Episode 24: Real Estate Investor: Cash vs. Equity vs. Passive Income
Summary
Let's talk investment terms! In today's episode, we define the terms cash, equity, and passive income, and if you had a choice, which would YOU choose? As a real estate investor, you must evaluate the "grief-to-dollars ratio", especially when it comes to passive income. We explore the 5 ways an asset makes you money while you sleep with passive income!
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Full Episode Transcription
Welcome to My Life as a Landlord, where we untangle all things housing and educate the curious. If you're looking for some entertainment with some honest, awkward conversations, you've come to the right show. I'm your host, Dr. Jennifer Salisbury. This is my life as a landlord. Welcome to it. Hello and welcome. This is my life as a landlord.
And I'm your host, Dr. Jen Salisbury. Soon happy you've joined me today. This is episode 24, real Estate investing. We're going to talk about three different tools as a real estate investor and figure out which is the best in whichever situation. Cash versus equity versus passive income. Yeah, we'll talk about all that, but first, let's define those terms. Let's talk about those terms. Mean cash. This is referred to as liquid, meaning you've got cash. You can literally walk into a store right now, use that cash to buy something, to buy anything, and it's immediate value, immediate use. Now equity, equity is a little bit different. Equity is considered not as liquid meaning you can't necessarily get the equity right this second. But if you've got an asset, let's say you've got a home or an apartment building or whatever it is, you've got appreciation on that asset, less your purchase cost, less your purchase cost, less your mortgage balance, depending on how you're looking at this. If you're looking at it for tax purposes or you're looking at it as just straight up equity, then it's a little bit different. So for example, let's say you bought a house for $150,000 and you sell it for $200,000. Well then you should have $50,000 in equity. Now that equity once again takes a little bit of time because you have to sell the house right? It's not liquid. But if it's your personal residence you would not have any capital gains per se on that house. Now of course depending on the situation that's not always the case. Depending on the situation you might have some capital gains in there. So make sure this is just an example. Otherwise you're going to pay some taxes. You're going to have tax liabilities on it and those taxes could potentially be as high as 25% or more. And so your $50,000 in equity may not actually be 50,000. It may be less than that. Maybe 35,000, maybe 38,000, whatever. But it's not as easy to get as having a fistful of cash. You've got to do something to access that equity. Another thing you can do, instead of selling the asset, you could potentially get a line of credit utilizing the equity on the asset. But again you still then have to qualify for a line of credit with some lending institution of some kind. And that doesn't happen overnight either. And so it's not as liquid. You get it? Okay. Then you've got passive income. Passive income is money that you make automatically even when you're sleeping. Now, this is money that can come in the form of equity. It can come in the form of cash. Very interesting. Passive income. We're going to talk more about passive income here in a minute. But those are your terms. Cash, equity, passive income. So let's talk about a scenario. Let's evaluate each one. Let's talk about a scenario where if you had, let's say you have $100,000 in cash, not that you would have that in your house somewhere, maybe, but if you had $100,000 in cash, you would then have that money would be subject to inflation. Meaning as the costs of everything go up, that money would not buy as much. Your buying power would go down. But it's easily spendable, right? It could potentially burn a hole in your pocket. You could go out and pay cash for a brand new car right quick to spend it. So $100,000 cash. Very interesting, having that much cash. I know somebody might be saying, well, Jen, wouldn't you go and buy gold? Well, you can. You can buy or and there's a different discussion there when we're talking about investments. But for just today's podcast, we're talking about cash versus equity versus passive income. And yes, we will have discussions about buying or. Okay, so $100,000 in cash versus let's say you have $100,000 in equity in equity. So you'd be subject to market value fluctuations because remember, equity is based on some kind of appreciation of an asset. So if in your area, everything is going up, up, and then it goes down, okay, well, then your equity goes down because, again, it's a potential number if you were to sell, right? That's what this equity value is coming in. But an equity, again, is not easy to access. You've got to do something to access that equity. So it's really hard to get. One of the things that Mike does when we're talking about refinance, seeing assets is amortization rates. Amortization terms will change. Many of you may recall not too long ago, pre COVID, you could get a mortgage for 30 years. Now, typically we're finding that the mortgage term is 25 years, which is interesting. Before all that changed, there were a couple of properties that we owned. We started at 30 years, and then we paid paid down the mortgage for five years, and we were at 25 years. And then when it was time to change, time to refinance and again, we're talking about equity. We're talking also about cash flow here. In a second, instead of taking money out, taking equity out of that asset, mike would say, okay, well, let's just leave the equity in there and let's change the term again to 30 years. So now you've got an appreciating asset with a longer term, what happens to your monthly payment? Your monthly payment goes down, so your cash flow goes up. And all the while, remember, most of the time, real estate assets appreciate eight, approximately 3% per year. So if you're holding it for five years, it's not linear. So it's not 15%, but it's not zero either. Right. So just talking about $100,000 worth in cash versus $100,000 in equity, little bit different if we're talking about how we actually measure that equity, how we get it. But let's talk about passive income. So. Mike's favorite subject. So 100,000 in cash, 100,000 in equity. Let's go to something very small. Let's say 3000 per month. Passive income. Let's just talk about bit of passive income. So again, passive income is you make money while you're sleeping. Right? Now, I want to be clear, this money is not made without effort. You have to still put some effort in. You still have to do something. And when you have business, which real estate assets and landlording and things like that, and real estate development, those are all businesses. So let's not kid ourselves. Passive income, there's still effort with it. So I can say, yeah, you make money while you're sleeping, but while you're awake, you still got to do stuff. This, this also includes other things. Not just rentals, but includes billboards. Some of you have storage lockers that you rent out or mobile home parks that you rent out. But there are other businesses. The same thing is a retail store restaurant. Some of those I'm mentioning are active income. Those are not passive income. But when you're talking about passive income, if you were to choose between $100,000 cash in your hand one time, $100,000 in equity, $3,000 per month, passive income that you had to do, little effort to get per month, and then just it keeps going, which would you choose? But I know which one I would choose. Let's talk more about passive income. We've defined these terms. I've given you a scenario here. And let's talk about how passive income makes money in five ways. I am betting once I say the five ways, you're going to go, hey, Jen, you forgot about this. That's fine. If I forgot about one way that passive incomes makes money, please jump on the Facebook group, my life is a landlord. And remind me about passive income. I've written these five ways down. And again, passive income is my choice, but it may not be yours. I get it. So let's talk about how passive income makes money in five ways. Okay, one. To get passive income, you've got to have an appreciation of an asset, right? We talked about this 3% per year on average. Assets appreciate. So the longer you hold an asset, you use that variable of time. The longer you hold that asset, the more appreciation you're going to have, the more cash flow you potentially are going to have and the more equity you're going to have. Right? You see how this is all playing into these other terms? Okay, so that's the first 1, second one. Every month that you pay your mortgage payment, 1s part of that is paying down the principal balance of the amount due on the note on that property. So not only is the value of the property going up, you're paying down the principal every month. So your amount due is less every month. Now, I understand capitalization allocation, when you sell it, you're going to have to pay some money back. I get it. But for the sake of this. 1s Discussion. We're talking about appreciation and paydown. Okay, let's keep going. If we're talking rentals, passive income from rentals, then depending on where you are rent values, rent amounts will very likely continue to increase based on demand. Right now, there is a housing shortage globally, and there's a lot of people who want to rent, and there's just simply not enough rentals at all, which is why Mike and I are so busy, which is a good thing. But that's the third way that you make money with passive income if you've got rentals, is your rent values are also increasing, so your monthly cash flow is going up every month. Number four, if you have property, if you have billboards or a tangible asset, you can touch it, you can feel it. And it's very interesting because if you're looking at any of the YouTube videos that Warren Buffett has put out, he has a very interesting perspective about cryptocurrency. And I'm not saying cryptocurrency is good or bad. I think it's very interesting technology, actually. But one of Warren Buffett's arguments for a brick and mortar investment is that is a tangible asset you can actually touch it cryptocurrency you can't necessarily touch. 1s And so is passive income making money for you? And it's debatable if it's actually going to make money because it's a tangible asset. However, depending on who you talk to, that is one way you could make some money. 1s Now, here's a very interesting way. This is the fifth way that I've got on my list here. Passive income can make you money. You can actually leverage that asset up to most of the time, up to 80% of the value of the asset and go buy something else. So let's say you have an apartment building that's worth a million dollars. Let's just say your note on it is 500,000. If you have a lending institution that's going to lend you 80% of the value, well, obviously you've already got 500,000 on that. So 50%. But there's 30%, or in this example, 300,000, that they could potentially give you a line of credit. Well, in that 300,000, you could potentially go out and buy another apartment building worth a million or even more million dollars, right? And so you can leverage your assets. In fact, those who have been doing real estate investment a long time, they use time to their advantage along with the real estate cycles. It's one thing I have not mentioned in this entire podcast today, is the real estate cycles go up and down and you've got different aspects of ideal times to buy and to sell and to rent and all of these different aspects. But when you are leveraging your assets, you want to do it strategically based on cash flow, based on percent of the interest rates, loan commitments. And you don't want to over leverage yourself either. But when you're looking at passive income, makes money while you're sleeping in five different ways, you've got appreciation, mortgage pay down, rent values increasing on a monthly basis. It's a tangible asset. And you can leverage that asset to buy more assets. It's a very interesting notion when we're talking about cash versus equity versus passive income. Very interesting discussion. All right, so we define those terms. I gave you a scenario here, and I talked a little bit more about as a real estate investor, passive income is very likely going to be the best long term solution for cash flow. You other than just having $100,000 in cash in your hand, $100,000 in equity, that's not easy. To get. Passive income, even a small amount that you're going to get every month and it's going to increase, is a very interesting notion, knowing that it's going to be in perpetuity. It's going to keep going on and on and on as long as you own the asset. All right, so here's your call to action. Ready? Michael Gerber wrote a book called The E Myth today. We talked a lot about assets and we talked about income, passive income, a little bit about active income. Michael Gerber's book. The e myth. E myth. Now, he's got lots of varieties of this book, so if you see different varieties, pick one that appeals to you, because the message is the same. Regardless of the version, the message is the same. He goes into detail about the three levels of business. One is being the technician. The technician is the person who does everything all the time, all by themselves. The second one is being a manager. A manager manages multiple technicians. And the third is the entrepreneur. The entrepreneur manages the managers. You'll see very quickly as you learn more about The EMyth and about setting up systems in your business, that passive income does not come easy, and it does not come without some effort. But if you've got your systems down by reading this book, one of his books, The EMyth, you will have great lessons learned on setting yourself up for not only active income, but ultimately for passive income. Thank you so much for joining me today. I'm super excited about next week's episode, another Salisbury adventure where I get to talk to you all about my trip to Moscow. I traveled to Moscow in the 90s as a midshipman, and, oh, my goodness, was that ever interesting. I can't wait to tell you all about it. See you next week.
Thank you for joining us this week. To view the complete show notes and all the links mentioned in today's episode, visit our website at www.mylifeasalandlord.com If you're looking for educational resources for getting into real estate investing, becoming a landlord, or even a better tenant, then I have a page on my website to get you started looking for a solution to the pickle that you're in. I have suggestions for that too. You can throw your situation on my Facebook group, My Life as a Landlord, and let our community help you with solutions. Also, before you go, make sure you subscribe to the podcast so you can receive new episodes right when they're released. You can either subscribe right now in the app you're listening to this podcast on, or you can sign up at www.mylifeasalandlord.com. Thank you again for joining me, dr. Jennifer Salisbury. In this episode Road of My Life As A Landlord I'll see you next time.