.
(2) Word will spread like wildfire that you evict for non-payment.
(3) As soon as rent is overdue, contact them. It is easier for them not to pay someone
who never calls.

Professional Property Managers: Every hour spent on managing existing property detracts from
your ability to find, analyze, negotiate, finance and own another one.
(1) Not only do they manage the property, they do much of the accounting.
(2) They typically charge 4%-to-15% of the rental income. The bigger your portfolio, the
lower commission rate they charge.
(3) Having a property manager enables you to work on your business, not in it.

Develop systems to manage your properties ... and systems to manage your managers. You
will benefit not only from Other Peoples Money, but also Other Peoples Time.
 When you invest in residential property, you
are dealing with people.
When you invest in commercial property, you
CHAPTER #14: Residential versus are dealing with contracts.
Commercial Property

Residential ... self-explanatory, people live there. I include apartment complexes, but some
banks do not.

Commercial ... where any form of commerce is transacted. I include industrial and hospitality
properties, too.

Governments have countless rules governing residential property, and they override anything
you may put into the lease agreement. With commercial property, whats in the lease agreement
is generally what goes.

Commercial landlords have far stronger remedies than residential landlords.

Comparisons:
Residential Commercial
Rental quotes: monthly or weekly annual
Tenant interest in improving
or maintaining property: no interest vested interest
Leases: short (or non-existent) long
Minor problems: tenants phone you tenants fix
Bureaucrats: protect tenants rights leave you alone
Capital required to buy: minimal large
Loans: 90+% of appraisal 50% to 60% of appraisal
Appraised value: same vacant or occupied occupied is 2x or 3x higher
Finding new tenant when vacant: easy (all about same) difficult (specialized)
Management overhead: high low

Of all the extremely high net-worth property investors I know, almost all own
predominantly commercial properties. I would rather have a large amount of money tied
up in commercial property rather than residential property.

More often than not, the effect of government

CHAPTER #15: Government
interference is exactly the opposite of that intended.
Interference

Markets:
(1) The property market is the largest industry in almost all Western nations.
(2) Other markets are highly regulated and controlled, but real estate is mostly left to the
natural forces of supply and demand.
 The reasonable person accepts the world. The
CHAPTER #16: Eight Golden unreasonable person insists on changing the world.
Rules of Property All progress depends on the unreasonable person.
Golden Rules:
(1) Make your money when you buy. Most of the profit comes from buying well.

(2) Always buy from a motivated seller. Dont feel guilty that you are buying at what seems to
be a steal. You are still paying him more than his next best offer.

(3) Fall in love with the deal, not the property. When it comes to investment property, leave
your emotions behind. Do the numbers work? What are the growth prospects?

(4) The first person to name a figure always loses. True in life, not just in property sales.

(5) Be counter-cyclical. Go against the grain. Buy when everyone else is selling, and sell when
everyone else is buying.

(6) Always buy with zero or little down. The less money you put in, the higher the returns to
you, and the more additional properties you will be able to buy.

(7) Seldom sell: People who sell never do as well as people who keep their properties.
However, it is sometimes wise to sell to cut losses or quit a property that is becoming a drain on
finances, energy or mental effort.

(8) The Deal-of-the-Decade comes along about once a week. The most important rule.

We are going to be dead for a very

CHAPTER #17: The World is Your
long time. Make the most of life.
Oyster

The game of Monopoly versus real life:

(1) You win the game by bankrupting your opponent. In real life you collect rent from
willing tenants
(2) In the game, you collect money only when someone unfortunately lands on one of
your properties. In real life, I have willing long-term leases.
(3) The game is played on a board. In real life, I own properties all over the world.

You can be a successful real estate investor with no qualifications, and with little money.
What it takes is diligence and persistence.