Robert Kiyosaki The Real Book Of Real Estate

Robert Kiyosaki The Real Book Of Real Estate
The REAL Book
Real Estate
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The REAL Book
Robert Kiyosaki
Real Estate
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Copyright © 2009 by Robert T. Kiyosaki
Published by Vanguard Press
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written permission of the publisher. Printed in
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387 Park Avenue South, 12th Floor, New York, NY 10016, or call (800) 343-4499.
Designed by Anita Koury
Set in 10.5 point Mercury
Library of Congress Cataloging-in-Publication Data
The real book of real estate : real experts, real advice, real success stories/Robert Kiyosaki.
p. cm.
Includes index.
ISBN 978-1-59315-532-2
1. Real estate investment. 2. Real estate business. I. Kiyosaki, Robert T., 1947-
HD1382.5.R33 2009
ISBN 13: 978-1-59315-532-2
Vanguard Press books are available at special discounts for bulk purchases in the United
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"I'm not a genius. I'm just a tremendous bundle of experience."
—Dr. R. Buckminster “Bucky” Fuller
From left to right: Dr. R. Buckminster
“Bucky” Fuller at eighty-six years old with
Robert Kiyosaki in 1981. Buckminster Fuller
was an American architect, author,
designer, futurist, inventor, and visionary.
Recognized as one of the most
accomplished Americans in history, he
dedicated his life to a world that worked
for all things and all people.
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Acknowledgments ix
Introduction, Robert Kiyosaki 1
The Business of Real Estate
1 The Business of Real Estate, Tom Wheelwright 5
2 A Real Estate Attorney’s View of Assembling and Managing Your
Team, Charles W. Lotzar 29
3 The Way to Exotic Wealth, Wayne Palmer 53
4 Profits from the Ground Up, Ross McCallister 71
5 Master Your Universe, Craig Coppola 89
6 10 Rules for Real Estate Asset Protection, Garrett Sutton 108
7 Of Marbles and Capital, Wayne Palmer 133
8 How to Avoid and Handle Real Estate Disputes, Bernie Bays 152
Your Real Estate Project
9 Buy by the Acre, Sell by the Foot: Understanding Real Needs,
Financial Logic, and Asking Questions, Mel Shultz 173
10 It’s All About Adding Value, Curtis Oakes 184
11 Analyzing the Deal, or Adventures in Real Estate, John Finney 200
12 Real Estate Due Diligence, Scott McPherson 222
13 Creating Value from the Inside Out, Kim Dalton 233
14 Financing for Real Estate Investors, Scott McPherson 251
15 Lease It and Keep It Leased, Craig Coppola 262
16 The Perils of Careless Property Management, Ken McElroy 276
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PART 3: Creative Ways to Make Money in Real Estate
17 Getting from A to B Without Paying Taxes, Gary Gorman 293
18 No Down Payment, Carleton Sheets 306
19 Marketing: Your Ticket to Finding and Profiting from Foreclosures,
Dean Graziosi 326
20 Entitlements: The Sleeping Giant of Real Estate Profitability,
W. Scott Schirmer 341
21 The Tax Lien Investment Strategy, Tom Wheelwright 371
22 Horse Trading: The Original Way to Wealth on the Great American
Frontier, Wayne Palmer 390
23 How to Create Retail Magic: A Tale of Two Centers,
Marty De Rito 409
Lessons Learned
24 What One Property Can Teach You, Kim Kiyosaki 433
25 In the Beginning... , Donald Trump 451
26 What Is the Most Important Thing You’ve Learned From Your
Father About Real Estate?, Donald Trump Jr. and Eric Trump 458
27 Overcoming the Fear of Failing, Robert Kiyosaki 466
Index 481
Credits 501
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or years I have been an advocate for financial education.While many other
financial advisors are telling people what they should invest in, I have been
telling people to invest in themselves—to invest in their own knowledge. That
is what I have done, and it has made me rich. I have also been telling people to
surround themselves with great teachers who are actively practicing what they
preach. The creation of this book was made possible because of the people I
consider my teachers. Each one has a lifetime of experience and a lifetime of
knowledge. And each one knows the importance of continual learning.
The contributors to this book generously gave of their time and their talent
so that you could see the possibilities, avoid the pitfalls, and understand the
methods of building wealth through real estate. They have recollected their
great achievements, and they have revealed their painful failures. I thank them
for their openness. The lessons we learn from our own mistakes and the mis-
takes of others are the most powerful.
These people are not only my advisors, but they are also my friends. Together
we have been through the ups and downs of the real estate cycle, ridden each
wave, and made money doing it. These are the friends I run my ideas and my
deals by. And because they are friends, I know that they will give me their
honest opinions. I thank them for that, too.
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I’d also like to thank Jan Ayres and Kathy Heasley of Heasley & Partners,
Inc., who took this book from ideas on a flip chart to a finished manuscript.
Special thanks to Rhonda Shenkiryk of The Rich Dad Company and Charles
McStravick of Artichoke Design for their work on the book’s cover. Finally,
thank you to my wife, Kim, who more than twenty years ago said yes to a guy
with no money and a lot of ideas.
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here are four reasons why I think a real book of real estate is important at
this time.
First, there will always be a real estate market. In a civilized world, a roof
over your head is as essential as food, clothing, energy, and water. Real estate
investors are essential to keeping this vital human need available at a reasonable
price. In countries where investing in real estate is limited or excessively con-
trolled by the government, such as it was in former Communist Bloc countries,
people suffer, and real estate deteriorates.
Second, there are many different ways a person can participate and prosper
with real estate. For most people, their only real estate investment is where they
live. Their home is their biggest investment. During the real estate boom from
2000 to 2007, many amateurs got involved with flipping houses—buying low
and hoping to sell higher. As you know, many flippers flopped and lost every-
thing. In true investor vocabulary, flipping is known as speculating or trading.
Some people call it gambling. While flipping is one method of investing, there
are many, more sophisticated, less risky ways to do well with real estate. This
book is filled with the knowledge and experiences of real, real estate investors—
real estate professionals who invest rather than flip, speculate, trade, or gamble.
Third, real estate gives you control over your investments, that is, if you
have the skills. In the volatile times of early 2009, millions of people were losing
Introduction: A Note from
Robert Kiyosaki
Why a Real Book of Real Estate
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trillions of dollars simply because they handed over control of their wealth to
other people. Even since the middle of 2008, the great Warren Buffett’s fund,
Berkshire Hathaway, has lost 40 percent of its value! Millions of people have
lost their jobs, which means they had no control over their own employment
either. The real, real estate professionals in this book have control over both
their businesses and investments. They will share their good times and the bad
times with you. They will share what they have learned while learning to control
their investments and their financial destiny. The learning process is continual.
And, finally, here’s my real reason for this book. I am sick and tired of finan-
cial experts giving advice on real estate, especially when they do not actually
invest in real estate. After my book Rich Dad Poor Dad came out, I was on a tel-
evision program with a financial author and television personality. At the time,
in 1999, the stock market was red hot with the dot-com boom. This financial
expert, who was a former stockbroker and financial planner, was singing the
praises of stocks and mutual funds. After the stock market crashed in 2001, this
man suddenly resurfaced with a new book on real estate, portraying himself as
a real estate expert. His real estate advice was beyond bad. It was dangerous.
Then the real estate market crashed and he dropped out of sight again. The last
time I saw him, he had written a book on investing in solar energy and was
claiming to be a green entrepreneur. If he were to write a book about what he
really does, his new book would be about raising bulls... and selling BS.
There are other financial “experts” who know nothing about real estate, yet
they speak badly about real estate and say it is risky. The only reason real estate
is risky for them is because they know nothing about investing in it. Instead,
they recommend saving money and investing in a well-diversified portfolio of
mutual funds—investments which I believe are the riskiest investments in the
world, especially in this market. Why do they recommend investing in savings
and mutual funds? The answer is obvious: Many of these professionals are en-
dorsed by banks, mutual fund companies, and the media. It’s good business to
plug your sponsors’ businesses and products.
Commissioning this book gives the public its first chance to learn from real,
real estate investors, friends, and advisors—people who have been through the
ups and the downs and who walk their talk. This book gives them the opportu-
nity to share the spotlight with the many media financial “experts” and speak
the truth. These real estate experts are true pros, and you’re about to move be-
yond the media hype. I hope you are ready. The Real Book of Real Estate is the
real deal.
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The Business
of Real Estate
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om Wheelwright is a rare combination of CPA, real estate investor, and
teacher. He has the ability to take the complex and often boring subject of
tax and tax law and make it into something that’s simple enough for a person like
me to understand.
Tom understands the tax code. He actually enjoys reading the tax code, and be-
cause he is such a student of it, he understands this lengthy document better than
anyone I know. Most CPAs focus on a very small part of the tax code. They focus
on the part that lets you and most Americans defer taxes until retirement—the
code relating to IRAs, 401(k)s, and other so-called retirement plans. Tom also pays
close attention to the other, much lengthier part of the code that shows you how to
reduce or eliminate your taxes permanently. The difference between Tom and
other CPAs is that Tom understands the purpose of the tax code. It’s not just a set
of rules. It’s a document that when followed is designed to reward certain behaviors
through lowering or eliminating taxes. Does your CPA see the tax code this way?
I consider Tom to be a very moral and ethical man. He is very religious, raised
in the Mormon faith. While I am not Mormon, I do share many of the values of
the Mormon religion—values such as tithing, giving at least 10 percent to spiritual
matters, and dedicating a number of years as a missionary. While I have never
The Business of Real Estate
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been a religious missionary, I have spent nearly ten years as a military missionary:
a Marine Corps pilot in Vietnam, serving my country.
One important lesson I have learned from Tom and others of the Mormon faith
is the saying, “God does not need to receive, but humans need to give.” This reminds
me of the importance of being generous. It is my opinion that greed rather than
generosity has taken over the world. Every time I meet someone who is short of
money, or if I am short of money, I am reminded to be generous and to give what I
would like to get. For example, if I want money, I need to give money. Having
been out of money a number of times in my life, I have had to remind myself to
give money at times when I needed money the most. Today I make a point of do-
nating regularly to charities and causes that are dear to my heart. My opinion is,
if I cannot personally work at a cause near to my heart, then my money needs to
work there for me. Going further, if I want kindness, then I need to give more
kindness. If I want a smile, then I need to first give a smile. And if I want a punch
in the mouth, then all I have to do is throw the first one.
I asked my friend Tom Wheelwright to be a part of this book not only because
he is a smart accountant—a team player that anyone who wants to be rich needs
to add to his his team—but also because he comes from a generous and sound
philosophical background.
Tom is a smart CPA who is an advocate of investing in real estate. Why? Be-
cause he knows that tax laws reward real estate investors more than they reward
stock investors. He is a great teacher, a generous man, and, most importantly, a
friend I respect.
—Robert Kiyosaki
was one of the fortunate few growing up. Unlike much of the rest of the
world—people who have been told to save their pennies and invest in mutual
funds—my parents taught me to invest in real estate and business. My father
had a printing business, and my mother handled their real estate portfolio.
So, it was natural that once I had received my education, both formal and
work related, I opened my own business. (I had a lot of education before I
finally opened my own business—a master’s degree in professional accounting,
thirteen years of experience with international accounting firms, as well as ex-
perience as the in-house tax advisor to a Fortune 1000 company. I was a little
slow to realize the power of business.) When I started my accounting firm, I
did it like most people: I worked all hours of the day and rarely took a vacation.
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When I did take a vacation, I still took calls from clients and colleagues. After
all, business never rests, so why should I?
Several years into my business, we had experienced significant growth, but I
was still working day and night and never taking a real vacation. And outside of
my business, I had no substantial assets. That’s when I read Rich Dad Poor Dad
and first met Robert Kiyosaki. He helped me realize that I was thinking about
business all wrong. It was not about how hard I worked, but rather about how
smart I worked.
Like many of you, my first real experience with Robert was at a Rich Dad
seminar. There I was, sitting next to my business partner, Ann Mathis, and her
husband, Joe. Robert was talking about a subject near and dear to my heart—
the tax benefits of real estate. Out of the blue, Robert asked me to come up to
the front of the room to explain the tax benefits of depreciation, introducing
me as his “other accountant.”
I had come to learn about Robert Kiyosaki and Rich Dad only a few months
earlier. One of my good friends, George Duck, had become the chief financial
officer at Rich Dad and had introduced us. I’m not sure who was more nervous
that first time I went on stage, Robert or me. Can you imagine putting an ac-
countant on stage? Robert had no idea that I had spent my life teaching in one
capacity or another, but he took the chance and put me up there anyway. This
began a long and inspiring relationship between us, and it really launched my
journey toward financial freedom.
I remember one of the first times Robert and I worked together. He used me
as “muscle.” That’s right, he used his accountant as his muscle. Robert had been
asked by a reporter to give an interview for the business section of the Arizona
Republic. The primary topic was how Robert could claim that he routinely re-
ceived 40 percent returns on his investments.
I went as the authoritative backup to Robert’s ideas. After all, someone might
not believe a marketing genius (i.e., Robert) when he says he gets these levels
of returns, but who wouldn’t believe an accountant? When it comes to investing,
numbers are everything, and who better to support the numbers than someone
who spends his life documenting, reviewing, and analyzing them?
That was one of the first opportunities I had to explain the benefits of lever-
age that comes from real estate. Not long before, I had started my own real
estate investing. You would think that with parents who were real estate in-
vestors, that I, too, would become a real estate investor. I had even spent my ca-
reer helping real estate investors and developers reduce their tax burdens.
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Not so. I didn’t actually begin investing in real estate until after the first time
I played Robert’s game, CASHFLOW 101®. This game had a powerful impact
on me. I saw, with my own eyes, the power of leverage in real estate. The game
was so powerful that the next day after playing the game, I called one of my
clients who had been investing in real estate for several years and asked him to
meet with me to show me how I could begin my own real estate investing.
And then I began making serious changes to my business. My partner, Ann, a
systems genius, created the systems, policies, and procedures in our firm so we
could focus on running the business and not working in the business. It took a
few years, but eventually we were able to step away from working for hourly
professional fees and instead supervise and grow a business that worked without
Now, I can take three weeks off each year with no e-mail or phone access, as
I did just recently when I took my oldest son on a trip to the châteaux region of
northern France. I didn’t have to worry about my accounting firm or my real
estate investments while I was gone because they were both running without
my daily attention.
Real estate investing is a business and should be run like a business.
Robert talks a lot about the CASHFLOW Quadrant, with each labeled as E,
S, B, and I. He emphasizes that we need to move out of the E (employee) and S
(self employed) quadrants and into the B (business) and I (investor) quadrants.
I have learned to take this one step further. That is, to move all I-quadrant in-
vesting into the B quadrant.
Think about what you could do with the time you would have if you didn’t
have to worry about tenants, repairs, and cash flow. How would it feel to elimi-
nate the frustration that comes from constantly watching your real estate in-
vestments and worrying about if a tenant might call you in the middle of the
night with a problem? You can eliminate all of this stress and free up hundreds
of hours of your time simply by running your real estate investments as a B-
quadrant business.
FIGURE 1.1 I’ve learned to take the quadrant a step further and
free up hundreds of hours of my time simply by running my real
estate investments like a B-quadrant business.
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It’s really not that difficult. You simply have to start acting like a business
and apply fundamental business principles to your real estate investing.
Business Principle No. 1: Strategy
Every business has to have a plan. Your real estate investing business is no dif-
ferent. A strategy is simply a systematic plan of action designed to accomplish
specific goals. There are seven simple steps to creating a successful strategy.
Step 1: Imagine
Begin your strategy with goals. Imagine where you would like your real estate
investing to take you. It may be a white sand beach in the Caribbean, unlimited
time with your family, or working for your favorite charity. My favorite places
in the world are Hawai’i, France, Arizona, and Park City, Utah. So my dream is
to own a house in each of these locations.
Don’t be afraid of being too aggressive. These are your dreams, after all, not
some number that is artificially imposed by a financial advisor. Our clients fre-
quently have dreams of financial freedom in as few as five to ten years. And
with a good strategy in place, anyone can be financially free in less than ten
years if they just start by applying these few basic business principles to their
real estate investing. So far, after six years of investing, I now have houses in
Hawai’i, Arizona, and Park City. France is on the agenda for next year. Pretty
aggressive goals, but I have been able to reach them in six short years by apply-
ing basic business principles to my real estate and business.
Step 2: Financial Goals
Determine what it will take to realize these dreams in terms of wealth and cash
flow. And commit to a date for accomplishing this goal. Then write down what
you currently have available in terms of investable assets less the liabilities.
This is your current wealth (also called net worth).
Step 3: Cash Flow Target
Of course, you will need to figure out the amount of wealth that it will take in
order to create your desired cash flow. A simple rule of thumb for calculating
this number is to multiply your desired cash flow by twenty. For me, I needed
$5 million in order to create an after-tax cash flow of $250,000 each year.
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Step 4: Current Wealth
Once you have your dream firmly in mind, the next step is to identify where
you are today. When considering where you are today, list only your real assets,
that is, those that are available to invest. Don’t list your car or your jewelry. But
do list the amount of equity in your home if it can be made available for investing
through a home equity loan. Here is an example of what I mean:
These first four steps are the essence of a process referred to as “dreamlin-
ing,” and I will use a simple illustration to show you what I mean. Here is what
my dreamline looked like when I first met Robert and started down my road to
financial freedom.
Step 5: Vision, Mission, and Values
After you have your dreamline in place, you can make a plan to reach those
dreams. This plan should include your vision, mission and values, the type of
real estate you will specialize in buying, and the criteria you use for choosing
your real estate investments.
July 1, this year July 1, 5 years
1 million investable
Net Worth
$250,000 Cash Flow
$5,000,000 Net Worth
Wealth Strategy
Liquid: Long-Term:
Savings Loans
Stocks & Bonds Real Estate
Mutual Funds Oil & Gas
CDs Business
Other Intellectual
Other Other
Sub-Total: Sub-Total:
FIGURE 1.2 Tom’s “Dreamline” When He First Met Robert Kiyosaki
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At this point, you may be wondering if I have truly lost my mind. After all,
aren’t vision, mission, and value statements only for true businesses? Exactly!
And your real estate investments are a true business. At least they should be if
you are going to reach your dreams in the shortest amount of time possible and
with the least amount of work.
When creating your vision, remember that this represents your focus for the
future, that is, what you want your life to look like when everything is in place.
Your mission is simply a statement of how you are going to go about your in-
vesting business. And your values are the values that you insist everyone you
work with in real estate share with you.
Tom’s Personal
Vision, Mission, and Values
Vision. My vision for financial freedom means having the time and resources to do
what I want, when I want. I know I have reached financial freedom when I can travel
anytime I desire, spend quality time with family and friends, and go on missions for
my church.
Mission. My mission to reach financial freedom is to invest in highly appreciating sin-
gle-family homes by researching foreclosures, borrowing from banks and sellers, hold-
ing properties for five to ten years, and obtaining tax leverage through depreciation.
Values. My values are these: abundance—recognizing that there are plenty of re-
sources and real estate deals to go around; caring—being kind and expressing grat-
itude; learning—taking the time to grow and improve my real estate knowledge;
and respect—treating others the way I want to be treated.
Step 6: Investment Niche
Once you have your vision, mission, and values in place, you can begin looking
at what type of real estate makes sense for you. Every successful business owner
knows that you are always most successful when you focus your attention on
something you enjoy doing and for which you have a natural ability. At my com-
pany, ProVision, we have a variety of tools we use to help people figure out
which type of real estate they will enjoy the most—multifamily, commercial,
industrial, raw land or single-family homes. My personal investment niche re-
mains highly appreciating single-family homes.
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Step 7: Criteria
The final step in your strategy—determining your investment criteria—is some-
thing that few people take time to do. And yet, if you can determine your in-
vestment criteria as part of your strategy, you can avoid a lot of headaches,
stress, and wasted time. You can also avoid making costly mistakes. And you
will save a considerable amount of time and energy, enabling you to focus on
only those investments that meet your criteria. As an example, here are my per-
sonal investment criteria:
You may be asking why you need to spend so much time and effort developing
a strategy. We teach our ProVision clients about the importance of strategy by
playing CASHFLOW 101® with them in a very specific way. If you have played
the game, you realize that, on average, it will take two and a half hours. We in-
struct our clients that their team (the players at their table) must spend the
first thirty minutes developing a strategy to win the game. This strategy includes
the type of assets they will invest in and their criteria for investing. All members
of their team, though playing as individuals, must follow the strategy precisely.
The result is astonishing. Each player gets out of the Rat Race and wins the
game in less than two hours. So even though they have spent an enormous per-
centage of their allotted time developing their strategy (roughly 20 percent),
they finish substantially earlier than they would have without their strategy.
This happens every time, so long as each team member adheres to the strategy.
Business Principle No. 2: Team
Just as every good business has a strategy, every successful business owner has
a very carefully chosen team of individuals and companies to help him/her
TABLE 1.2 Tom’s Personal Investment Criteria
Criteria Decision
Minimum appreciation 10%
Minimum rate of return 50%
Cash flow or cash on cash return -0-
Price range $200,000-$600,000
Maximum amount of investment/deal $80,000
Maximum time commitment 5 hours per month
Location of investment Western U.S.
Price as a % of value 85%
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succeed. Your team will add considerable leverage to your investing. You can
take advantage of your team members’ time, talents, contacts, knowledge, and
Tips for Building a Team
Plan. Think carefully about what skills you need on your team. For example,
you are going to need an attorney, an accountant, a banker, at least one property
manager, and others. Decide on the skill sets you need before you decide on
which people will fill those roles.
Referrals. The best team members almost always come as a referral from some-
one you trust. But make sure the person referring is also a real estate investor
and is knowledgeable about your situation and needs. A trusted advisor, such
as an attorney, accountant, mentor or wealth coach, can be a good source of
Agreements. Make sure you have good, clear agreements in place with each of
your team members so they know what is expected of them and what they can
expect from you.
Before we leave the concept of a team, let me give you my personal experi-
ence with developing a real estate team. Anyone who knows me realizes that I
spend most of my day growing my business. This doesn’t leave me much time
for real estate investing. But I love real estate investing and understand com-
pletely the importance of it in my wealth strategy.
I estimate the time I spend each week on real estate to be no more than one
hour. Yet, I make in excess of $100,000 per month through my real estate in-
vesting, all because I have developed a great team and applied the other business
principles we are talking about in this chapter. This brings me to our next prin-
ciple: accounting.
Business Principle No. 3: Accounting
You may wonder if I include accounting as a basic principle of business because
of my accounting background. While I have to admit to a natural bias in favor
of good accounting, I believe that if you were to ask one hundred successful
business owners if good accounting (including good reporting) were critical to
their business, at least ninety-five of them would agree.
Why? Because good accounting leads to good reporting, and good reporting
leads to good decisions. If you don’t have the information you need, how are
you going to make good decisions, such as when you should sell a piece of real
estate or how to know if your portfolio is producing the desired results?
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Great entrepreneurs understand the purpose of accounting. Here are a few
of my personal keys to great accounting.
Key No. 1: Purposeful Accounting
Accounting should never be done solely (or even mainly) to satisfy the IRS or
other regulators. Accounting’s primary purpose should be to provide accurate
and useful information so that you can make the best decisions. Poor investors
think that the only reason to keep records is so their accountant can prepare
their tax return at the end of the year.
This is a huge mistake. Good accounting is critical to good decision making.
Without current, accurate numbers, how are you going to make the decision to
buy, sell, or refinance your property? And how will you know which property is
doing well and which is doing poorly? You won’t even know if your property
manager is doing a good job or not.
Several years ago, Ann and I purchased a group of fourplexes in Mesa, Ari-
zona. The price was good based on the information we had at the time. We kept
Real Life Story: My Team Took Care of It All
o how do I make time for real estate? You guessed it—I have a terrific team.
They are so good, in fact, that the only time I have to spend is to quickly review
reports, make decisions (which are pretty easy, since I have very well-defined in-
vestment criteria), and sign documents. I remember one time recently when I was
speaking to my team leader and he informed me that a tenant had vacated a house
unexpectedly and not turned off the water. My team leader, who is not the property
manager, drops by all of my houses on a regular basis and noticed that the tenant
had left. He rushed into the house only to discover that the pipes had broken (this
was in Utah in the dead of winter), and the house was flooded. The cost of repair
was in the neighborhood of $50,000.
My team leader immediately took action. After turning the water off, he called
the property manager and the insurance agent. He arranged for the repair company
to renovate the property, made sure the insurance accepted the claim (before
spending any money), and went after the property manager and tenant for any
damages not paid for by the insurance company. I did not have to worry about a
thing. And I probably spent only thirty minutes total dealing with this mess (signing
authorizations and talking to my team leader).
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 14
very close track of the cash flow and the income from these properties. But
after a year or so, it became clear to us that these properties were not going to
generate positive cash flow in the near future. At the same time, we noticed
that cap rates (see Principle No. 4, p. 17) were going down. So, based on our
numbers, we sold the fourplexes. Because of the decrease in cap rates, we were
able to make a significant profit, and we stopped losing money each month.
Key No. 2: Accurate Bookkeeping
While good accounting should go far beyond mere bookkeeping, it begins with
accurate and appropriate bookkeeping entries. Accurate bookkeeping is the ba-
sis for creating useful reports and analysis.
Bookkeeping is merely the process of entering the results of transactions
into a record that can be used for reporting and analysis. I suggest to most of
my clients that they outsource their bookkeeping to their accountant or some
other professional bookkeeping service. For those who want to do it themselves,
I recommend using a very simple accounting software program, such as Quick-
Key No. 2a: Chart of Accounts
Begin by setting up a chart of accounts (this is just a list of the accounts you are
going to use to classify your receipts and expenditures). The accounts you use
should be those that make the most sense to you. For example, one person may
list printer paper as an office supply while another may list it in the more general
category of office expense. It’s simply a matter of how detailed you want your
reporting to be. Just remember that if you did not create an account for it, you
cannot create a report for it.
Here’s a little trick for you: You don’t have to create a separate chart
of accounts for every property. Instead, you can create a “class” for each
property. This allows you to do all of the bookkeeping for your real estate
business in one Quickbooks “company” while creating the detail and report
options that you need in order to understand what is happening with each
If you need help setting up your chart of accounts, ask your accountant/
CPA—a critical member of your team—to lend you a hand. This person should
be happy to help, and can do this fairly quickly for you.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 15
Key No. 2b: Detailed Data Entry
Once you have your chart of accounts set up, you are ready to begin entering
your data. Remember that you need to enter the details of every transaction.
Most transactions will have some cash involved, so if you enter the details every
time you receive or spend money, you probably will catch 98 percent of your
transactions. Some transactions don’t have cash involved, such as recording de-
preciation expense. These are done through journal entries. Since you will likely
have some journal entries to do, I will give you a brief explanation of how to do
Understand that every transaction has two sides to it for accounting pur-
poses; a debit side and a credit side (think left and right so the total of the left
side always equals the total of the right side). Expenditures are always a debit
to the expense, income, or asset account (left side), and a credit to cash (right
side). Receipts are always a credit to an income, expense, or liability account
(left side), and a debit to cash (right side). To increase an expense or an asset,
you debit that account, and to increase income or a liability, you credit that
Key No. 2c: Journal Entries
When you enter a receipt or an expenditure into Quickbooks, the software au-
tomatically creates both the debit and the credit. But sometimes you will need
to make a correction or adjustment to your books when there has not been a
cash transaction. You do this with a journal entry. When you make a journal
entry, you simply enter both a credit and a debit. Let’s use our depreciation
journal entry as an example, since everyone has to make this journal entry at
least once a year:
Debit to Depreciation Expense in the amount of depreciation calculated for
the period (usually based on tables provided by the Internal Revenue Service or
your accountant). See page 26 for more details about the Magic of Depreciation.
Credit to Accumulated Depreciation in the same amount (this account is an
offset to the asset account for the asset you are depreciating, such as a building).
See? It’s simple.
Key No. 3: Consistency
Learn to use the correct accounts, and use the same accounts for all similar re-
ceipts and expenditures. If you decide to put paper costs into office supplies,
always put purchases of paper into office supplies. Don’t put them into the
office supply account one month and the office expense account the next month.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 16
Key No. 4: Frequency
Do your bookkeeping no less than once a week. Two problems happen when
you get behind. First, it becomes overwhelming, and you will tend to continue
putting it off until the end of the year when it becomes urgent for your tax re-
turns. This creates the second problem: Not having up-to-date bookkeeping
means you cannot get good reports to make good decisions.
Key No. 5: Online Banking
Personally, I do my bookkeeping every Friday morning. It takes me less than
one hour because I use the systems that are available to me, such as online
banking and automatic bill pay. Quickbooks will automatically classify all of my
online banking to the right accounts with a few clicks of the mouse. I actually
find it quicker to do the bookkeeping myself using these systems than if I were
to use an outside bookkeeper (I tried that once and found it took me more time
to correct the bookkeeping than if I just did it myself using online banking).
The next principle I’m going to share with you is how to get good reports
from your bookkeeping software. If you review these reports each month, you
will be able to make good decisions about your real estate business quickly and
Business Principle No. 4: Reporting
All successful entrepreneurs understand the importance of managing their busi-
ness by metrics. Metrics is simply a measurement of the day-to-day results of the
business. Sometimes these measurements are raw numbers, such as cash flow.
Other times they take the form of ratios. And still other times these measurements
are comparisons, either to a previous period, to targets, or industry averages.
If you don’t know your numbers, you don’t know your business.
Report No. 1: Statement of Cash Flows
Let’s start with the king of all raw numbers: cash flow. Unfortunately, it’s rare
that a real estate investor has a clear picture of his/her true cash flow. You should
know the cash flow from each property as well as the overall cash flow for your
real estate business.
There is a tendency among real estate investors to believe that all they need to
know about cash flow is the difference in their bank account from the beginning
of the month to the end of the month. But the real key to using cash flow as a tool
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 17
is to understand where the cash came from and where it went. A standard ac-
counting report that you can use to figure this out is the Statement of Cash Flows.
This report, though rarely used among real estate investors, is the most important
report of all.
It begins with operating income. Operating income includes rents minus nor-
mal cash expenses, including repairs, maintenance, and management fees. It
then details nonoperating items such as financing transactions and investing
transactions. Financing transactions include any money that flows to or from
your business because of loans. These include your mortgage payments as well
as any loans you take out or money you put it. Investing transactions include any
money that flows to or from your business because of investing activities. These
include down payments on properties and cash from the sale of a property.
The end result is the increase or decrease in the amount of cash you have at
the end of the period (month, quarter, or year) compared to what you had at
the beginning of the period. This report makes it clear how much of your posi-
tive or negative cash flow is coming from operations versus other activities,
such as financing or investing. Wouldn’t it be great to know this and be able to
TABLE 1.3 Tom’s Statement of Cash Flow
Property A Oct - Dec
Net Income -6,706.40
Adjustments to reconcile Net Income
to net cash provided by operations:
Escrow Accounts -174.40
Security Deposits 800.00
Net cash provided by Operating Activities -6,080.80
Accumulated depreciation 6,790.00
Accumulated amortization 18.00
Net cash provided by Investing Activities 6,808.00
Mortgage Payable -258.34
Net cash provided by Financing Activities -258.34
Net cash increase for period 468.86
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 18
TABLE 1.4 Most Common Ratios Used to Analyze Property Results
Ratio Numerator Denominator Tells You
Cap rate
Net Operating
How much the
property is earning
Annual increase in value
plus income
Cash invested Total return
Cash on Cash
Net cash from
investment after taxes
Cash invested Cash return
Current ratio Current assets
Ability to pay
Debt/equity ratio Total de b t Net Equity Leverage
Return on
Net operating
Total assets Profitability
Debt coverage
Net operating
Annual debt
Ability to service debt
from cash flow
Loan to value (LTV) Debt Value of Property Leverage
Internal Rate
of Return (IRR)
Complex formula
Average annual
return on investment
find out this information at any time? Table 1.3 is an example of a statement of
cash flows for one of my properties. I pulled this report directly from my Quick-
This report tells me several things about this property. First, it tells me there
was positive cash flow. Second, it tells me that there was a loss for tax purposes
(net income was negative), producing additional cash flow for me through de-
preciation. Third, it tells me that I paid down my mortgage by $258, which is
an additional benefit to me. If all I knew was that my cash had increased by
$468 for the period, I would never have learned these other important benefits
from this property and may have thought the property wasn’t doing too well.
Report No. 2: Ratio Analysis
While raw numbers are helpful to know, serious analysis of your real estate
business comes from ratios and comparisons. A list of the most common ratios
used to analyze your results is found in Table 1.4.
Two of the most important ratios are the cap rate on your properties
and your return on investment (ROI).
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 19
Ratio No. 1: Cap Rate
Your cap rate (or capitalization rate) is simply your net operating income di-
vided by the value of your property. Remember that this figure represents the
value of the property, not the cost of the property. Let’s look at an example.
Suppose your property produces $10,000 per month in rent, or $120,000 for
the year. And suppose your operating expenses (remember, this doesn’t include
mortgage interest or principal payments, or depreciation) are $70,000. This
means that your net operating income (NOI) is $50,000. If your property is
worth $500,000, then your cap rate is 10 percent.
You can use this information to make decisions. Let’s suppose
that you have a loan on the property with a 7 percent interest rate. If your
cap rate goes below 7 percent, then you need to think about selling the
property. Why? Because now you have what is called “negative leverage.”
Negative leverage occurs when your return is less than you are paying
on your loan. At this point, it is actually costing you money to borrow
because the cap rate is lower than your borrowing rate.
When Ann and I sold our fourplexes in Mesa, the cap rate had dipped down
around 5 percent. The interest rate on our mortgage was 6.5 percent. So we
were now into negative leverage. On top of that, we had negative cash flow. So
it was time to sell the properties. And we did so at a substantial profit because
we watched the cap rate. When we purchased the properties, the cap rate was
around 10 percent. Though our net operating income never increased, our prop-
erty value doubled simply because of the cap rate decreasing from 10 percent
to 5 percent.
Ratio No. 2: ROI
Another ratio we review is Return on Investment, or ROI. This ratio tells us
how a property is doing overall. It’s critical to review this ratio on a regular
basis. I know several investors who calculate expected ROI when buying a prop-
erty but never again. Like the cap rate, your ROI can tell you if you should be
holding on to the property or if you need to do something different with the
For example, one of my criteria for investing is an after-tax return of at least
30 percent. This includes cash flow from the property and the appreciation on
the property plus my tax benefits from the property and principal reduction
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 20
on my mortgage. A few years ago, I bought a property in Utah that looked like
it would have an ROI of 35 percent over a five-year period. But it turned out
that the property was very difficult to rent, so the ROI was less than expected.
Once it was clear the ROI was going to fall below my 30 percent requirement, I
sold the property and found another property that better fit my investment cri-
teria. It should be obvious to you by now that a lot depends on coming up with
the appropriate investment criteria. Many of your decisions will be based on
Working through your numbers and applying them to your criteria is where
another member of your team—your wealth coach—will be critical. Everyone
should have a coach for his/her business. Your coach should be someone well
versed in real estate and in overall wealth strategies. Go to www.ProVision for more information on wealth coaching.
Report No. 3: Comparison Reports
The third type of reporting is comparison reporting. Comparison reports take
the actual data from your real estate business and compare it to some other
data, such as industry standards, past performance, or expected/budgeted per-
formance. Let’s suppose that when you bought your property, you expected
that it would appreciate 10 percent per year. Suppose the actual appreciation is
15 percent.
Your appreciation report should show you not only your current apprecia-
tion, but also your expected appreciation and perhaps the average appreciation
in the market. This gives you a good idea of how you are doing compared to the
market and to your own expectations and whether you might want to consider
buying more property in that market or selling what you have so you can buy
other property that better meets your criteria.
Can you see how important it is to have good reports? It’s not just the raw
data you want; it’s also the ratios and the comparisons. One of my biggest com-
plaints about many property managers is that they produce terrible reports. Typ-
ically, they give you only the raw data, and frequently even that is impossible to
understand. Let me show you the type of report my property manager gives me.
While it doesn’t give me any analysis, at least it gives me the data in a way I
can create my own analysis. I can see immediately that I have positive cash
flow, which meets my criteria. I now need to take this information and put it
into my reporting system (Quickbooks or something similar), and from that
system I can create reports that give me cap rates, ROI, and other analyses.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 21
Business Principle No. 5: Taxes
If you want to make an immediate impact on the return on your real estate, you
need to pay close attention to tax laws.
The fastest way to increase your ROI on a property is to take advantage
of the tax laws in place to encourage real estate investment.
The single biggest expense for most people is taxes. In the United States,
which is routinely considered to be a low-tax country, the average business
owner earning $100,000 pays more than 50 percent of his earnings to the gov-
ernment in some form of taxes. These include income taxes, property taxes,
transfer taxes, sales taxes, employment taxes, and excise taxes, not to mention
estate taxes.
Some ancient civilizations equated a 50 percent tax to being in bondage. Yet
here we are in the twenty-first century paying more than 50 percent of our in-
come in taxes and accepting this as okay. The good news is that if you are in
business, and particularly if that business is real estate investment, you can eas-
ily lower this rate from 50 percent to 20 or 30 percent. In fact, many of our
clients at ProVision who are serious real estate investors legally pay no income
tax at all.
Think about what you could do with the extra money you would have if you
reduced your income taxes by even 20 or 30 percent. How much more real es-
tate could you buy? How much faster would your portfolio grow? I once calcu-
lated that someone in the 30 percent tax bracket could double his investment
portfolio over seven years if he simply maximized his tax benefits from real es-
tate and reinvested these savings into his portfolio.
TABLE 1.5 Real Life Example of
a Good Property Report
Property Address Lease Rate: $1200/mo
Rent Collected: $1200.00
Less 8% Management Fee: $96.00
Expenses-HOA Fee: $105.00
Amount to Owner $999.00
Mortgage Payment: $987.90
March 2009 Cashflow: $11.10 +
April 2009 Projection: $999.00
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 22
When I tell people that they can legally reduce their income tax by 30 percent
or more, they are immediately skeptical. They think I must be getting my clients
into some tax shelter. They are correct. That tax shelter is real estate investing.
And it doesn’t matter whether it is residential, commercial, or industrial prop-
erty. In the United States and many other countries, real estate is a highly fa-
vored investment under the tax laws.
In the United States and many other countries, real estate is a highly
favored investment under the tax laws.
So let’s talk about what you can do to receive the maximum tax benefit from
your real estate. We will focus on the laws of the United States, but keep in
mind that many other countries have similar laws. So even if you don’t invest in
the United States, these tax reduction principles may apply to your real estate
investments in Canada, Europe, or other areas of the world. Here are five ways
to reduce your income tax by 30 percent or more.
Tip No. 1: Tax Strategy
What? A tax strategy? Didn’t we just talk about creating a business strategy for
our real estate earlier in this chapter? And now we are going to create a tax
strategy? That’s right. A tax strategy: a systematic plan of action for permanently
reducing or eliminating income taxes.
A good tax strategy is like a good business strategy in many ways. You have
to look at the big picture, including not only your real estate but also any other
businesses and investments you own. And you have to look at it from a long-
term perspective. My personal tax strategy includes aspects relating to my two
sons. One of my sons, Sam, works in both of my businesses and wants to be in-
volved for many years to come. My other son, Max, has no interest in business
and wants to write children’s books. So my tax strategy keeps my sons’ interests
in mind. They both own parts of my business, but I have to structure their own-
ership differently, since one is actively involved and the other is not.
Many of our clients work together as a couple on their business. My wife, on
the other hand, has no interest in business per se and is interested in helping
me only with the speaking part of my business (she is a wonderful speaker and
entertainer). So my tax strategy cannot, for example, include my wife as a real
estate professional.
A good tax strategist could really help here. So, another team member
for you is a tax advisor who specializes in tax strategies.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 23
Your tax strategy needs to be a plan that you can readily accomplish without
making life too complicated. Of course, a good tax strategist could really help
here. So, another team member for you is a tax advisor who specializes in tax
Tip No. 2: Entity Structure
Which type of entity should you use? Should you use a limited liability company
(LLC), a corporation, or a partnership? Or should you avoid using an entity at
all? In some countries, where there is not a lot of litigation, you may not need a
separate entity for your real estate. But in the United States, where 95 percent
of lawsuits worldwide are filed, the proper entity is essential. Let’s look at a
quick overview of the tax entities available in the United States.
While every person’s situation is different, let me give you a few pointers
about which entity you may want to consider for holding your real estate in-
vestments. From an asset protection standpoint (discussed in detail in another
chapter of this book), LLCs are frequently the best entity to use. One of the
great things about LLCs is that they don’t have any tax consequence. You can
elect to tax an LLC anyway you want. An LLC can be treated as a sole propri-
etorship, a partnership, an S corporation, or a C corporation.
For most real estate rental properties, you will want to be taxed either as a
part nership or a sole proprietorship. Don’t make the mistake of putting your real
estate rentals into an S corporation or a C corporation. This could spell disaster
if you ever have to take the property out of the corporation to refinance it; you
will be taxed as if the corporation sold the property to you at its fair market
value. I had someone in my office recently who owned his investment property
in an S corporation. We estimated the tax cost of refinancing to be in the neigh-
borhood of $250,000 simply because of the entity structure.
Business Structures
General Limited
FIGURE 1.3 Overview of Entities
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 24
Don’t make the mistake of putting your real estate rentals into an
S corporation or a C corporation. This could spell disaster if you ever have to
take the property out of the corporation to refinance it; you will be taxed as
if the corporation sold the property to you at its fair market value.
If you are a real estate dealer or developer, you may want to consider S cor-
poration taxation. This includes those of you who want to fix and flip properties.
The reason? You can significantly lower your social security taxes by owning
your property in an S corporation. And since you probably won’t need to dis-
tribute the property out of the company except when you sell it, you won’t have
the bad income tax consequences I spoke of earlier.
Tip No. 3: Travel, Meals, and Entertainment
Remember that the United States and most other countries tax only the net in-
come from a business. So any expenses that you can treat as deductible expenses
lower your income tax. The most overlooked deductions in the real estate busi-
ness are travel, meals, and entertainment expenses. The rule in the United States
for meals and entertainment is that if you discuss business before, during, or
after the meal or entertainment and the discussion is necessary and ordinary
for your business, then you get to deduct the cost of the meal or entertainment.
I’m not talking about going to dinner with your real estate agent or your ac-
countant (though I’m sure they would appreciate it). I’m talking about going to
dinner or a sporting event with your partner. For most of you, your business
partner in real estate is your spouse. My experience with business owners is
that when they go to dinner with their spouses they almost always talk about
business. And if you and your spouse are working on the real estate business
together, I can virtually guarantee that you are talking about your real estate
every time you go out to eat.
My wife and I eat out once or twice a week on average. I cannot even re-
member the last time we had dinner out and did not discuss business. These
discussions are essential to our success as business owners, even though she
does not maintain a very active role in any of our businesses. She has a perspec-
tive, though, that I find extremely useful as I make business decisions.
So stop paying for your meals out of your personal bank account, and start
paying for them from your real estate business bank account.
Travel is a little more difficult to deduct, but not much. If you are traveling
within the United States, you simply have to prove that your primary reason
for the trip was business. You prove this by showing that you spent more than
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 25
50 percent of each eight-hour workday discussing or working on your real estate
investment business. This could include your annual meeting or you could sim-
ply be investigating real estate opportunities in that location.
We had one client who applied these principles and ended up with a $1 mil-
lion deal. He really liked to travel to New Mexico. Knowing that he had to look
at real estate to deduct his travel expense, he set up a meeting with a local real
estate agent to review land development opportunities in his vacation spot. He
ended up finding a deal that netted him $1 million. And, of course, he got to
deduct his travel expenses.
Tip No. 4: Depreciation
After Robert and I met with the Arizona Republic journalist to discuss 40 per-
cent returns, we walked across the street to have lunch at a local restaurant.
Robert asked me what I thought about depreciation. I told him I thought it was
like magic. Where else can you get a tax deduction for something you didn’t
pay for and that is appreciating in value? Yet that is exactly what happens with
depreciation in the United States, Canada, and many other countries. Here’s
how it works:
Say you pay $500,000 for a house that you are going to rent. You put $100,000
of your own money into the house, and the bank loans you $400,000. You get a
deduction for a portion of the cost of the house each year—not just a portion of
your $100,000, but of the entire purchase price. Let me show you the calculation
for U.S. tax purposes.
Let’s estimate that 20 percent (or $100,000) of the cost of the house was for
the land. Even the IRS recognizes that land does not wear out, so we don’t get
to depreciate the land. But we do get to depreciate the remaining $400,000. At
a minimum for residential property, we should get a deduction of 3.636 percent
or $14,545 each year. And that’s assuming that the entire $400,000 is allocated
to the building. You can increase this deduction by doing what’s called a cost
segregation or chattel appraisal.
Briefly, here is what happens in a cost segregation. Your accountant or his
engineer goes through your property and segregates (on paper) everything that
could easily be removed from the building and is not necessary for its basic op-
eration from the building itself. Those items that can be removed are called
personal property or chattels. Personal property can be depreciated at 20 per-
cent or more per year.
In our case, let’s suppose that $100,000 of costs is segregated from the build-
ing. This would increase our annual depreciation deduction from $14,545 to
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 26
$30,900—more than double. So while our property appreciates, we still get a
tax deduction for depreciation of more than $30,000. This is the best of all de-
ductions, since there is no cash outlay involved other than the down payment
on the property.
So if our cash flow is $30,900 or less, we will not pay any income tax on our
monthly cash flow. And if our cash flow is less than our depreciation, then we
create a tax loss from the property that we can use (with proper planning) to
offset income from other sources. This is the primary reason many real estate
investors are able to reduce their income tax by 30 percent or more and why
some real estate investors pay no income tax at all. See how this can increase
your return on investment?
Tip No. 5: Documentation
Last but not least, let’s talk briefly about the importance of properly document-
ing our real estate transactions and expenses. Without good documentation,
the IRS has the right to disallow your deductions. What a waste of good deduc-
tions! We have already discussed the most important form of documentation—
good accounting.
In addition, there are other forms of documentation you must keep. For travel,
meals, and entertainment, you must keep receipts, and you must note who you
were with, where you went, what you discussed, the date of the event, and why
you incurred the expense. For automobile deductions, you need to maintain a
log of business versus personal miles driven. And for your entities, you need to
write down minutes that detail all of your meetings and major transactions.
Documentation is not the most fun part of real estate, but it’s not too difficult
if you just take a few minutes a week to take care of it. Stay on top of it. If you
don’t know exactly what you need to document, consult with your tax preparer.
Remember that if it isn’t documented, then you probably cannot prove to the
IRS that it was a legitimate deduction.
So there you have it—five easy opportunities to reduce your income taxes
while making tons of money in your real estate business. Now you can see why
smart business owners include tax planning as one of their keys to success. Ap-
plying these basic principles to your real estate business will enable you to build
enormous wealth in a very short time. Remember to begin with a strategy, add
a team, maintain good accounting, regularly review your reports, and minimize
your taxes by creating a long-term tax strategy. The sooner you begin treating
your real estate investing as a real business, the sooner you can stop working so
hard and start reaping the profits that are there for all good real estate investors.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 27
Ways to Learn More
ProVision Wealth Strategy U—a free resource at
ProVision Business Start-up Kit—a series of five training modules on starting
up your real estate business. Includes courses on bookkeeping, year-round tax
planning, entity structuring, and setting up a business.
ProVision School of Wealth Strategy—a monthly subscription to compre-
hensive training materials on building wealth. Includes courses on creating
your wealth vision, building your wealth team, and designing your personal
wealth strategy.
ProVision School of Tax Strategy—a monthly subscription to comprehensive
training materials on permanently reducing taxes. Includes courses on design-
ing your family tax strategy, involving your children in your real estate business,
and getting the greatest tax benefits out of your real estate.
For more than twenty-five years, Tom Wheelwright has strategically de-
veloped innovative tax, business, and wealth strategies for sophisticated
investors and business owners across the United States and around the
world, resulting in millions of dollars in profits. His goal is to teach people
how to create a strategic and proactive approach to wealth that creates
lasting success. As the founder of ProVision, Tom is the innovator of
proactive consulting services for ProVision’s premium clientele, who on average, pay much
less in taxes and earn much more on their investments. He coaches select clients on their
wealth, business, and tax strategies; lectures on wealth and tax strategies around the world;
and is an adjunct professor at Arizona State University.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 28
first met Chuck Lotzar in 2001 or so when he was a senior partner in a national
law firm. At Chuck’s former law firm, I delivered a presentation to approxi-
mately ten attorneys that covered my rich dad’s philosophy on money, wealth cre-
ation, and wealth management. Chuck seemed to be the only one out of the ten
who understood or was interested in what I was saying.
In 2003, Kim and I used Chuck to finalize one of our biggest real estate invest-
ments. It was a zero-down deal that would put more than $30,000 a month net
income in our pockets. If not for Chuck, this deal could have been our biggest
nightmare. He found irregularities that most people, including most lawyers,
would have missed. On top of that, after the deal was closed, Chuck offered to give
us a discount on some of his firm’s legal fees since he felt his firm did not work as
effectively as it could have. Needless to say, we told him to bill us in full and keep
the money. He had more than earned it.
In 2007, Chuck again came to our rescue, this time as our personal attorney
against our former business partner. The lawsuit was the worst, most vile event in
Kim’s and my life. If not for Chuck, I do not know where Kim and I would be today.
The good news is that Chuck Lotzar has turned out to be far more than our real
estate attorney. Through Chuck’s guidance, the Rich Dad Company has emerged
stronger, better staffed, and much more profitable. Personally, I have emerged more
2Charles W. LOTZAR
A Real Estate Attorney’s View
of Assembling and Managing
Your Team
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 29
mature, wiser, and less of a hothead, which is a miracle. Chuck has not only made
Kim and me vastly richer; we have become better entrepreneurs and investors.
The lesson again is this: It is often through our worst deals with the worst
people that the best people emerge.
—Robert Kiyosaki
know attorneys see the world differently than most people. A working rela-
tionship isn’t just a working relationship; it ideally should be a contract be-
tween two parties with built-in protections, limitations, and provisions, just in
case the relationship goes south. A piece of real estate isn’t just a piece of prop-
erty; it’s an asset that brings with it the need for appropriate entity structure,
identification of risk, allocation of risk, mitigation of risk and liabilities, and a
host of other legal protections and caveats associated with its development,
management, and eventual sale.
I know you’re thinking life is easier when you are not an attorney. You’re
probably right! But for me life as an attorney and particularly a real estate at-
torney is full of the excitement, the challenges, and the accomplishments that
can come only from working with people so that they sleep well at night, have
their family fortunes protected, and bring their dreams to life. It’s a profession
that keeps me continually learning, which I love. Real estate is a dynamic field
that keeps every day at the office new and fresh.
The likelihood that you are reading the chapter written by an attorney first
is slim, so I’ll assume you’ve read at least a few chapters before mine. If you
have, you’ve probably noticed that there are a number of references in them to
team members: the professionals it takes to make a real estate deal actually
happen. Many of the contributors list the types of team members that they need
in the type of real estate work that they do and how they have helped.
Well, I will echo their beliefs. Team members are the deciding factors in
spelling success or disaster for a real estate project. In my practice, I have seen
teams that operate seemingly effortlessly and others that are clumsy and doomed
to failure. So how do you assemble one that works effortlessly, and avoid the
kinds that are disasters waiting to happen? The answer is, you can’t. You can
only try to do your best and know that the reality of your team—particularly as
you are just starting out—will fall somewhere in the middle of those two ex-
tremes. Your job will be to assemble and manage a group of pros that makes its
way progressively more efficient to close every deal you do.
My perspective on teams and team members is different from the views of
many in this book because I am one of those team members. Many of the others
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 30
in this book are the investors who drive the team. They delegate to team mem-
bers who advise them. I’m the one they delegate to and who advises them on
how to lead the team. That gives me a slightly different perspective. Combine
that with my attorney’s perspective and you have a chapter with three primary
1.To tell you who you need on your team and how to know you have a winner.
2.To identify known risks and make sure that they are properly allocated
among other writing parties, including the members of your team.
3.To establish performance measures and deadlines, and to follow up to make
sure that each of those performance measures and deadlines are met in a
timely manner.
See, this is where my lawyer’s mentality comes into play. I know your team
will not be perfect, no matter how perfectly you follow this book’s directions,
how well you interview potential team members, or how ironclad their refer-
ences were. Life and real estate deals are not that cut and dried. So what do you
do? Well, quite simply, you do your best on the front end, and you attempt to
protect yourself on the back end.
Three Rules of the Game
Before you say to yourself, “This team thing seems like more trouble than it is
worth. For my project, I’ll keep it simple and do most of the work I need alone.
I’ll keep the team small—as small as possible—and that will minimize my prob-
lems,” understand that it is very hard to do anything in real estate alone. It is a
team sport and as such, I have assembled my Three Rules of the Game.
Nowhere else will your team come into play more than when it is time to
perform your due diligence. It’s a necessary part of every real estate deal, and
with the right team it can be your best friend and actually a lot of fun because
you often find the hidden gems that can signal great opportunity. On the other
hand, it can be the beginnings of a vivid nightmare you are living because you
are the proud owner of a “problem-property,” thanks to a team that missed
something big during due diligence. Again, the first camp is the place to be.
You’ll recall that the due diligence period is usually not less than sixty days
in length. Its purpose is to discover any problems and opportunities with a
property to determine whether you want to go through with the transaction,
and if so with what specific stipulations. It’s also designed to allocate and alle-
viate risk among various parties: the buyer, the seller, the lender, and the various
third-party professionals on your team.
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As I mention in rule number two, when it comes to due diligence, you want a
team that will be willing to learn the truth about the property and tell you the
brutal facts. If your baby is ugly, you need professionals and advisors who aren’t
going to be afraid to tell you the truth to your face—before the acquisition takes
place. So let’s delve into the team members and their roles from a fellow team
member and a lawyer’s perspective.
Consider these your core team members, the ones you’ll need for virtually
every real estate deal you do. I believe that people generally fall into two cate-
gories: those who are relationship oriented and those who are transaction ori-
ented. Although I have a law practice based on the ability to successfully
complete transactions, I am a relationship-oriented person who generally seeks
out other teammates who are also relationship oriented. I am willing to work
with other teammates who are transaction oriented, but I do so recognizing
that their ability and willingness to step up to solve a problem is limited, espe-
cially after the transaction closes.
Real Estate Attorney
Notice how I wrote real estate attorney, not just attorney. That’s the first tip I
will give you right up front. Real estate transactions are significantly different
from other transactions, so it is critical to hire an attorney who understands
Chuck’s Three Rules of the Game
Rule No. 1: Talent pays for itself. Accept that hiring a capable and talented real estate
team to complete your transaction is in your best interest. Although there will be
costs up front, your investment should more than pay for itself over time.
Rule No. 2: You are hiring folks’ brains; let them use their brains to solve your prob-
lems. Allow teammates to give you their honest and complete assessment of any
transaction given the circumstances presented—you want to know all of the prob-
lems so that you can craft solutions and quantify the costs of obtaining those solu-
tions. Unfortunately, in some instances you will learn that the cost of continuing with
the transaction outweighs the opportunity to be achieved, and you are forced to
stop so as to prevent yourself from throwing good money after bad.
Rule No. 3: It is better to hire someone with outstanding judgment and wisdom
than a person who has merely completed similar types of transactions.
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and is experienced in real estate. Contract attorneys without real estate experi-
ence are not good enough.
The reason I am so emphatic here is because a good real estate attorney can
take a lot of the pressure off you by acting as the quarterback and taking re-
sponsibility for coordinating the entire team. A good attorney is strong, experi-
enced, and at the same time self-confident enough to know when he or she
needs your input or help from a third party. There are times when a real estate
transaction will have nuances that your lead real estate attorney—no matter
how experienced—may not have ever encountered before. You don’t want your
attorney learning on your transaction; you want an attorney with a network of
people, inside or outside the firm, that he or she can call on to bridge any gaps.
Often a good real estate attorney can be the master of the due diligence
budget and calendar and keep all the other team members on track and on time
with their deliverables. That means you’ll want your attorney on board early,
right at the very start, to handle the early documents, such as the term sheet or
the letter of intent, to make sure that the allocation and assignment of risks are
thoughtfully documented for closing.
Real Life Story
very real estate opportunity is different, and it’s the truly unique ones that
sometimes cause your teams to expand beyond your expectations, even into
the realm of the unbelievable.
Too often real estate investors become successful based on their ability to over-
come numerous problems, and they become insensitive to the weight of certain
problems that would otherwise thwart a transaction. I recall one group of clients who
were prolific real estate investors. Although they were astute business people who
accomplished a number of successful transactions in sequence, their history of suc-
cess impeded their ability to walk away from a bad deal, even when they knew that
there would be insufficient equity in a transaction and visible and indivisible deferred
maintenance issues with the heating and cooling system for the apartment complex,
which needed replacement and caused the buildings to settle in the ground by more
than one foot! No matter how successful you have been in the past, you need to
replicate good habits for the diligence and closing with each new transaction.
Most often, however, your team will be highly predictable and consist of several
core members. You will find that the more you work with them, the better you will
all work together, which will increase your efficiency.
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A good real estate attorney can be your greatest ally. I frequently find myself
providing ideas and advice that will enhance my clients’ transactions and their
businesses as a whole. At our firm, we approach projects from a business-
owner’s perspective. Business owners want us to tell them the things that are
standing in their way, of course. But they also want us to come up with innova-
tive ways to transcend the problems and get the deal done. If you have an attor-
ney who seems to be pointing out all the problems without posing solutions,
that’s a sign that you may need another attorney. If you have an attorney who
conducts himself or herself in a manner that makes you uncomfortable, e.g.,
rudeness, or overly passive or overly aggressive under the circumstances, then
that’s another sign that you may need another attorney.
Specifically, it’s our job to read and analyze all documentation, including
third-party reports, title and survey, purchase and sale agreements, and loan
documents. Sometimes, we may be requested to draft these documents along
with corporate entity documents when dealing with equity investments and
Hiring a Real Estate Attorney?
What to Look For, and What to Watch Out For
What to Look For
Portability of past knowledge, wisdom, and judgment
Availability of time to do the work
An understanding of professional limitations
• Openness to engaging the assistance of other lawyers or law firms
A willingness and ability to work as a team player
• Experience in various forms of real estate transactions
• Experience with complex finance structure of real estate transactions
Demeanor and approach to the practice of law, e. g., that’s part gentleman,
part pit bull
The support of the law firm—how deep is the bench?
What to Watch Out For
Any past malpractice claims
Any past Bar complaints
Experience with contracts, business, and litigation, but not in relation to real estate
A personality and/or demeanor incompatible with the client’s personality
and/or demeanor
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Your attorney can either bill you hourly for his or her work or provide a soft
estimate for the scope of work. Should the scope of work exceed the estimate,
the additional work is billed at the hourly rate. Another payment method is
hourly against a hard estimate. These agreements generally have a large con-
tingency built in for unforeseen events that is payable at closing. This type of
contract can put the attorney and the client at odds. You want your attorney to
find the unexpected—that can save you in a real estate transaction—but if you
are worried that the work of searching for the unexpected will cost you more
money, you may be thwarting your own success. In the best instances, the fruits
of the deal, or the savings in terms of money and/or risk, a contingent fee that
changes which party is in control will more than pay for any attorney fees.
Many of our clients feel we have more than earned our fees, and that’s ideally
what both sides want.
Over the years I have focused a good portion of my law practice working on
contingent-fee matters related to large revenue bond financings and tax credit
projects. Whenever I have a contingent fee, I want to be the person with the
most control over the ability to advance and close the transaction. However, a
lawyer’s compass needs to be completely aligned with the interest of his client,
regardless of his fee arrangement.
How to Construct an Effective
Engagement Letter
ost members of your team will require an engagement letter before beginning
work. They may provide one, or you can. To protect yourself, make sure the fol -
lowing points are included:
• Spell out scope of work, particularly the roles of each party.
Specify the nature and timing of payment, including timing of service and
due date.
• Define the particulars of termination for both the contractor and you.
Be specific on needs (software) and deliverables (eight copies of plans, etc.)
due to cost and which party will bear the cost.
• Disclose conflicting relationships.
• Identify and allocate known risks.
• Dispute resolution.
• Limit liability.
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Real Estate Brokers
Real estate brokers are important team members because they are the genera-
tors of opportunities. They can decide who sees a property that is coming on-
line first and can be the bearer of great opportunities. What it takes is a broker
who understands the importance of relationships and working as part of a team.
On the other hand, many brokers are transactional, living and dying by their
fees, which naturally results in an eat-what-you-kill mentality. They will indis-
criminately pose opportunities that are nothing more than distractions because
they do not fit your business goals. What you really want is a real estate broker
who looks out for your best interest, understands your needs, and seeks out op-
portunities that match them. That adds value.
Beyond this, the true role of a real estate broker is to bring a willing buyer
and willing seller together, not necessarily to ensure his or her client gets the
best deal. But the good ones do both. They work to execute the best possible
transaction for their client from start to finish.
Sometimes a real estate broker will perform what is known as dual repre-
sentation, which means the same broker will represent both the buyer and the
seller. On the surface, this may seem like an opportunity to save some money in
commissions; after all, typical transactions have two brokers who must share
Real Life Story: How to Know Your Real Estate
Broker Is Looking Out for You
he dual brokerage relationship does not trouble me when I see sophisticated
parties on both sides of a transaction. The broker frequently has problems
when there is a mismatch of sophistication among the parties. I have had many
conversations with brokers who had dual agency relationships that they regretted
once problems arose.
I have found that the best real estate brokers have the client’s interests at heart.
The best example I can give relates to my good friend and client, Craig Coppola,
who was acting as my real estate broker in my attempt to buy an office building for
my law firm. Although I had my heart set on buying a particular building, Craig was
a good friend and professional broker who looked me in the eye and told me that it
was not in my best interest to act and that I needed to be patient as the market was
trending downward. Clearly, Craig’s advice was in my best interest and not in his
short-term interest since no commission would be paid.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 36
the commissions. But dual representation can be tricky, and in the very least it
requires full disclosure of all known facts and circumstances to avoid conflicts
of interests.
While most people in business recognize the need to adjust to market
changes, real estate brokers really need to moderate their styles as market con-
ditions fluctuate. During the boom times of the mid 2000s, many real estate
brokers, based on the volume of work, became more transactional as they tried
to close as many deals as they could. But the best ones knew that booms also
create busts, and it’s the real pros who maintain relationships during the booms
that have business during the down times. The best brokers also know that the
height of the market is not the time to buy and provide that level of counsel to
investor clients. They are market advisors as well as salespeople who are in it
for the long term and know that no deal today is worth the loss of many deals
tomorrow. That’s the kind of broker you want.
I have found that almost all business is based on some form of mathematics,
and it is important to have accountants who are well versed in the intricacies of
real estate. In fact, much of the advice that I gave you with respect to establish-
ing a relationship with a real estate attorney has equal weight to establishing a
relationship with an accountant.
I have also found that one of the first folks hired internally by real estate in-
vestors is an accountant who will be charged with working cooperatively with
an outside accounting firm. Frequently, the internal accountant is charged with
a substantial amount of responsibility beyond accounting and feels pressure to
limit the involvement of the outside accounting firm. If the internal accountant
is strong enough, then there will not be problems. Unfortunately, problems fre-
quently do arise based on lack of communication and sophistication.
A strong real estate accountant will understand the effect of changes in deal
structure on the various tax attributes such as amortization, depreciation, and
losses (which are inevitable during a construction phase since no money is
being generated during the development and construction of the project). Ad-
ditionally, a real estate accountant will know when it is in your best interest to
obtain a cost segregation study to identify the component parts of the
building(s) so as to allow for an accurate and possibly accelerated application
of amortization and depreciation.
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First of all, special thanks to Greg Zimmerman and Chris Ilg for sharing their
knowledge on this subject. Architects are critical members of any real estate
team because they have the ability like no one else to provide creativity, innova-
tion, and magic that can transform an ordinary property into a showpiece. They
also have the ability to create a lot of expense that sometimes isn’t needed at all.
Good architect partners understand that while they may have the ability to
turn a property into a project that provides accolades and acclaim, the project
objectives may dictate otherwise. The project may require the architect make
minor modifications that deliver big results. They are not exciting modifications,
and they are often not very dramatic. They may not even be all that rewarding
to do, but sometimes that’s the nature of the project, and although the design
work might be mundane, it can deliver a big payoff for the investors. And that
is anything but mundane. While it’s more fun to redesign an apartment building
to create exciting loft living environments, a profitable, cash-flow-positive proj-
ect may require only that the architect figure out how to fit a washer and dryer
in each existing unit. This is actually one of the biggest challenges faced in the
apartment industry. The trend is away from common area laundry rooms, and
architects are challenged to make washers and dryers work in small spaces.
Design professionals are a lot like physicians or attorneys. They specialize.
While there are excellent neurosurgeons out there, you don’t want the neuro-
surgeon performing your heart surgery. And the attorney who makes a living in
divorce court isn’t the one you want handling the financial complexities of a
real estate transaction. Just the same, you don’t want the architect who designs
million-dollar homes designing your mini-storage investment property. You
want the architect who can design those structures in his or her sleep.
But the biggest reason why you want to work with experienced, specialized
architects is because they know the ins and outs. National and local codes
change almost daily. Only architects and their firms can keep up with it all.
Even the slightest revision to any of the several codes could have a serious im-
pact on a design. As an attorney, I have seen too many investors’ projects get
caught up in the complicated codes and laws of building, remodeling, and restor-
ing a property. It wastes a lot of time and can get messy. It’s never easy to fight
city hall, and with the right architect who knows the laws and the regulations,
you should not have to.
Let me elaborate on the word experience. Architecture is a lifelong endeavor,
and it is not unusual for an architect to require years of experience before truly
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 38
gaining the amount of competence required to guide the client through a highly
specialized project. It’s not necessarily just the design aspects that I am talking
about. It’s the peripheral know-how that cannot be learned in school but can
come only from doing things like working through the political process. Work-
ing positively and effectively with federal, state, and city employees is a honed
skill that only comes over time. And let’s not forget the value of a keen sense for
anticipating market trends. After all, the work you are hiring from an architect
may be happening today, but it needs to be valued by customers for years to
Once you interview and select your architectural firm from these perspectives,
you can also look at other important requirements like working relationship and
costs. I won’t elaborate too much on the fact that regardless of how skilled the
architect, if that person can’t work with the team or with you, you need to keep
looking. Relationships are everything, particularly when it comes to the architect.
Too often the design side of the project can put off the trades side of the project
by being overly demanding about aesthetics and not being open to finding rea-
sonable solutions that don’t compromise the look and function of the project.
It’s extremely important to have a strong and collaborative working relationship
between an architect and the general contractor. Forcing the architect or the
general contractor to work with an architect or general contractor that they
don’t work well with leads only to trouble for the property owner.
When it comes to money, be prepared to fully spell out exactly what you are
hoping to achieve—your objectives—and how you would like to achieve them.
Share your budget both for the design aspects of the project and for how much
you plan to put into the building process. You must be concerned at this point
with the architect’s fees, yes, but also the cost to build out the architect’s design.
Experience Is Everything
When you work with an experienced, specialized architect partner, you reap the
• Design moves along quicker.
There is not a steep learning curve.
You get a completed design that works with fewer surprises.
• Plans, although custom, are somewhat field-tested.
Building is smoother because the plans have commonalities with past projects.
• He knows the ins and outs of building codes.
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Again, having been involved in many real estate projects, I have seen architects
create designs that are simply too costly to build under the predefined budget
and profitability constraints. Those are severe mistakes that can cost time and
money. Architects and contractors must communicate to avoid these kinds of
The better the information that you give the architect up front, the more ac-
curate his fee proposal should be. Understandably, it is difficult to have a handle
on every issue surrounding a project; things do come up that are unexpected.
But there are ways to protect yourself a bit from costs getting out of control.
First of all, you may want to begin your working relationship with an architect
by putting together an agreement for the due diligence and preliminary
design/consulting work. There is nothing wrong with doing this, and as long as
both you and the architect understand that further work is contingent on the
success and outcomes of the preliminary work, you may find this is the best
You can implement this kind of arrangement with either a phased contract
or better yet, a time and materials contract with provisions for a subsequent
contract using the American Institute of Architects (AIA) form B181, which is a
standard agreement between an owner and an architect. You can find this form
on the Internet when you search AIA B181. It may serve as a good reference for
The benefit of this arrangement is that you can move forward without a huge
commitment and no real idea of what can be done. That’s handy because most
likely at this point, you won’t have much idea of what can be done. That’s why
you need the architect. The benefit to the architect is job security. It’s nice to
know that if the due diligence is favorable, all further work, including time, de-
signs, and working drawings will be developed in his or her office. That also is
excellent incentive for the architect to work harder to find feasible design solu-
tions that fit into the budget for the project. If he or she wants more work, then
make the project work.
I’ve seen this approach work well quite often. One minor, but important,
point is that the services you contract with the architect may require the services
of other consultants. I recommend contracting with them directly to maintain
knowledge and control over the outside service provider’s work and progress.
Assuming the project moves forward, and you and the architect have exe-
cuted the contracts, the next phase is all about communication. The best, most
efficient projects I’ve been associated with have been ones where the design
team holds weekly meetings and provides progress plans and updates for re-
view. With so many moving parts to any design project, keeping everyone in-
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 40
formed is always a top priority. When well executed, it speeds up the process
and delivers far better outcomes.
Once the design and development phase is complete, the construction docu-
ments get under way. At this point, it is the architect who should control the
consultants and keep the attorneys and lender informed of all progress. As a
ring leader for the design and construction side of the project, all information
needs to funnel through the architect to maintain control and ensure that no
deviation to the schedule, scope, and of course, fees are made without his or
her knowledge.
Civil Engineer
Civil engineers are frequently hired by your architect. They are responsible for
locating existing utilities and developing the plans to connect to them or deter-
mine if and how to upsize the capacity. ALTA surveys are part of this process, as
is obtaining a “will serve” letter from the utility provider, which legally obliges
it to serve the particular project with utility service.
Civil engineers are also responsible for such things as drainage, grading re-
quirements, and in cases where canal irrigation is involved, that too. Your ar-
chitect will inform you when and why a civil engineer is needed for a project.
Your architect will review all contracts for service from not only civil engi-
neers but all related design consultants. And I recommend you allow your real
estate attorney to review these documents as well, solely from a legal perspec-
tive. By contrast, the architect will review them to make sure the intent of the
design is being met and to look for gaps and overlaps with the goal of a seamless
scope of service.
You will want to execute the contracts once your real estate attorney and ar-
chitect have reviewed them and given them the go ahead. Often these contracts
contain contingencies or line items in them that are part of the contract, but
which could be separately executed or deleted as needed. Your attorney and
architect can point these out, but be aware that if these contingencies are exe-
cuted in the course of work because of requirements in the field, they can and
often will cost you more money.
In my experience, civil engineers are not known for adding on unneeded
services, but rather omitting services. And it is very difficult as a property owner,
particularly if you have not been doing this work for twenty years, to know what
the civil engineer should have done until there’s a torrential rain and you find
half your parking lot is submerged in a murky brown puddle. Then you know
more work should have been done regarding drainage. These things happen.
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The challenges a civil engineer can solve go beyond the concrete world of
grading, utilities, and drainage. I always recommend to my clients that they
find civil engineering firms with a lead engineer or representative who is not
only knowledgeable of civil engineering but knows how to walk the corridors
of city hall. Political savvy is a huge value-added advantage. Knowing the people
who matter and then presenting your case before city officials and a crowd of
interested citizens without acting and sounding like a civil engineer is a real
ace card to hold.
Three Most Common Pitfalls with Civil Engineers
1. Delivering in a timely manner.
2. Plans that do not have sufficient detail to match the existing utilities.
3. Plans that fail to adequately take into consideration the property’s topography
as it relates to water retention and drainage.
Overcome these problems by holding your civil engineers to incentivized timeta-
bles and have your engineer, architect, and your contractor review the drawings
with all those involved in advance.
Professional Surveyor
We’ve all seen surveyors standing in the middle of the street, gazing through
their transits and taking measurements of the ground. This information is pre-
cisely what makes property owners and lenders sleep well at night, knowing
that the properties they are considering during the due diligence phase are all
that they have been stated to be. And best of all, they report this information
with a very official document that bears all the appropriate seals and certifica-
tions. It’s the real deal, and it becomes a matter of public record.
So what exactly are surveyors looking for, and looking at, through those tiny
site scopes? When it comes to most projects, they are confirming or establishing
the following:
Easements. The surveyor is designating or verifying the access into and out
of the property.
• Dimension and Location of Property. The surveyor is looking at and marking
the property lines to determine the property’s exact size and location in re-
spect to other properties.
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• Encroachments. The surveyor is looking at the property lines and determin-
ing if any structures belonging to another party are within your property
line... or yours within theirs. This can affect the appraised value of a prop-
erty and cost money to remediate.
Location of All Buildings and Improvements. The surveyor is determining
the exact placement of all buildings and improvements within the land parcel
to assert that they are placed as specified and that they are within the con-
straints of local building codes.
Nonvehicular Access. The surveyor is determining the exact placement of
any nonvehicular access easements like pedestrian walkways that may exist
on the property. These can impact building improvement and building place-
ment plans.
• Traffic Calming Measures. The surveyor is looking at and indicating or plan-
ning the location of traffic-calming improvements such as speed humps, me-
dian plantings, etc., that slow traffic and improve the environment for
residents, pedestrians, and bicyclists.
Of course, every project dictates what your surveyor will need to do, and ev -
ery piece of land brings its own unique needs, too. In the mountainous, boulder-
ridden terrain of Arizona—a state with strict laws related to indigenous plants
and natural formations—surveyors indicate the location of every giant saguaro
cactus, every palo verde tree, and any rock outcroppings that are to be preserved
as natural space.
Ultimately, your title company and the surveyors themselves do not want
there to be any gaps between adjacent properties. There are a lot of reasons for
this when you think about it. One is ownership. Who is responsible to care and
maintain the gap area? A second is liability. Are both owners, one or neither, re-
sponsible for a mishap that may take place in between property lines?
Another is property value. It can be really expensive to buy a small piece of
land that your project may need in order to be compliant with development re-
quirements related to setbacks, ingress, and egress, etc. Remember, just because
you may need additional land to complete your project does not mean that your
neighbor has to sell it to you.
Hazardous Substance Site Assessment Engineer
This is a professional you want to bring on very early in the due diligence process
because if he or she finds there are hazardous substances on the property, you
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may want to rethink everything. Your lenders will strongly advise and may even
insist upon it. You simply must know the status of the property in terms of haz-
ardous substances. There have been too many cases where—and these are the
worst kind—entire housing developments have been built in areas that were
later found to be toxic. Love Canal in New York is one of them. Cases that are far
less dramatic, but still incredibly expensive, are those where a hazard exists but
can be remediated. You never want to find yourself responsible for the first sce-
nario; it is actually quite difficult, given the law and requirements for develop-
ment and redevelopment today. But in the event of the second case, which is
more likely to occur, at least know what kind of remediation costs you are in for.
When selecting an environmental engineer, begin by finding one who is fully
accredited in the field. Having a trustworthy relationship with your mortgage
banking professional is also key. The mortgage banker will know which envi-
ronmental engineers are responsive and familiar with the reporting require-
ments of a broad spectrum of lenders. The lender may have a list of preferred
providers that may at times take selection out of the borrower’s hands. It is also
important that while your environmental engineer is thorough so as to identify
actual existing recognized environmental conditions, he does not create un-
necessary work by requiring more expensive Phase II reports.
During due diligence, you must contract what is called a Phase I hazardous
substance site contamination study. Among the many things the inspector looks
at, he or she will perform a visual assessment of the site and surrounding prop-
erties; interview the owner, neighbors, occupants; and take a look at the site’s
history. The goal is to determine if any hazardous materials were ever manu-
factured, stored, or dumped there. At this stage the inspector doesn’t take any
Ideally, you will receive a clean Phase I report and not need any additional
testing or a Phase II study in which the inspector takes samples of the discov-
ered hazardous materials. This process can be costly and time-consuming be-
cause sometimes just getting the “samples” requires excavation and core
Interestingly, certain entities in the chain of title may have remediation re-
sponsibility should hazardous materials be found. In addition, they have a dis-
closure responsibility should they know of these hazards during the due
diligence period. Lenders obviously are looking for a clean Phase I report so
that there is no drag on their ability to seize collateral and liquidate, should the
need arise. This action usually requires stepping into the chain of title, and it’s
best if there are no obstacles due to a history of hazardous materials liability.
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Recently, engineers to prepare Phase I and II reports have sought to limit
the amount of their liability to property owners by having their engagement
letter or contract specify that damages are limited to the amount of fees paid to
the engineer. Obviously, limitations of this nature do not afford the property
owner the benefit intended when a professional engineer was hired to conduct
the Phase I or II investigation and report.
Escrow Officer/Title Agent
The more real estate deals you do, the more you will get to know your escrow
officer/title agent. This person acts as a neutral party who is attempting to carry
out the express written instructions of the buyer, the seller, the lender(s), and
in some cases the real estate brokers. They review and verify all documents
and pass the documents along with the funds between the appropriate parties
in the transaction. They are there at closing.
Again, my approach to this chapter is from a legal perspective. Where I have
seen issues relating to this area is in title insurance. It is the title agent who is-
sues the title insurance policy. Title insurance is insurance covering the past
because it protects only against losses arising from events that occurred prior
to the date of the policy. Coverage ends on the day the policy is issued and ex-
tends backward in time for an indefinite period. This is in marked contrast to
property or life insurance, which protect against losses resulting from events
that occur after the policy is issued, for a specified period into the future. A
Title policy protects property owners and lenders from monetary losses that
could result from ownership of a property’s title, which may include fraud, liens
against the property, or errors missed during the title search. Title insurance
does not prevent loss of marketability due to a title claim, and that is important
to know if you are going to assume ownership of a property.
In other words, a title insurance policy does not obligate the title insurance
company to make corrections to your property’s title if a problem is discovered;
rather it simply provides a basis to receive monetary compensation for your
loss at a maximum level specified by the title policy limits.
I am frequently surprised by a real estate investor’s willingness to accept a
title company’s offer to “insure over” a known risk because the title insurance
does not cure the apparent defect in the title; which may come back to haunt
the property owner in the future.
The policy covers only the amount of the loan, so the policy’s cost is based on
this amount. It is best to obtain both a lender and owner’s policy. The coverage
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extended to the owner is usually referred to as the ALTA policy, which must be
based in part on a survey.
The talent associated with escrow and title officers varies widely. For that
reason it is important to know who we are dealing with and their approach to
solving problems. An effective escrow agent anticipates the demand of the
transaction for all parties and is proactive. I am very loyal to escrow and title
officers who I know have the capacity to close complex transactions in a timely
manner. Unfortunately, I had to kiss a few toads in order to find folks who are
Mortgage Broker
Selecting your mortgage broker is one of the most important decisions you will
make. You want to find a mortgage broker, who like the architect you choose,
specializes in your area of investment. You may not know this, but the brokerage
industry is a specialty business, and few brokers possess the expertise needed
to service all areas of the lending arena. I want a broker who is well versed in
not only the execution of the loan but also very in touch with the local trends.
If your proposed project is not well suited to the market, your mortgage broker
should tell you outright or will facilitate the market telling you. Either way,
you’ll know because the process will be arduous and most likely not well re-
ceived by lenders.
Almost anything can trigger lending difficulties. Perhaps the proposed proj-
ect isn’t right for the location. Or maybe the location is right, but the timing
isn’t right for the project. Sometimes the lender will raise flags because the
plan and proposed product didn’t go through enough feasibility studies or a
satisfactory amount of market research to ensure the project is on target. Any
investor who comes to a mortgage broker without having done his or her home-
work and as a result made the proper adjustments to the plan and design will
find the underwriting will stall, and a loan will be next to impossible to attain.
That’s a failure by the investor.
A failure on the mortgage broker’s side can happen, too. A good mortgage
broker should guide you to the most appropriate lending vehicle and steer you
clear of the ones that are not in your best interest. Too often I have seen or
heard of mismatches between a product and the type of loan terms, even when
the product has qualified for that kind of loan. A mismatch can impact a lot of
things, not the least of which is the pro forma of the property. It can also con-
tribute to reduced profitability. And loan vehicles such as city, local, and federal
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 46
funding have stringent requirements so their cost-benefit is questionable, unless
the fit is just right. Your mortgage broker should be very clear about every loan
term so you can take full advantage of them and avoid the pitfalls. If there is
something you don’t understand, do whatever it takes to clarify it.
You also should ask your mortgage broker what they know about tax credit,
HUD financing, and related agencies, and ask them to relate to you the advan-
tages and disadvantages of these financing vehicles. Experience with them in
addition to knowledge about them is a real advantage. The last thing you want
is a mortgage broker who is learning on the job with your project. Look for a
seasoned veteran.
In the absence of a good mortgage broker partner, some real estate attorneys—
I am one of them—also specialize in obtaining the most favorable financing ve-
hicles available. It is a service we provide, and I am sure we are not alone. Given
that your attorney is looking out for your best interest, he or she will analyze the
loan for more than just interest rates and amortization schedules. He or she will
read the fine print and the finer points to discover any possible ways a loan, be-
cause of its terms, could come back to bite you years later.
Insurance Agent
I won’t go into big detail on this one except to make a few points. Have an in-
surance agent who specializes in real estate and development early on in the
process to avoid easily avoidable pitfalls. The lender generally has the specific
coverage required for your transaction. You should be able to rely on your in-
surance broker to easily interpret the requirements and deliver an insurance
certificate covering the same within twenty-four hours.
Over the years, as lending has become more oriented to packaging loans for
sale in the secondary market, lenders have dictated the types of insurance that
must be obtained, as well as the limits that they believe to be appropriate. Your
insurance agent should be able to provide you additional insight with respect
to the suitability of the proposed forms of coverage applicability of the proposed
There are probably entire agencies in your city or town that offer mostly real
estate, construction, and development insurance. There are a number of things,
based on your project, that will require insurance of one sort or another. Insur-
ance is all about risk management and the question becomes how much risk
you want to assume versus if you should pay a premium to have someone else
assume it. If you know in advance the type of insurance you will need, you can
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factor it into your project budget and determine if the project is feasible and
will deliver a solid return with these added costs. If it won’t, then you may want
to reconsider the project entirely.
1031 Exchange Intermediary
Every time a client presents me with an opportunity to participate in an IRC
Section 1031 transaction, I insist that he or she had his or her accountants run
the numbers to determine the effect of paying the taxes versus deferring the
tax with an exchange. From my vantage point, the tax savings do not replace
the need for a strong real estate transaction for the replacement property. I be-
lieve you make money buying real estate; which is best demonstrated when you
sell real estate.
Many times, investors are working on a project that will be part of a 1031 Ex-
change. There’s an entire chapter in this book about exchanges, but in a nutshell,
a 1031 Exchange occurs when you sell one property and purchase another prop-
erty under the tax code 1031 and minimize or avoid paying taxes on the gain.
Anytime a 1031 Exchange is involved, you should have a qualified intermediary
execute it. The reason is simple. If there is any misstep with the procedures of
the exchange, you will not qualify and you will end up paying the taxes you
were trying to avoid.
You want to know exactly how much the tax is and weigh the pros and cons
of the exchange. A good test in my opinion, is asking yourself whether or not
you would go forward with the transaction if an exchange was not involved. In
other words, would you still consider this opportunity a good investment? Even
if you answer yes to this question, I always make sure my client has discussed
the exchange with me and his or her tax advisor so the entire plan can be viewed
in light of the investor’s bigger financial picture.
There are also nontax reasons for exchanges. Here are a few that you may
not have considered:
Exchange from fully depreciated property to a higher value property that
can be depreciated.
Exchange from non-income-producing raw land to improved property to
create cash flow.
• Exchange to meet location requirements.
• Exchange from a larger property to several smaller properties, used to divide
an estate among several heirs or for retirement reasons.
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Exchange from a tenants-in-common interest in one property to a fee interest
in another property.
So what do you look for in a qualified intermediary? Exchangors must feel
confident that exchange funds will be safe and available for the successful con-
clusion of their exchange. It is best to hire a qualified intermediary that, first,
comes highly recommended by other real estate investors. You should also do
your own due diligence to determine how the intermediary is investing funds
it has on hand. Recently, a large intermediary was unable to fulfill its funding
obligations because it had invested the bulk of its funds in auction rate securi-
ties, which became illiquid overnight! If you cannot understand the nature of
the intermediary’s underlying investments, then you should not let the inter-
mediary hold your money!
Second, be sure to obtain a written guarantee for the exchange of funds. And,
finally, verify that the qualified intermediary has fidelity bond coverage, prefer-
ably in the amount of $100 million professional liability insurance and employee
theft and dishonesty coverage.
General Contractors
Nearly all real estate projects involve some construction or renovation. And for
that reason, having a general contractor run the show is a good idea. Unless
you are a general contractor yourself, you should never attempt to manage your
own construction, no matter how well you think you can do it. If you are an in-
vestor, remain an investor.
It should almost go without saying that you want to be very careful which
contractor you choose. Your decision will greatly impact the quality of your
project. You can get excellent referrals from your architect who may even rec-
ommend one particular contractor. And if you have selected the right insurance
agency in your city or town, the one that specializes in construction and does
the bond work for all the contractors in town, you will be able to get some solid
referrals from them as well. Other than that, you can ask your attorney, mortgage
brokers, lender, and look around town at the projects that are currently under-
way. That will give you a good idea of which companies are the most reputable.
No matter how tempting it is to go cheap and hire a small-time player for
your “small job,” it is never a good idea to hire any contractor who isn’t licensed
and insured. As an attorney, I will never allow my clients to assume the astro-
nomical risks that they are assuming when working with a contractor or any
trades person who is not licensed and insured.
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I think it is always a good idea to determine whether or not the general con-
tractor can obtain a performance and payment bond. If you learn that the gen-
eral contractor is unable to obtain a performance and payment bond, you should
find out exactly why that is the case. If the general contractor is involved in its
own development activities, bonding companies will frequently shy away from
the risk. However, if the general contractor is not involved in development,
then bonding companies should be more inclined to underwrite the risk asso-
ciated with the general contractor’s affairs. If a performance and payment bond
is obtained, the general contractor will pass the cost on to the developer, which
may be significant.
Your general contractor is responsible for carrying out the design plans to
the letter, and for managing the trade contractors (subcontractors) who will
actually do the work. General contractors seldom actually perform any of the
trades themselves; they are simply very experienced project managers who
know the process of construction and know the people and the companies that
will get the work done. Pick a good contractor and you elevate your chances of
having good trades people working on your project. You should look for general
contractors who pay their subcontractors and material men in a timely manner
and have a systematized manner of obtaining all of the required lien releases.
Too often, general contractors who are struggling look to use subcontractors
and material men as a form of working capital financing, as a result of the gen-
eral contractor’s failure to pay them in a timely manner. Ask for a list of refer-
ences who are subcontractors from various trades and material men from
various product lines.
How do you know you have a good contractor? First of all, look at their pre-
vious projects. Walk through them. Is the quality up to your standards of excel-
lence? You can tell by looking at finishes and details. If the details are shoddy,
one can only assume what lies behind the walls hidden from view isn’t much
better. Second, and perhaps even more important, is ask the tradespeople. Does
the contractor pay them on time, or is the company always running way behind
on payment? This could be a sign of cash flow problems. Stay as far clear of that
as you can. What you don’t want is to have construction loan draws that are
meant to be buying your building materials going to pay off an old debt on an-
other project.
And speaking of money, building costs—like anything else—can start out in
one solar system and end up in a completely differently galaxy if not closely
managed right from the time of the initial estimate. To set a price, you’ll need a
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clearly defined budget, a clearly defined scope of work, and a clearly defined
From my vantage point, I believe that folks starting out in development
should look to work with established general contractors who have obtained a
performance or payment bond for the project. The additional costs associated
with the performance and payment bond are substantially less than the poten-
tial downside.
Construction Risks That Can
Cost You Money
s an attorney, I’m always concerned about risks, so here are a few that I have
encountered, which you’ll want to keep within your field of view. It will save you
• Poorly defined separation of functions between architect, engineer, and contractor.
Scope creep that causes a small project to become a big one based on change
Project acceleration. This may be done as a way to provide an incentive for your
contractor to complete your project prior to the original date for purposes of in-
terest savings, favorable material pricing, or changes and deadlines for laws or
• Poor working relationships between parties that cause a lack of collaboration and
Keeping your contractors happy is pretty easy. Mostly what they want is to
be paid on time. They, in turn, have subcontractors to pay and paying them on
time keeps their tradespeople happy. Pay on time and you have a happy worksite.
Contractors also tend to take great pride in the work that they do and feel a
great sense of accomplishment bringing a building out of the ground. And, fi-
nally, they value their relationships with owners, designers, and subcontractors.
Work as a team, keeping all these things in good standing, and you’ll have a
general contractor who will become a valued asset to your real estate investment
You can learn more about contractors in Chapter 4, in which Ross McCallis-
ter talks about profits from the ground up.
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A Few Final Words
Any real estate project is all about minimizing financial risk, time risk, design
risk, and quality risk. It’s about choosing the right people to help you achieve
this and working collaboratively all along the way. If you are the type of person
who seems to foster adversarial relationships, this will be difficult. That’s not
to say that there won’t be times when being tough will be required. There most
definitely will be.
You’ll find as you go from simple projects to the more complex that your team
will have to function at a higher level with greater cooperation and problem-
solving abilities. In all instances, and with every project—big or small—that you
do, have a good attorney looking out for your interests. Find the best one you
can, and let him or her do the job you deserve.
Charles W. Lotzar is founder of the Lotzar Law Firm, P.C., a diversified
practice with representation of clients in commercial and real estate
transactions, low-income housing, tax credit financings, administrative
proceedings, and various forms of tax-exempt and taxable bond financ-
ings. A former senior partner in the national law firm, Kutak Rock LLP,
Lotzar is involved in all phases of real estate development, including debt
and equity financing. He has extensive experience in dealing with public contracts and issues
related to public officials, and he has been involved in bond financings that have an aggregate
value in excess of $5 billion.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 52
ayne Palmer is an artist and a creative genius. However, his creativity is
not seen in a painting or heard in the harmony of a song. Wayne’s creative
genius comes from seeing what cannot be seen: putting a deal together out of the
invisible and creating a financial masterpiece.
Wayne is really an alchemist, taking different disciplines such law, taxes, mar-
keting, and design and transforming them into exceptional real estate investments.
In other words, it is not the building or the raw land that is the investment. It is
the ability to create value out of the elements and forces that surround real estate
that gives Wayne his advantage.
Wayne’s mastery of creative financing can’t be fully described; it must be expe-
rienced. As you study Wayne’s three chapters in this book, you’ll begin to see what
I mean by that. You’ll begin to understand the difference between Wayne and the
rest of the world. Wayne can see a way to make a deal work in less time than it
takes most people to pick up a pen and sign their name. And his often simple solu-
tions to financing problems will leave you asking, “Why didn’t I think of that?” He
has a rare gift that maybe he was born with, and that his lifetime of experience as
a real estate developer, certified real estate note appraiser, certified cash flow mas-
ter broker, and licensed continuing education provider has certainly honed. Wayne
is one of kind, and he presents to anyone reading this book an opportunity to see
the world of finance in a way that you’ve never seen it before.
The Way to Exotic Wealth
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Wayne is a man I trust. If a person is going to be creative, it is imperative that
he or she holds him or herself to the highest of legal, ethical, and moral standards,
which is Wayne’s true strong suit. While he is always pleasant, enthusiastic, and
speaks with a smile, his graciousness does not interfere with his straightforward
candor. He will tell you what he thinks, even if it means saying that he thinks the
deal stinks or that the person representing it is either incompetent or of shady
The beauty and power of real estate investing is found in the scope of creativity
each property affords the investor. Whenever I am at a dead end, brain dead, and
in need of a shot of creativity, Wayne is the person I call.
—Robert Kiyosaki
sat staring at the envelope with the anticipation of a youngster on Christmas
morning. Seeing the title company logo, I had a pretty good idea of what
was inside. After months of patient teamwork, the escrow had finally closed. It
had required our best collective skills to complete the transaction. I felt a vi-
bration that I knew was part steel on paper and part the tingle of adrenaline as
the letter opener glided through the cotton bond. I carefully reached in and re-
moved a single document and unfolded it. It was a proceeds check made payable
to my company for $1,175,206.16.
As I paused to savor the victory, my mind wandered back over my thirty
years in real estate. How had we come so far? I remembered days in the distant
past when lunch money was hard to come by. What was so different about then
compared to now? Why was it so relatively easy today to make a million dollars
on a single transaction while it had sometimes seemed so difficult to make a
living years ago? As I breathed in the magnitude of the moment, one word came
to mind, and it wasn’t the economy or boom times or anything about having
more money. It was simple: formulas.
The word “formula” is rarely used in the real estate industry. We hear about
formulas in math and chemistry, but not in real estate. What could a cluster of
numerals and digits, strung together with mathematical operatives, possibly
have to do with making money? I smiled at the thought, realizing how few peo-
ple in real estate understand the power of one good formula. I noticed a wave
of gratitude flood over me. I felt so lucky to know the formula that had proven
to be worth a million dollars.
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What could a cluster of numerals and digits, strung together with math-
ematical operatives, possibly have to do with making money?
A Harvard friend once explained to me that certain truths are too big and
too powerful to express, except in the language of mathematics. Even Einstein
and his fellow physicist couldn’t explain the nature of our universe with mere
words, only with equations. Formulas allow us to identify, condense, and use
chunks of information that would otherwise be too big to manage.
As I held a $1 million check in my hand, I thought about all that had led up
to receiving it. If I were to write a formula to express how that had happened,
what would it be? I put the check down on my desk where I could glance at it,
and just for fun, I picked up a pad and pen to see if I could create a formula that
captured the key elements. Since I didn’t major in math, I didn’t intend to come
up with anything of cosmic significance. I just wanted to know if there was a
way to boil it down to one simple and concise expression. After a few failed at-
tempts, scratch-outs, and rearrangements, I looked at what I had scrawled on
the paper with a strange sense of satisfaction.
W = ( XO (T+E) ) / K
Yes! That was it! My entire career summarized in one inch or less. All of the
study, all of the acquired skills, all of the systems I had learned to operate within
the “big system” we call real estate were included. I knew I was on to something.
I could see that if I could put the essence of my formula in writing, others could
save years of struggle by applying the same principles to build their own wealth.
That is what I set out to do!
So what exactly does the formula mean?
[W] WEALTH equals [X] EXCHANGE multiplied by [O] OPPORTUNITY
multiplied by the sum of [T] TALENT plus [E] EQUITY divided by [K]
Let’s look at what each of these variables mean.
W “Wealth”
What is it? The word clearly has different meanings for different people.
Tabloids provide ample examples of the fabulously rich and famous who often
appear to live miserable lives in spite of their money. On the other end of the
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spectrum, I have seen those who barely survive economically but who seem
blissfully happy. True wealth, it would seem, is not only about cash in the bank,
although most definitions of wealth do include a certain amount of money. I
know my own definition of wealth has evolved over time to include freedom,
good health, peace of mind, happy relationships, education, recreation, and the
ability to serve others. However, for purposes of this chapter and this book, my
formula—W = (XO (T+E)) / K—focuses primarily on monetary wealth.
I define monetary wealth as assets that generate enough cash flow to sustain
my chosen lifestyle indefinitely, with minimal time and effort required on my part
to manage them. In Rich Dad terms, it is getting out of the rat race. Wealth is an
end result, just like the million-dollar check was the end result of one transac-
tion. Becoming wealthy is an overarching goal of the game of business.
I have concluded that one of the great gifts of living in a free society is that
everyone has the right to choose what works best for them and how much
wealth is enough.
X “EXchange”
Whenever an economic transaction occurs, there is an eXchange of value that
takes place. In ancient barter- or commodity-based economies, a cow may have
been traded for several bushels of wheat. Milk was traded for eggs. Chickens
were traded for hogs, etc. In each of these transactions, it is easy to see the sym-
metry of the exchange. In currency-based economies, we trade money for goods
and services. Regardless, if we look past the symbols of value, such as the ani-
mals or the coins, we can see that something else is actually being exchanged.
What is the “something else”?
It has been said that energy is everything and everything is energy. With
modern scientific tools, such as electron microscopes, we have learned that
things are not what they appear to be. What appears to be solid is actually a
mass of atoms that each has electrons swirling around the nucleus at astonishing
speeds. Each atom that makes up any substance on earth is pure energy. There
is relatively as much space between the nucleus and the electrons of the average
atom as there is between the earth and the sun. What we see as solid isn’t solid
at all. We only perceive it as such.
Our perceptions about money are much the same. We have come to think of
it as real wealth, but is it real, or is it only the symbol of the energy that consti-
tutes real wealth? I would suggest that the real wealth, or value, that is ex-
changed in any economic transaction—the “something else”—is not the money
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but the energy that the exchange of the money causes to move from one place
to another. If I use my money to buy oil, it is not the oil that I want but the
energy contained in the oil that has value to me. If I exchange my money for
food, the value isn’t in the food itself but in its ability to provide me with physical
energy and perhaps some pleasure in the eating.
The X in our formula represents the eXchange of energy that takes place in
a transaction. There are elements of both quantity and quality to each of these
exchanges. The element of quantity is easy to see. I pay $2 for a loaf of bread,
$3 for a gallon of milk, $4 for a gallon of gas, or $6 for a pound of fish. The
aspect of quality is a bit trickier.
Left to its own devices, nature always returns to balance. In the deserts of
the Western United States, we have lots of rabbits. From time to time, the pop-
ulation of rabbits may increase to the point that they overrun their habitat. In
response, nature produces only enough food in the habitat for so many rabbits,
and so the weakest starve and die. Or, the coyotes in surrounding areas discover
that rabbits are plentiful and come to dine on the bounteous bunnies. As human
beings, we have the opportunity to rise above the random and seemingly violent
balancing that’s found in nature, by committing ourselves to balancing the en-
ergy of our transactions right up front. This is where the quality of the exchange
comes into play. If I make sure that I give full value, or in other words, a full
measure of energy, in each transaction to which I am a party, I harness the
power of nature in providing perpetual abundance. Nature is inherently abun-
dant when balance is maintained.
So, for purposes of our formula, a fair exchange of energy is simply to con-
sciously give something equal to or greater in value than what one receives. It
is a living commitment to the principle of win/win. It is taking pride in the
quality of one’s contribution. If I give at least as much as I want to receive, na-
ture will balance the scales by seeing that I get full measure in return. If I give
extra, I create a vacuum and nature rushes to fill a vacuum, so I set myself up to
receive a greater portion. Once this principle of energy eXhange is understood
and followed, there can no longer be any lack of any kind. Natural law will see
to that.
O “Opportunity”
Oh, say, can you see? “America is [still] the land of opportunity.” In my opinion,
this statement is actually truer today than it has ever been. If anyone doubts its
validity, I invite them to observe the accomplishments of people immigrating
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to the United States. They typically come to America with little money, lacking
in language skills, and having no background about how Americans do things.
Yet, many immigrants build successful businesses, buy nice homes, and end up
sending their children to the best schools available, all within a fifteen-to
twenty-year period. They seize opportunities and acquire wealth that forever
changes their economic standing.
“America is [still] the land of opportunity.” In my opinion, this
statement is actually truer today than it has ever been. . . . However,
I don’t believe America is the
land of opportunity.
However, I don’t believe America is the only land of opportunity. Through
my travels, studies, and friends, I see tremendous entrepreneurial possibilities
in every capitalist country in the world. It is a matter of clear vision and of train-
ing ourselves to see things as they are, not as they once were, or as we hope they
might be.
I would ask this of anyone doubting the quality of today’s opportunities: Are
you willing to work as hard, study as long, and sacrifice as much as the immi-
grants that come to this country do? I think it is an important question because
those newcomers are today’s competitors, just as the ancestors of most Ameri-
cans were the newcomers competing for opportunities when they passed
through Boston Harbor or Ellis Island. I have no patience for those who stand
around whining about things, instead of harvesting the opportunities that are
everywhere to be found. Some may cite economic downturns as evidence that
the good days are gone. To the contrary, times of economic turbulence may ar-
guably provide greater opportunities to build wealth even faster.
I trust in Buckminster Fuller’s concept of “ephemeralization,” which para-
phrased is to progressively do more with less, faster. The technological revolu-
tion we are part of gives us incredible competitive capability and leaves us
without excuse. Yes, many things are different now than they were generations
ago and may be even more difficult in some ways. However, given all of the ad-
vantages we have that our ancestors lacked, I believe we still have the edge. I
know I wouldn’t want to trade places with them.
Think about the leverage inherent in just a few of our modern conveniences:
Air travel. More than once, I have left Europe in the morning and arrived home
in the Rocky Mountains by nightfall, traveling in the comfort of kings. It took my
ancestors months of sacrifice and peril to make the same journey by ship.
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Cell phones. I am able to talk to anyone from almost anywhere, at minimal ex-
pense. I remember the days when I had to get back to my office before I could re-
turn calls, act on a thought, or solve a critical problem. Now I can make use of
drive time, down time, and spare time as it occurs, with the greatest convenience.
Word-processing software. Decades ago, what constituted a workforce of
several secretaries in an office of several hundred square feet is now the size of
a book and sits comfortably on my lap. My PC gives me word processing ca-
pacity with instant correction, printing, graphics, and even video and sound, if
desired. It even surpasses the capacity of entire publishing companies of an-
other era.
Electronic document transfer. When I first started in real estate (1976) there
were no fax machines. I put fifty thousand miles a year on my car, just chasing
down signatures on documents and delivering them to mortgage companies,
title companies, clients, etc. Now I can send a fully executed copy to everyone
simultaneously, without ever leaving my desk and without using a single sheet
of paper or a thimbleful of gasoline.
The Internet. It is difficult to begin to estimate the value of so much infor-
mation at one’s fingertips. The physical equivalent of the electronic information
available on the Internet today would obviously fill the world’s libraries and
require a staff of several thousand to retrieve when needed. Even then, it would
be impossible to match the speeds at which such information is delivered to
my computer screen. It is as though all of the knowledge in the world is just a
click away. How could our forbearers compete with that?
Consider how only these few tools multiply a person’s time, especially when
you consider the time, effort, and knowledge it would take to physically repro-
duce the results one can achieve by using these spectacular tools. We truly live
in a time of marvelous opportunities.
As I see it, the biggest challenge in real estate today is to sort through the
hundreds of opportunities that are constantly available to determine which
ones are the best and which ones truly warrant the allocation of precious time,
talent, and capital. My only frustration with “opportunity” is that I cannot pos-
sibly invest in all of the good deals I see.
Since opportunity is all around us and the challenge is to sort through the
many to find the fabulous few, I believe the most important aspect of the “O” is
to become skilled at analyzing opportunity. While this book is full of powerful
ideas on how to do just that, here are my basic guidelines in the form of ten ques-
tions. (Yes, we literally put every deal through the “Ten Questions” routine!)
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Wayne’s Opportunity Filter—Ten Questions
1. Is the project in harmony with our major goals and purposes?
2. Are the people involved of good character, and will we likely enjoy working with
3. Does the project make sense as explained?
4. Does it promise returns equal to, or better than, our target rates?
5. Do we have, or can we hire, the skill required to successfully complete the project?
6. Do we have, or can we get, the capital needed?
7. Do we have the time to successfully oversee the project?
8. Does it provide at least three acceptable exit strategies?
9. Can we live with the worst case scenario, and is it within our risk profile?
10. Is it a win/win for everyone concerned?
We call this our Opportunity Filter. If we are satisfied with the answers to
these ten questions, we will go to the next step and do in-depth underwriting,
or “due diligence,” as it is called in our industry.
Let’s go back to the million-dollar check mentioned at the beginning of this
chapter and walk through the project that generated it. As background, the
project was a sixty-acre residential development that was only partway through
the entitlement process and was in foreclosure. The owners had twenty-four
hours to cure the default or they would lose the property, their down payment
of nearly $200,000 cash, and more than $3 million in equity.
1.Was the project in harmony with our major goals and purposes? Yes. We are
real estate lenders and developers, and it fit well within our portfolio.
2.Were the people involved of good character, and would we likely enjoy work-
ing with them? Although we had just met them, their references were positive,
and we were willing to give it a go, knowing we could remain lenders only if we
chose to do so.
3.Did the project make sense as explained? Yes, the proposed lots were in high
demand, and the views from the property were exceptional.
4.Did it promise returns equal to, or better than, our target rates? Ye s. The
owners were willing to pay our standard hard-money rates.
5.Did we have, or could we hire, the skill to do the project? We saw the owners
to be a bit weak in their ability to complete the project, but they had plenty of
equity to insure their performance. We were content we had the skills on our
team, even if it turned out that they didn’t.
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6.Did we have the capital required? Yes. We had the money on deposit to make
the loan and knew we could borrow to complete the improvements, if necessary.
7.Did we have the time to successfully oversee the project? Yes. The project
was close to home and could be spread across our existing staff, without over-
loading anyone.
8.Did it provide at least three acceptable exit strategies? Yes: (a) get paid off as
agreed; (b) complete the project in partnership with the existing owners; or (c)
foreclose on the property and sell it or complete the development ourselves.
9.Could we live with the worst case scenario, and was it within our risk profile?
The answer turned out to be “No,” because we discovered the property did not
yet have a deeded right of way for access. Although a contract was in place
with the neighbor to provide access, it contained no deadline for doing so. This
was a deal breaker for us. It threw us outside of our risk profile because we
couldn’t get title insurance without deeded access to the property.
10.Is it a win/win for everyone concerned? No. Because of the problem with the
access, it was not a win for us.
So, how did we solve the problems identified in numbers nine and ten (above)?
We renegotiated the terms of our proposed loan agreement with the owners. We
knew that we had legal grounds for getting the access from the neighbor. If it
took a year longer under the worst case scenario to acquire the access by litigation,
we simply needed a way to be compensated for our added exposure. Our so lution
was this: In addition to our loan fees, and as an offset for our additional risk, the
owners agreed to grant us a 35 percent ownership interest in the property.
It took us ten months to acquire the access, at which time we sold the prop-
erty for a $3.35 million gain. The check in the envelope was our 35 percent
share of the net profit.
Sometimes opportunities must be massaged a bit to discover the real gems
lurking beneath the surface.
(T+E) “The Sum of Talent and Equity”
This is the mathematics of synergy. One plus one is greater than two. Talent is
wasted without equity, and equity tends to dissipate without talent. However,
properly combined, T+E equals pure power. While it may be true that it some-
times takes money to make money, my experience tells me that of the two, talent
or equity, talent is somewhat more important in building and maintaining
wealth. For example, who wouldn’t want to have the talent of Warren Buffett
managing one’s equities? Of course, Mr. Buffett is not for hire. I understand it is
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often difficult to acquire Berkshire Hathaway stock because Buffett’s talent has
proven so exceptional that the current owners rarely sell their shares. I see that
as an undeniable testament to talent. The stock market at large would throw
billions of dollars at Mr. Buffett to have him get the results his talent has
achieved for his investors.
There is an old adage that states, “When money meets experience, the expe-
rience gets the money, and the money gets the experience.” I have found that
money (or equity) will flock to anyone who demonstrates an ability to protect
it and cause it to grow. So, let’s consider the value of talent.
T “Talent”
The New Oxford American Dictionary defines talent as aptitude, gift, knack,
technique, ability, expertise, capacity, and faculty; strength, forte, genius, skill,
and artistry.
It is easy to see that Mr. Buffett has all of these elements of talent on his
team. I refer to the Buffett team because in today’s business environment, things
move too fast and are too technical for any individual to successfully compete
against a talented team. I must admit it took me a while to realize this glaring
truth. As a self-employed “S,” within Rich Dad’s CASHFLOW Quadrant
, I took
pride in doing everything myself. I remember the day it finally dawned on me
that others could actually do some things better than I could. An employee, to
whom I had reluctantly delegated a task, not only completed it ahead of sched-
ule, but did it better than I would have done and in a way I would not have con-
sidered. I felt a huge weight lift off of my shoulders as I realized that it wasn’t
all up to me anymore.
Since that glorious day of independence, I have devoted much of my time to
building project teams that consist of the best players I can find. Team building
became the key for my move from the “S” (self employed) to the “B” (business
owner) quadrant (see Robert Kiyosaki’s book, CASHFLOW Quadrant). The re-
sults have been astounding. With an in-house staff of less than ten people and
outsourced “partners” of perhaps another dozen, I am now able to manage fif-
teen companies, nearly six hundred investor accounts, and as many as twenty
projects at a time. It sometimes takes my breath away to see how productive
our team has become. There are weeks when we close dozens of real estate
transactions of one kind or another. I am so proud of my people for the way
they produce and for the pride they take in the quality of their work.
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Here is a snapshot of the team we assembled for the “million dollar” closing:
1.The previous owners, who became our partners.
2.My business partner, Reed, is our systems guy. I believe every team must
have Reed’s equivalent to truly excel. He takes care of all of the details re-
quired to run our businesses, such as communication systems, information
systems, and personnel systems. The genius of his systems organizes our
staff to handle every detail of every project and to respond to otherwise im-
possible deadlines.
3.My support staff, including our receptionist, Lindsey, my administrative as-
sistant, Johanne, Renee who runs our document department, Lincoln, who
operates our real estate company, Julie, Dan and Victor in accounting and
Lila, our file clerk.
4.Our private investor clients, who, in part, provide the capital we use to fund
our loans and acquisitions.
5.Civil engineers to design the proposed subdivision, roads, and utility systems.
6.Lawyers to advise, to draft documents, and to litigate if necessary to secure
the needed right of way.
7.Accountants to keep accurate records, establish budgets, and give tax guidance.
8.Title officers to work through issues of boundary lines, easements, legal de-
scriptions, and in resolving the right-of-way issue.
9.City officials, who worked with us to approve our proposed development
and who helped formalize the needed right of way.
Each potential investment requires unique talent. I encourage you to learn
what is needed for a given project and build a team made up of those who have
spent their lives honing exceptional, fundamental skills that qualify them to be
part of your team. I don’t know who plays on Mr. Buffett’s team, but I would
wager with confidence that they are people of outrageous talent. After proving
the talent of your team, and with a few wins to your record, you, too, should
find it relatively easy to attract all of the equity you need to become wealthy.
E “Equity”
Definition: value, worth; ownership, rights, and proprietorship (New Oxford
American Dictionary)
Having said that equity is perishable without talent, let me now say that eq-
uity is everything when financing real estate—once one has the talent to activate
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the equity. Equity leads to net worth on your balance sheet. Equity is the symbol
of entrepreneurial wealth. Equity is capital, and understanding the role of equity
is a key to raising capital.
I also view equity as paper wealth. Currency is paper. Stock shares are paper.
In real estate, the difference between the value of the property and the debt on
the property is paper equity. Mortgages are paper assets for those who own the
notes and have the rights to receive the payments made by borrowers.
There are two segments of the real estate business where I have learned to
use equity in unique ways to achieve outstanding results.
The first is using equity as a tool in the “equity marketing” arena covered in
Chapter 22 and the second is real estate paper, or private mortgages. In each of
these realms, equity is applied in specific formulas to accelerate the accumula-
tion of personal wealth.
Let’s look at the second part of equity—the private paper portion. Private
mortgage paper is created by converting the seller’s equity into financing for
the buyer. A private note comes into existence when a seller “carries back,” or
in other words, loans equity to a buyer in the form of seller financing or when
an owner pledges equity as collateral for money loaned against the property.
Since all seller equity is capital, under our definition, seller equity provides one
of the most convenient and effective sources of financing for the purchase of
the seller’s property. Think about it: all seller equity is part of a huge pool of
potential financing for the building of your portfolio. Once you know how to
use seller financing, it is like having a pre-approved credit line for millions of
dollars just waiting to be tapped.
When I purchase real estate, I have trained myself to look to the seller’s eq-
uity first and foremost for financing. In the overwhelming majority of the prop-
erties we have bought over the years, seller financing played some role. Even in
the best of markets, when bank financing is plentiful, I prefer to use private fi-
nancing, for many reasons.
The Benefits of Private Financing—For the Buyer
1.Negotiable. Whereas banks and mortgage companies usually dictate the
terms of their loans, a private note can include any clause the buyer and
seller might agree to, such as lower interest rates, alternative collateral, ir-
regular payment schedules to match income fluctuations, and payments tied
to the performance of the property or project, to name a few.
2.Always available. Lending goes in cycles, and supplies of mortgage money
sometimes dry up. Private financing is always available because there is con-
stant equity in certain properties in the marketplace.
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3.Not credit driven. Private financing may be available, even if a credit score is
low, income is difficult to verify, or debt ratios are high.
4.No aggregate limit. Once the average borrower has a few loans outstanding,
institutional lenders may restrict further borrowing. There is no set limit to
what a real estate investor can borrow privately.
5.Flexible loan-to-value ratios. Banks and mortgage companies have set limits
on loan-to-value ratios (LTVs), but it is possible to borrow 100 percent of
the purchase price of the property from the owner with private financing.
6.A ship for rough seas. In tough times, institutions have historically been rigid
in their default and foreclosure procedures. When making payments to a pri-
vate party who doesn’t want the property back, it is possible to re-negotiate
terms, extend deadlines, and in general, work together to get through the
storm. Equity is preserved for both parties, and in the process, creates an-
other win/win.
These advantages of private financing for the buyer are clear, but I am often
asked why sellers would carry back. What’s in it for the seller?
Benefits of Private Financing—For the Seller
1.Providing financing for a buyer in a slow market might make the property
sell quicker.
2.By making it easier for the buyer to qualify for financing, sellers often get a
higher price for the property.
3.A seller carry-back sale is usually considered an installment sale by the IRS,
and any gain on the sale is deferred until the principal portion of the loan is
received. Properly structured, an installment sale can push the tax conse-
quences of the sale many years into the future (See Internal Revenue Code
Section 453i).
4.The seller earns income from the interest portion of the payment. The rates
of interest paid by buyers on private mortgages are usually higher than the
rates paid by banks on certificates of deposit. This means that a seller can
earn more money on a carry-back loan than he or she could by selling the
property for cash and depositing the money in a CD at the bank. This is es-
pecially a boon to sellers who are of retirement age. It is as though they con-
vert their home equity into an annuity of sorts.
5.A private note, properly structured, is legal tender. The seller can borrow
against the note or use it for a down payment on his next property or even
sell it for cash if desired. Selling a note for cash may result in the seller re-
ceiving less than the full face amount of the note.
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Real Life Story: How Private Financing
Can Work for You
s an example, I purchased a condo from a private party who owned the unit
free and clear. They agreed to accept a $20,000 down payment and to carry a
note of $78,000 at 7.5 percent for twenty years. The monthly principal and interest
payment was to be $628.36. I asked for a clause in the note that provided for all
payments made in the first year to be allocated to principal, such that the interest
rate for the first year of the note was effectively 0 percent. The seller would still re-
ceive the same monthly income, while I could prepay as much of the balance as I
desired, within twelve months, without interest. However, 7.5 percent interest would
begin accruing against the unpaid balance on the first anniversary of the loan. That
one simple clause, written into the private note, shortened the amortization of the
note from 240 months to 205.68 months, a savings of $21,565.76. You might note
that the savings exceeded my down payment. In other words, the zero interest
clause was, in essence, an agreement by the seller to rebate my down payment if I
paid on the note to maturity.
I trust that now you can see how equity in exchanges and equity in paper,
combined with talent, can turbocharge your investment results. I believe this
is one of the most important benefits of understanding and using wealth for-
mulas. Unless you were born into money or win the lottery, learning how to
harness various forms of equity that currently belongs to someone else, will
likely be your fastest road to riches.
Now, before we get to the last part of the formula, let’s consider what we
have learned so far:
Wealth is our goal—to be wealthy is to get out of the rat race
X stands for the balanced exchange of value and for the context of the real
estate exchange marketplace
O is for opportunity that is all around us, all of the time, just waiting to be
multiplied by the synergy of
Talent plus
Looking once again at the million-dollar deal, let’s take an inventory of
what we had when the borrowers walked into our office with their problem.
The property owners were about to lose a chunk of Wealth in foreclosure. We
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were prepared to provide an eXchange of value using our cash and Equity
Marketing formulas. We were presented with an Opportunity to help someone
else solve a problem and to profit by doing so. We had the Talent, and they
had the Equity to provide safety for our capital. It would seem the stars were
all aligned, right? Wrong! There is one more critical element to the formula
that I am convinced makes all the difference in today’s business environment.
I call it the “K” factor.
K “Speed/Time”
In mathematics, a factor is defined as a number or algebraic expression by
which another is exactly divisible (New Oxford American Dictionary). You may
notice that in my wealth formula, the product of everything else is divided by
K. K is the last operation that defines the ultimate sum of the wealth. So what
could possibly be so important as to warrant this key spot? The K is critical to
the equation because to me it represents time multiplied and compressed, as
with the metric system K, which is the symbol for kilo, or one thousand. How
can I do one thousand times more, a thousand times faster? In other words,
SPEED! How much ground can be covered in the least amount of time?
We live in a world where transactional time frames are being condensed and
collapsed by the effects of technology. What once took months to accomplish
now takes seconds or no measurable time at all. When Benjamin Franklin lived
in Paris as the U.S. ambassador to France, he communicated with his family
and government through letters. Those letters took up to six months to arrive
in the United States by boat from Paris. Today telephone, e-mail, text messaging,
and facsimile technologies make such communications instant. We can some-
times do almost everything in almost no time at all. To compete and succeed
today, we must prepare to accomplish ever more in ever shorter time frames in
every way possible.
Even though all of the stars seemed to be aligned in our million dollar deal,
there was one glaring exception. If we couldn’t salvage the owner’s Wealth by
funding the transaction within twenty-four hours, the Opportunity for eX-
change of value would expire, and all of the owner’s Equity would be lost, re-
gardless of how much Talent we had as a team. The key was the need for speed.
Without speed, all else was of no value. Without the K factor, everything that
preceded it in the formula was meaningless. Anything divided by zero is zero.
What was the key to our speed?
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The Keys to Speed
1.Private capital—the money system. Because we control private capital, there
was no need to make a loan application to a bank, order a lengthy appraisal,
wait for a meeting of the loan committee, or wade through the rivers of red
tape surrounding institutional transactions. In short, we were working in a
niche market where their bureaucratic structures knock the banks out of
the box. They simply could not compete with us on the basis of speed, and
our client was indeed in need of speed.
2.Technology—the mechanical system. Under Reed’s direction, our office is
wired with high-speed Internet, and we maintain accounts that connect us
to all kinds of data sources. These allow us to rapidly download title infor-
mation, zoning maps, tax rolls, market information, property histories, satel-
lite photos, and demographic data pertinent to our decision-making
processes. We can access much of this information instantly or communicate
very quickly with others who may be in possession of electronic versions of
the data that can be instantly forwarded to us. We can build a loan file in a
matter of hours instead of weeks.
3.Talent—the training system. Our staff has a broad scope of talents and disci-
plines necessary to gather and process information, create documents, com-
municate with vested parties, and support all others involved in the process.
We work as a team. We function as a whole, slicing and dicing the workload
and delivering the intended results in dramatically condensed time frames.
4.Relationships—the people system. We consciously invest in people. We do
all we can on a day-to-day basis to treat others as we would like to be treated.
We make every effort to accommodate others when called upon. We have
an absolute rule in our businesses that requires telling the truth and keeping
our word to everyone at all times. By making this investment in others, we
find that they are there for us when we have a need for speed and they readily
respond to our requests. We see these people as extensions of our team’s tal-
ent and resources. Our network of connected people is one of our greatest
assets. We also have an unbreakable rule: No matter what else is right with a
transaction, if the people piece is wrong, we walk away. As Robert Kiyosaki
so aptly teaches, “You can’t do a good deal with a bad partner.” The guidelines
we have set and hold to in our companies protect the integrity of our teams.
Our people abide by such high standards that we rarely need to fire anyone.
If the bad guys slip under the radar to find a way onto our team, they soon
leave because they are made so uncomfortable by the culture that everyone
else upholds. We have zero tolerance for lying, cheating, stealing, gossiping,
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petty politics, and sexual harassment. We intend for our business relation-
ships to last for a lifetime and create an environment that is mutually re-
spectful, safe, clean, fun, and productive.
Time is the investor’s friend in an appreciating market. As we say,
“Appreciation will cover a multitude of investor sins.” However in a down
market, time is the enemy, and the need for speed, for precision, and for
bullet proof decision making becomes even more critical. Speed is often
the difference between success and failure, especially in a contracting
real estate market.
Many modern tools allow us to cover more ground in less time. I encourage
you to use cell phones, computers, e-mail, text messaging, a paperless office,
video conferencing, and anything else that gets more out of the time allotted.
To illustrate how valuable this can be, one of my favorite tech tools is a digital
voice recorder. I keep it in my pocket most of the time. When I have a creative
idea or think of something I need to do, I make a quick note of it on the micro
recorder. Because I can talk faster than I write, this high tech tool consolidates
what would be a scattered pile of sticky notes into one location. I use the
recorded notes to compile my daily to-do list. This habit keeps important ideas
and tasks from slipping through the cracks. It also reduces my stress levels
considerably because my mind is free of all of those details. In addition, I keep
an audio journal of important thoughts, events, and new things I learn. It is
amazing how valuable some of that information is at a later date, especially
when imbued with the emotion of the moment, as captured in my voice. It ac-
celerates the learning process and the implementation of new ideas. Perhaps
the most important benefit of all is that it saves so much of my time, which is
So, there you have it! W = ( XO ( T+E ) ) / K. Wealth is XOTEK. To make it
easy to remember, say it phonetically. It sounds like “Wealth is exotic.” Now
you have your first formula for achieving exotic personal wealth.
On a bright spring morning in May, a few days after receiving the million
dollar check, I walked down the hall to my office. It was my birthday. I noticed
a document taped to the door at eye level. It was a copy of a deposit slip with a
printout of my discretionary business account balance. It had been posted there
by my accounting staff as a birthday surprise. It showed available funds of
$1,217,674.44. All of the bills were paid. There were no strings attached to that
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 69
It struck me that I had more than a million dollars in cash with which I could
do whatever I wanted. I sat down at my desk and again let the full impact of the
moment settle in on me. My thoughts were strangely drawn once more to those
times in the past when I struggled to learn the secrets of abundance. Of course,
I felt joy, peace, gratitude, and a sense of well being, but most of all, I felt vindi-
cated for every effort I had made through years of hard work, tireless study, and
the gathering of experiences that collectively prepared me to close million-
dollar transactions. A sense of excitement welled up inside of me. I knew it was
only the beginning because, now, I had the formula for replicating the same
success over and over again.
I glanced at the equation I had scratched on the pad of paper a few days ear-
lier. I felt so utterly blessed. I thought of thousands of other people who are out
there in the world, going through the same process I had been through; strug-
gling to find the right combination, the right recipe, the right formula for their
own success. I picked up the piece of paper and with a smile, folded it and care-
fully tucked it in my pocket. I knew it would come in handy soon, when I would
have a chance to share it with someone else who was diligently searching for
the way to XOTEK Wealth.
Ways to Learn More
A soon-to-be-published book on real estate formulas, by Wayne Palmer
Wayne Palmer is widely regarded as a master of the creative structuring
of real estate acquisition and financing, using notes and other forms of
real estate paper, together with 1031 Equity Marketing formulas. As the
owner and manager of National Note of Utah, LC, and several other com-
panies, Wayne is a Certified Real Estate Note Appraiser, Certified Cash
Flow Master Broker, a Licensed Continuing Education Provider, and holds
the Equity Marketing Specialist (EMS) designation with the National Council of Exchangors.
He has been involved in real estate development since 1978 in Utah, Idaho, Arizona, Hawai’i,
and Minnesota.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 70
oss is Ken McElroy’s partner in their business MC Properties. Kim and I are
often financial partners with Ken and Ross in a number of their projects and
have done very well financially, even in tough economic times.
There are three primary reasons why our investments with Ross do so well.
The first reason is that he is a builder. He understands the ins and outs of the con-
struction industry. Second, he is a property manager. This is important because
the key to long-term investing in real estate is professional property management.
And third, Ross is exceptional at finance by managing the ratios between debt, eq-
uity, and expenses. When it comes to real estate investing, he is the complete pack-
age. On top of that, he is a great guy. He is fair and honest.
In 2002, when the Tucson apartment market was hot, Ross’s background al-
lowed us not only to do well buying existing apartment houses but also building
new apartment houses. One of our first investments together was the purchase of
an existing apartment complex his company was managing. This gave us an ad-
vantage because we knew the numbers were honest—which is important since
most pro forma numbers provided by realtors are lies. Second, the property had
an additional ten acres of vacant land. Once we bought the existing apartment
house, our next step was to begin construction on an additional one hundred units
on the vacant land. Then with the increased rents a few years later, Ross refinanced
the property, and Kim and I got all of our initial investment money back. This
Profits from the Ground Up
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means each month we receive a check from the positive cash flow, and Kim and I
have zero invested in the project. If you do the math, this means Kim and I have
an infinite return on our money. In layman’s terms, an infinite return is truly
money for nothing... every month.
This is why Kim and I love being partners with Ross McCallister and Ken
—Robert Kiyosaki
erhaps you’ve already read and maybe even re-read Rich Dad Poor Dad by
Robert Kiyosaki, as well as my partner Ken McElroy’s book, The Advanced
Guide to Real Estate Investing, and now you are ready to take the plunge and in-
vest in real estate on your own. That’s probably why you bought this book writ-
ten by real estate professionals, each of whom have been earning their livings
in real estate for decades.
There are pages in this book that are full of tremendous opportunities and
innovative ways to make money in real estate. But one avenue of investment
you may not have thought of and may want to consider is to develop your own
project from the ground up.
The profits you have heard about from real estate development are mind
boggling, and if you are like most people, the numbers leave you frothing at the
mouth for a piece of the development pie. Yes, there is tremendous profit to be
made from real estate development, but as with any high reward venture there
is also the possibility of tremendous financial losses if you let your emotions
override good judgment, or if you don’t know what you are doing.
In this chapter I will outline some of the steps you need to take to evaluate a
development opportunity, steps I’ve gleaned from my expertise in developing
apartment communities during the past three decades and from some twenty-
plus projects of about four thousand units. And because my experience is pri-
marily in apartment development, that is what we will talk about. However,
these fundamentals apply to any commercial development, such as office or re-
tail, and to any size apartment community, be it four or four hundred units.
For me, development from the ground up is the most exciting way to invest
in real estate. There are few professional accomplishments more rewarding
than to see a project go from conception to reality. And it’s even better when
that project produces positive financial results. Yet, with that said, nothing can
be more frustrating than working for years (yes, years!) to start your project
and battling through environmental and governmental regulations, market con-
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ditions, financial institutions, and your own continuous questioning about
whether all this frustration and risk is worth it. That side of the business is a re-
ality, too, even for those of us who have many projects already under our belts.
I know you can see yourself as the owner of that “perfect” corner lot at Main
and Better Main, graced with a structure and a monument sign bearing the
name you have been dreaming about for years. Maybe it’s (insert your dream
name here!) in large letters on the monument sign in the front. You can see all
the happy families living there, and you can hear the ka-ching of the cash regis-
ter as the rents roll in every month. But before you build that sign or take that
cash to the bank, let’s talk about some of the decisions you must make first be-
fore you consider embarking upon this adventure.
The main lesson I have learned in thirty years of apartment
development is that each project is unique and different. Each will
bring its own set of opportunities and challenges.
Before you call me when you are in the middle of your next development
and say, “But Ross, you didn’t tell me I would need an environmental impact
study on the duck-billed humpback pygmy field mouse!” remember, I did tell
you that something always comes up to make your project harder than you
thought it would be.
A Clear Vision
From the beginning, for any project to be truly successful, you need to have a
clear vision of what you want to build and how developing this property meets
your own objectives. That means you also need to actually have objectives—or
better said, you need a solid understanding what you want this project to
achieve. One of the reasons MC Companies—the company Ken and I own—has
been successful in development is that we have an infrastructure in place within
our firm to develop, construct, manage, and profitably operate multifamily com-
munities. We are careful to select communities large enough to support an on-
site staff, earn economies of scale, and that fit within our investment model.
We are careful to keep our egos in check and build for the market rather than
for our own self esteem.
When we take on a new development, we draw upon each and every one of
those disciplines—development, construction, and management—from inception
to ensure that we make good decisions in the present because we know they
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will impact the future. This inclusive team approach is crucial to the successful
development and operation of our multifamily communities. If you do not have
expertise in all these areas, then it’s in your best interest to create a team whose
members do have the expertise in each of these fields before you venture into
multifamily investments, whether you are building a duplex or four hundred
Develop for the Long Term
Without exception we build communities with the full intent of operating them
once they are done. If the market is strong and the right buyer knocks on our
door after the development is complete, we have an alternate option to make
money on the investment, but we don’t enter a project with this end in mind. It
takes many months, or years, from the time we create the vision of our finished
community to the time when we collect even a dollar in rent from the first ten-
ant. To predict what the market will be like at the finish line is not always pos-
sible. But if you plan to own and operate the project after it is built and use
those numbers in your pro forma, you begin with a more solid platform—a
better business premise—from which to launch your development, lease it up,
and operate the community profitably.
Let’s look at the other scenario—from the point of view of building and selling
rather than building and operating. What if the market changes from the time
that you planned your development to the time it is built and ready for you to
operate? If you have not planned on operating it from the beginning, the likeli-
hood of you recognizing the changes, knowing how they affect your project,
and then making the necessary adjustments are slim. In the end, you may find
yourself holding an obsolete project or one that would require some serious
adjustments to fit the new market conditions.
My examples are not entirely hypothetical. In the spring of 2006 the apart-
ment market was hot, and any project completed could be sold for a big profit.
Many developers began projects with the idea that they could cash in upon
completion with an immediate sale. So, thousands of units were developed and
built over the next two years. In 2008, banks had changed their qualification
and ratios for loans, and their credit criteria changed dramatically, too. Investor
money was not readily available, either. Economic conditions had deteriorated,
resulting in higher unemployment and a tight economy. The market for new
apartments was, at best, weak. Investors were demanding lower purchase prices
to compensate for the slower economy.
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Consequently, many developers found themselves sitting on their shiny new
properties in a down economy, with cautious investors, reluctant banks, and a
weak market for their product. All the assumptions they had made two years
prior were based on factors that no longer applied. Because they didn’t develop
their projects with the idea that they were going to operate them, they created
a scenario dependent on a sale and ripe for financial disaster!
Ken and I have avoided this situation because we plan from the start to op-
erate the communities once they are completed, and we make sure all our ac-
tions are consistent with our investment objectives. Consequently, we have
been able to adjust to market changes and ride out the difficult times, all the
while building long-term value.
I don’t believe that it is possible to hit a real estate cycle perfectly.
If you do, it’s luck. Building value from real estate development over the long
term takes skill and expertise. It also takes an operator’s eye to recognize
market shifts and a mind-set that is open to change.
Your Market Niche Focus
Just as you simply must have your objectives for a development in place, you
must decide which market niche your apartment project, or other project, will
fill. Here are the basics I consider when looking for a market niche:
• What are the demographics of the area you are considering?
• What is the salary level of the area?
Is there a college population looking for more off-campus housing, and is
that the type of community I want to run?
• Where are the major employment centers?
• Are new businesses and employment being generated in the area?
What other communities are in the area that a prospective tenant will con-
sider, and are they the same class as the community you are developing, that
is, luxury, blue-collar, or subsidized housing?
• What can I build, and how much rent can I charge?
• Will I enjoy owning and managing the community?
In 1999, we took over the development of an eighty-unit townhome commu-
nity in a town with lots of retirees. Twenty-four units had been built, and only
two had sold in more than one year. When we inspected the project, it was ob-
vious why the sales weren’t happening. Each unit had two bedrooms with a
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detached garage. When homeowners came home, they would park in the garage
and would have to walk sometimes hundreds of feet through the property to
enter their front doors. A review of other competing townhomes for sale in the
area revealed they all had attached garages. Homeowners park, get out of their
cars, and take a few steps right into their homes. Is it any surprise why an
elderly buyer would prefer the competition?
When we took the project over, we bought the two sold units back and con-
verted the entire community to an apartment project, offering it for rent, not to
retirees, but to the people who worked in the town. We completed construction
of the eighty units, leased the property to full occupancy within six months,
and operated the project at a profit until we sold it four years later. That’s un-
derstanding the niche and developing for it. The original developer of the town-
homes clearly did not understand the market niche, which meant he did not
understand the buyer.
The most beautiful project imaginable will not rent if it’s built in the wrong
place. A luxury apartment community may be your dream, but if you build it in
a blue collar area, you won’t be able to lease the community or be able to charge
enough rent to make the economics work. Matching the needs of the commu-
nity with the project you develop is crucial to your success. Research and know
your demographics before you proceed. Only research will give you the per-
spective that you need before you take another step forward.
Where to Build Your Community
You’ve most likely heard it before in this book and likely everywhere else: loca-
tion, location, location. As you are standing on that dusty lot, filled with years of
accumulated trash, a couple of homeless camps, and overgrown weeds, envision
where the main entrance to your community will be located. Pretend you are
driving in and driving out. Look around you. What do you see? If the view is of
an industrial complex across the street, a junkyard, or poorly maintained build-
ings, don’t just brush it off. Signs like that generally mean the area isn’t going to
entice many people to choose your community no matter how beautiful you make
it. On the other hand, sometimes negative factors like these can be minimized.
We developed an apartment project on a site where our due diligence revealed
that a processing plant was located just half a mile away. The plant took used
grease from restaurants and processed it to be reused. When the plant was op-
erating, it stunk to high heaven. But the site was an excellent infill location in a
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good school district. The clincher was when we discovered that the processing
plant was in the midst of implementing rigid pollution-control measures. We
were able to pull off a really nice, affordable apartment community in an under-
served area with confidence. Research paid off.
While a panoramic view of the mountains or ocean may not be possible, or
even relevant to your community plans, don’t forget to envision what residents
will see and feel coming home. Is it welcoming? Does it feel safe? Would you
want to call that home after a long day at work?
Before Beginning a Multifamily Development Project,
Ask Yourself These Questions
Lifestyle and Convenience
• Will your community have good exposure to drive-by traffic? Heavy drive-by traffic
is a plus when you are trying to attract potential tenants, but possibly a negative
for residents concerned about traffic noise. On the other hand, the cutest, most
affordable community in town could suffer high vacancy rates if it is located on a
street no one can find, even with a blitz of advertising.
How far from the major thoroughfares will your community be, and how easy is
the access to them? Is that important for the type of community you are planning
to build?
• How easy will it be for residents to get to work, school, shopping, the movies, etc.?
• Where are the schools in relation to your community? What is the reputation and
rating of those schools? What are the transportation options to and from those
• What are the employment opportunities in the area? What mass transit is available
to help your residents get to work?
• Is the major downtown area easily accessible?
Social Amenities
• Are parks, movie complexes, theaters, arcades, and sports facilities an acceptable
distance from your proposed community?
• What is the “flavor” of the part of town you are considering?
• How does your apartment community plan fit in with the area?
Neighborhood Amenities
• Is shopping in close proximity?
• Is a major grocery store nearby? It matters for those 10 p.m. milk runs.
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Development of Your Site
By this point, you understand that you must choose a site based on your demo-
graphic research. Now consider your site from the development perspective.
How easy will bringing the project, literally, out of the ground actually be? This
is perhaps the most critical analysis you will need to do, and it is the one that
will have the biggest effect on your development costs. Is the site fairly flat,
with a minimum of site prep work required? Or does the site have some geo-
graphical features that are interesting but challenging?
Flat sites are wonderful, and they typically will allow for the highest density.
That is, they allow you to construct the most units per acre. Drainage becomes
your biggest concern with flat sites because water will not flow off them without
effort. On the other hand, a lovely, hilly piece of land can make for an interesting
project. But on the downside, density will be a challenge, and the geography it-
self can run up the site development and infrastructure costs very quickly. Foun-
dational structures like retaining walls can take a huge chunk of your
development budget in the blink of an eye. The point is, each site provides its
own set of challenges and opportunities. You need to understand how they af-
fect the number of units you can build and at what costs.
When considering the location of your community, consult with your local
governing bodies regarding zoning and other development requirements as
soon as you can. Your local government development department can help you
determine the required process for gaining permission to develop your project.
Be wary, though. I’ve found cities and counties are notorious for seeing new
development as a significant revenue source, and they look for opportunities to
solve their problems and budget overruns at your expense. For example, some
will make approval of your project contingent upon the city or the town getting
concessions from you. You need to understand the law and the regulations, so
you know what a government jurisdiction can and cannot legitimately require.
Do not take their word as gospel without checking. And most of all, be prepared
to do battle on every issue.
Can you tell that I speak from experience? During the approval process for
one project we developed, the city initially required us to build a traffic median
in the middle of a six lane street—the major highway through town—with the
excuse that the median was required to provide safe access to the proposed
apartment community. Medians are not cheap! We were going to incur several
hundred thousand dollars in off-site expenses that threatened to jeopardize
the entire deal. However, after many sleepless nights, a great deal of contem-
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plation, and consultation with our development team, we were able to deter-
mine that, although we were required to augment the street improvements to
provide safe access, we could do it by slightly redesigning the entrance to the
project and re-striping the street, at a cost of only $3,000.
Just as important as knowing how to work with the city or town is knowing
how to work with the utility companies. On your to-do list should be checking
with the utility companies that will serve your community for availability of
their services, hook-up fees, development fees, and monthly service rates. I’ve
seen too many novices get surprised by utility access and hook-up issues. An-
other often overlooked detail is checking on the possible future infrastructure
requirements of your site. For example, if your site is on a heavily traveled two-
lane street, and the city decides to widen it to four or six lanes, you will be as-
sessed for your portion of the cost, and you will lose part of your site for the
right-of-way. Be prepared for these issues by knowing they can happen up front,
then plan your development accordingly.
Oh, and let’s not forget the remote possibility, which in some parts of the
country isn’t that remote, that your site could have archeological or environ-
mental significance. Find out what rules are governing those discoveries in ad-
vance of even buying the land. Remember, finding out that your site is the home
of those endangered duck-billed humpback pygmy field mice, or the next Machu
Picchu, could either kill your development entirely or put it on hold for an in-
definite period of time while experts complete expensive studies and develop
mitigation plans.
Another tip that every developer must know is the value of checking for any
riparian or wetland conditions on the property, as well as drainage, flooding
potential, and soil conditions. You don’t want your beautiful new community
to be in a lake when the summer rains come. And you don’t want to find your
buildings slowly—or not so slowly—sinking into the ground because of poor
soil conditions. When evaluating a site, you must consider all these factors. I
know there are quite a number of them, and I can’t stress enough that each site
has its own nuances. As a developer you must be prepared to spend the money
to do a proper evaluation. It’s pretty easy to see the cost implications if you
Your Development Team
In our company, Ken and I have worked out clear guidelines regarding who will
handle which areas of development and management, based on our respective
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professional backgrounds. At the same time, we constantly consult with each
other and make joint decisions.
You do not have the expertise to handle all the development, manage-
ment, and construction phases for the community you want to build. You need
to start by putting together a development team with the strongest expertise
in each area you can find.
We’re always certain to clarify up front and in writing who will be the team
leader and who will make the final decisions. That holds people accountable and
gives them ownership. It’s fine to use people you know, but this is not the time to
give your sister-in-law’s cousin his first break in the development business!
Your Architectural Team
The next person on your team will be your architect. Ideally, this will be some-
one you have worked with in the past and have traveled a lot of rocky roads to-
gether. This person will have the experience and relationships with the
governing jurisdiction to guide you through all the government requirements.
He or she will also coordinate all the other design professions that you need,
and will provide the site plan, design, and building elevations, unit plans, project
amenities, and construction drawings with specifications.
Other members of your development team that your architect will coordinate
• Mechanical engineer who will design the plumbing and HVAC systems.
Structural engineer who will design the foundations, the framing require-
ments, and the roofing system.
• Electrical engineer who will design both the underground electrical systems
and the building electrical requirements.
Civil engineer who will design the grading requirements for your site, in-
cluding drainage, parking lot, and zoning compliances.
Your Contractor
The contractor will be the guy or gal who is going to take all these drawings,
plans, and specifications and construct your community. Think of him/her as
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translating the two-dimensional plans into three-dimensional buildings, from
overseeing the grading of the site all the way through handing over the keys of
the finished units. You will want a general contractor licensed in the state in
which you are building and who hires only licensed subcontractors in each trade
qualified to do the work. Reputation and past performance of the general con-
tractor will be your main guideline for this professional. Once chosen, you will
want to have a signed contract between you as the developer/owner and the
general contractor that will delineate the terms of the relationships including
Common Construction Contracts
Lump Sum or Fixed Price Contract—In this type of contract, the contractor
agrees to provide specified services for a specific price and receives this sum
upon completion of the project or according to a negotiated payment schedule. If
the actual costs of labor and materials are higher than the contractor’s estimate,
his profit will be reduced. If the actual costs are lower, the contractor will get more
profit. Either way, the cost to the developer/owner is the same.
Cost Plus a Fixed Fee Contract—In this contract, you as the owner/developer
will pay the contractor the actual costs of construction plus a fee to the general
contractor. If the actual costs are higher than the estimate, the owner must pay the
additional amount. If the actual costs are lower, then the owner gets the savings.
Guaranteed Maximum Price Contract—This contract states the owner/devel-
oper will pay for the costs like a Cost Plus contract, but the contractor will guar-
antee that the costs will not exceed a maximum amount. In the event that actual
costs are lower than the estimates, the owner keeps the savings. As costs rise,
the owner must pay for the additional costs up to the guaranteed maximum.
Thereafter the contractor pays.
The Construction Team
For as important as the general contractor is to the success of any project, un-
derstand that the success or failure of your construction relies heavily on the
expertise of the entire construction team. I cannot stress enough the importance
of hiring a qualified, financially stable contractor who employs a bright project
manager, assigns experienced superintendents, and hires excellent tradespeople.
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Carefully scrutinize each person who will be involved with the construction of
your project; not only is that your prerogative, it’s your job. In addition to your
general contractor being licensed in the state of your project, he or she must
also be fully insured and be bondable. Another tip, and I know, everyone needs
to get their start somewhere, but give careful consideration before you agree to
allow your general contractor to break in a new superintendent or project man-
ager on your job. His limited experience in the field may cost you money and
may even jeopardize the quality of your finished product.
So just who constitutes a construction team? Your team should include a
strong project manager. It is this person’s responsibility, among other things, to
decide which subcontractors will be awarded the contract for the project and
to set the construction budget. The project manager studies the plans and spec-
ifications submitted by the architectural team and based on his or her experi-
ence will often suggest adjustments or changes in the plans. A few choice
suggestions made by a perceptive and confident project manager can save you
thousands of dollars in the construction budget without affecting the quality
or the appearance of the finished product.
Each project has at least one on-site superintendent, based on the size and
scope of the project. The superintendent is responsible for the day-to-day op-
erations of all the subcontracting trades who will be working on the project at
any given time. Superintendents set the schedule for the trades to ensure the
proper flow of work. There is a sequential order to construction; for example,
you don’t want the painters arriving before the drywallers have finished putting
up the walls. And you certainly want to make sure all the necessary site work—
such as grading, compacting, etc.—is done before the concrete folks come to
pour the building pads. This right-on-time kind of scheduling takes a person
who has been around the block and knows how long things take to complete. It
takes a person who knows what the demand is for the various trades and knows
the appropriate lead times. It also takes someone who can forcefully, yet pro-
fessionally, get you the best treatment from the subs.
Between the subcontractors, superintendents, and the project manager, this
construction team is responsible for continued communication with the archi-
tect and engineers and for attending to construction methods and details that
don’t always show up on the drawings, yet become obvious as construction is in
progress. They should also be in continual communication with the testing tech-
nicians, building inspectors, financial institution inspectors, and, of course, you
the owner/developer! Remember, this is your baby, and you cannot deny the
fact that you are ultimately responsible for the design and construction pros.
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The project manager also has another very vital role, one you will come to
appreciate. He or she is the person responsible for keeping a close eye on the
construction budget. That involves closely monitoring if or when a particular
trade is out of sync with the budget, and making adjustments before the close
of the project. This is the person who looks out for your financial interests and
communicates with you to discuss any overages. In construction, things often
take longer and cost more than originally planned, so having a good project
manager with good communication skills is a real plus.
Where does the general contractor make his money? When you get your first
glimpse of a construction budget, you’ll notice a line item built in for a specified
percentage of the overall construction budget for the contractor’s overhead and
profit. Remember, construction costs are negotiated between you and the con-
tractor, so you need to understand all the components of the construction
budget, including direct costs for labor and materials, subcontractors, and gen-
eral conditions, as well as profit and overhead.
Finally, you are part of the construction team, too. It is up to you to use every
means available to make sure that the contractor builds the project correctly
and pays his bills.
This includes hiring third party quality-control inspectors; requiring proof
of payment for the materials and labor, such as lien waivers; and possibly re-
quiring a payment and performance bond.
Your Title Company
Title companies have been mentioned several times in this book, and here they
are again. Just as they play a role in acquiring existing property, they play a role
in new development, too. Here it is their job to hold all monies involved in the
transaction of the land transfer in escrow. They also provide a title report and
title insurance. The title company can help you by periodically checking to
make sure that the contractor is paying his bills and that no liens have been
filed against the project by a subcontractor. You don’t want to have your build-
ings almost completed only to find out that there is a lien on the property from
an unpaid sub. It happens!
Your Property Management Company
Contrary to what you might think, you’ll need a property management company,
even before your project breaks ground. It is the property management company
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that will prepare the market analysis and determine the rents your community
can reasonably charge. From there they help you prepare a realistic operating
budget. The way management companies make their money is usually based
on a percentage of anticipated gross annual rents. Having an experienced prop-
erty management company has been a true key to our success. The market
knowledge and expertise it provides is something we would never dream of
doing without.
Your Financing Partner
Unless you are related to Daddy Warbucks or recently won the lottery (if that
describes you, let’s talk!), you will need to obtain financing for your project.
You may qualify for various forms of financing from governmentally controlled
financing, to commercial banks, to private money. All are viable and all come
with certain requirements.
It is possible to qualify for governmental or commercial bank loans that offer
development and construction financing. These lenders historically will lend
from 65 percent to 85 percent of the total cost of the project. The credit crunch
of 2008 has changed those lending percentages, and developers are required to
have more of their own cash in their deal, but regardless of the amount, those
capital sources are options. However, governmental or commercial bank lenders
will have a first mortgage priority, meaning that in the event of a default, they
get paid first. Their interest rates are based on the current market.
Another finance option is securing money from private lenders, meaning in-
dividuals wanting to invest in a real estate project as opposed to stocks or bonds.
If you have a successful track record and a convincing business plan/sales pack-
age for your proposed community, they will lend you the money with the con-
dition that they receive an interest payment as well as a percentage of the profits
from the operations of the completed project and any sales proceeds. Although
private lenders are typically more expensive than traditional lenders, they are
more flexible and may lend you a higher percentage of the project costs.
Given the scope of your project and your financial contacts, your funding
may possibly come from a combination of these sources, depending on how
you structure the financing. Most of the projects Ken and I work on are struc-
tured to obtain a commercial bank loan for approximately 67 percent of the
total amount needed for the project, with the remaining 33 percent contributed
as the equity, which may come from investors, our own funds, or both.
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Your Business Plan
Obtaining financing isn’t as easy as strolling into a bank with a good idea. It
takes much more than that. In reality, to obtain financing, you will need a busi-
ness plan. Business plans come in many shapes and sizes, and you can find nu-
merous templates for them all over the Internet. But let me cut to the chase
and tell you exactly what banks want to see. This eliminates all the unnecessary
fluff that they don’t read anyway. Here’s what you need to include in your busi-
ness plan:
Executive Summary, which explains the purpose of the project and gives a
financial summary. You actually can write this first or last, but it’s always the
first few pages of your plan.
Property Overview, which includes a description of the site, unit mix, floor
plans, site plan, elevations, and pictures of the site.
Market Overview, which presents neighborhood features, city economics,
and the local apartment market.
• Financial Pro Forma, which includes development costs, construction costs,
and projected operations income and expenses.
• Developer résumé which highlights your credentials.
Development team résumés, which highlight the credentials of your archi-
tect, engineers, and property managers.
Those are the components lenders care about and are the sections they read.
No amount of fluff or page volume will make up for a poor job assembling the
details in these sections of the plan. Complete analysis and a realistic business
case surrounding that analysis have a better chance of receiving funding. A
sketchy plan based on incomplete research and analysis with blue sky projec-
tions won’t. Not only is this document obviously important in your getting the
financing for your project, the exercise of doing it helps articulate and establish
your goals and objectives. It is the exercise that helps you determine if your
project can ultimately be profitable, and let’s face it, you should want to know
that as much as the lender does.
Will You Qualify for a Loan?
Ken and I have spent our entire careers building our credit and financial stand-
ing, as well as building our network of contacts within banking and investing
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circles. These bankers and investors know our reputation and qualifications
and are willing to entertain a development proposal that we present to them.
Our track record and financial strength give banks and investors confidence
that we can complete and operate a financially viable project. When searching
for financing for your project, whatever your sources, you can count on them
scrutinizing your background particularly in these areas:
What is your financial strength? If you are building the community under the
umbrella of a company, what is the financial strength of the entire company?
What is your development experience? Have you successfully built numerous
projects before, or is this your first time at bat? If this is your first develop-
ment, what attributes and strengths do you have that will put to rest concerns
about your experience?
• Have you had one or more previous projects fall through in some way?
• What are the backgrounds, experiences, and strengths of your development
team? Are they all solid and strong, or are there any weak links that could
potentially cause hesitation from the source of your loan?
• What is the source of the equity you will be bringing to the table for this proj-
ect? How much of your own money are you willing to invest in the project?
The stronger your answers to each of these questions, the better the terms
and rate of loan you will be able to qualify for. A lender will ask these questions
regardless of the type of loan you are seeking—a construction loan or a perma-
nent loan. And that leads us to our next subject.
Short-Term Loan vs.
Long-Term Loan
A construction loan is a short-term loan with a term length from six to thirty-
six months, depending on the size of your project and construction budget.
Construction loans usually have variable interest rates and are interest-only
loans. The lending institution holds your project as collateral during the course
of the loan. In the event of default, you will lose your property. Construction
loans are also typically personally guaranteed by the developer, meaning the
bank has recourse to your personal assets in the event of default.
Unlike with other loans, with a short-term construction loan the lender will
not hand over to you the full amount of the loan all at once. Rather, you’ll receive
it in monthly payments based on the percent of completion of your project.
This process is called a draw, and each month your construction team will sub-
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mit an application to the lending institution. The lending institution will send
out an inspector to verify the work is completed as stated in a workmanlike
fashion and that all local government inspections are complete and approved.
Only with the inspector’s approval will the lender issue that month’s draw.
After construction is completed, then you, the developer, will need to obtain
a permanent loan. The permanent loan is long-term financing that will require
a monthly payment for principal and interest. The proceeds of the permanent
loan are used to pay off the short-term construction loan, and possibly repay a
portion of your equity. Sometimes, a lender will provide a construction loan
that will convert to a permanent loan upon construction completion. This has
the advantage of reducing your financing risk. There’s always the outside
chance that you may have trouble getting long-term financing once the project
is done. With a loan of this type, that financing is already in place.
Financing terms can be very complicated. Our company never takes on a
loan without thoroughly reviewing the loan documents ourselves, as well as
having the documents reviewed by an attorney who specializes in real estate fi-
nancing. Be sure you understand what you are obligating yourself to.
A Few Final Words
You, the developer, will put yourself on the line for the money to fulfill your
dream, but you won’t see your profit until the project is completed and opera-
tional. While the rewards of a well-thought-out and well-constructed project
are fantastic in the end, it is a long journey, and there is a lot of risk along the
way. The processes I used for building my first home in 1976 for $29,000, and
the communities we have built for more than $30 million are basically the same:
lots of time, research, due diligence, expenses, and sleepless nights.
By the time we identify a site, analyze the market, hire the professionals, ob-
tain financing, and start construction, we have invested huge amounts of time
and money. Every day during the development process a new challenge presents
itself. It is a major commitment and financial risk to take on an apartment de-
velopment, with the prospect of financial reward in the distant future. The de-
velopment process is complicated and frustrating but also exciting and fun. You
cannot anticipate everything, but you can succeed if you approach your project
methodically, get the best advice and help, don’t cut corners, and never give up!
The personal and financial rewards are unsurpassed.
Hang on for a challenging adventure. Watch out for the duck-billed hump-
back pygmy field mice and all the other bumps in this ride. You are either going
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to enjoy developing and building a new community as much as I do, or you will
find that it isn’t your cup of tea. Either way, I wish you much success!
Ross McCallister is a thirty-year industry expert in real estate/develop-
ment and finance. He is a co-partner of MC Companies and oversees in-
vestment analysis, development, construction, financing, business
development, and client relations. He is a licensed real estate broker and
a licensed general contractor. Ross has developed and constructed more
than four thousand apartment units in Arizona and managed condo-
minium conversions in Oregon, Las Vegas, and Arizona valued in excess of $300 million.
Prior to founding MC Companies with Ken McElroy, Ross was president of The McCallister
Company, a real estate syndication firm and property management company. Ross believes
in “giving back” and has served the real estate industry on various boards throughout his
career, including the Office of the Governor’s Arizona Housing Finance Authority Board.
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ommercial real estate is very different from residential real estate. Craig Cop-
pola is recognized as one of the best commercial real estate brokers in the
United States. That is why he is my partner in commercial real estate investments,
and we have done extremely well financially.
When Kim and I began our transition from residential to commercial real estate,
the first thing we had to do was let go of a residential real estate investor’s mind-
set. We had to see real estate investing through a different set of eyes. If not for
Craig’s experience, Kim and I might have lost a lot of money paying for our com-
mercial real estate education. Craig is great because he is a tremendous teacher
and takes the time to explain what we fail to see.
As an example, Craig’s education of Kim and me began with our interest in a
beautiful office building in a great location. It was a cute structure, built in the
1980s. The first thing Craig said was that there was not enough parking. He did
not even look at the building. Since the 1980s, zoning laws had been passed requir-
ing more parking spaces. If we wanted to improve the building, we would have to
tear it down completely and rebuild from the ground up to comply with the new
zoning law. The second lesson from Craig on the same building was that “Cute
buildings attract cute businesses.” He went on to say, “Rent to well-run businesses,
not cute people running cute businesses. You’ll have fewer headaches and earn
more money.”
Master Your Universe:
Get the Lay of the Land
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Craig is the most well-organized person I know. He has his days planned to the
minute. He is constantly studying and investing in his personal development—his
business—yet time with his family takes the highest priority. Craig is a great family
man and natural teacher, and he is priceless as a real estate partner.
—Robert Kiyosaki
eople who know me know that when I commit to doing something I gen-
erally jump in with both feet. And that is probably an understatement. It’s
not that I’m foolhardy about it; people would say I’m methodical and possibly
relentless. I don’t make rash decisions, and I don’t give up. That’s the way I ap-
proach my business goals, my personal goals, and my family goals. People would
also say I’m consistent.
One of my passions in life has been baseball. I was an all-state high school
and all-conference college player, and I was even drafted and played profes-
sionally with the Minnesota Twins organization. But after baseball, I knew I
needed something that I could throw myself into 100 percent, something that I
would love just as much and that would help me achieve my life goals.
Like so many people, my story of how I entered the real estate profession is a
classic friend-of-a-friend story. I won’t bore you with the details, but suffice it
to say I did my share of dues paying. I didn’t mind. My mentality then was no
different than it is now and no different than it was playing baseball: Everything
I do makes me stronger, smarter, and faster and gives me the only thing I ever
ask for in life—an unfair advantage.
Yes, I want an unfair advantage and I do what it takes to get it—ethically.
Getting the unfair advantage ethically usually means no shortcuts, lots of home-
work, discipline, and sacrifice. At least that is how it has been for me. When it
pays off, those long days and longer nights of poring over real estate offering
Memorandums, market comparables, and property financial data become dis-
tant memories that are replaced with cash, which flows into my mailbox on a
monthly basis. It’s a beautiful thing.
My career in real estate has afforded me spare time to do other things that I
love; that was part of my plan when I got into this business. I wanted to be able
to spend more time with my family, participate in my kids’ lives, and pursue
other passions in life such as running, Tai Kwon Do, and of course, baseball.
Today my passion for baseball takes the form of coaching a youth club base-
ball team—the Arcadia Rat Pack—and I approached that in much the same way
I’ve approached everything else I’ve set out to do: with a startling amount of
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research, analysis, planning, and detail all in preparation for intense action. I’m
not coaching a pro sports team, but regardless, I had batting lineups (based on
who from the opposing team was pitching), training schedules, practice sched-
ules, scouting reports, game strategies, substitution plans, even a plan for who
was going to coach first base. Some of the parents, I’m sure, thought I was going
a little overboard.
But to me “going overboard” was simply preparing the team to face every
challenge in practice so that when those same situations came up in a game,
they weren’t new. I wanted to give those kids the unfair advantage, ethically. In
essence, my role was to put those kids in a position to win.
That included mastering our universe and knowing the lay of the land. What
teams were we going to be up against? What were their strengths and their
weaknesses? How could we exploit those weaknesses and overcome their
strengths? What do we do in a first-and-third situation? What’s our bunt defense?
How do we handle a “run down”? We studied, strategized, and practiced all this
and more. We made it all the way to the state finals and were state runner-ups—
that was victory to us. Sixteen wins and three losses. The team played great
and came away with better and more confident kids. I want the same for you
when it comes to commercial real estate investing. I want you to win! I want
you to be the master of your universe before you even think about investing in
In real estate, mastering your universe takes the form of knowing
intimately your chosen area of city or town, fully understanding and enjoying
your preferred type of real estate investment (also known as “asset class”),
and being tuned in to the real estate cycle.
In real estate, mastering your universe takes the form of knowing intimately
your chosen area of city or town, fully understanding and enjoying your pre-
ferred type of real estate investment (also known as “asset class”), and being
tuned in to the real estate cycle. Once you’ve achieved all this, you are in a great
position to begin considering properties. Here’s your first pitch:
Let’s Take a Ride
Even if you have lived in the same city or town your whole life and feel you
know every road and every building, humor me, and still hop in your car and
take a ride. This won’t be a ride to simply look at buildings; it’s a ride to help you
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look at your town or city with what I like to call “real estate eyes.” Actually look-
ing at the buildings is a minor thing at this point. This drive will help you to un-
derstand the lay of the land—the environment the buildings are sitting in—from
many different perspectives. The drive is about location, location, location.
Start your drive with the goal of trying to understand the overall city from a
real estate investment perspective. Be observant. What do you think is impact-
ing real estate values in one neighborhood or another? Even if you think you
know the area in which you want to invest, it’s still a good idea to understand
what’s going on in other areas of your city or town. Those things will play a
part in the value of the area you like best.
By now it is probably no surprise to you that I live by my schedule. My days,
weeks, months, and years are open to change, but they are highly planned.
Whether you are a heavy scheduler or not, if you really look at your life, you’ll
likely find that we are all creatures of habit. We drive the same way to work and
the same way home, day in and day out. Not only do we miss the opportunities
on that drive, but we never see the changes that are taking place in the other 90
percent of our community. So the first thing I recommend in order to get the
lay of the land and master your universe is to drive a different way to work. If
you normally take the highway, then take the residential streets. If you always
stop at the same Starbucks for coffee, then go to a different coffee shop. Take in
a variety of scenery and people.
Recommendation No. 1: Master your universe by driving a different way
at different times to work, and take in the world from a real estate perspective.
You’ll be surprised by what you see.
Once you think you know an area, travel there at different times of the day.
How about evenings, weekends, and at night? Really take the time to see how
people live in this area, how it is trafficked. You may be surprised. There are
neighborhoods that not only have changed over time, but there are neighbor-
hoods that change with the time of day. I’ve seen parts of town that are “hap-
pening” spots during the week and during lunch, but they are absolute ghost
towns during the dinner hour and at night. If you’re looking for a great building
for a daytime business, this area of town could be the right place. But if you’re
looking for a building for an evening business, look elsewhere. Your goal here
is to look at an area and “get it.” That means you get what it’s about, and you
know what is a fit. Once you “get an area,” you will begin to be able to see the
future. This is a gut response that may be helpful to write down. You’ll have an
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opportunity later to test how right you are when you talk to the experts who
will eventually be on your team—appraisers, inspectors, attorneys, brokers, and
Look for “The Path of Growth”
When it comes to understanding the lay of the land, I look for what real estate
pros call “the path of growth” in the market. Even in cities that as a whole are
not growing, there usually are areas that are. How do you recognize the path of
growth when it comes to commercial real estate? Look for the areas where
home builders are buying land, where new homes are being constructed, and
where elementary schools are being planned and built. City governments are a
great resource for this information because they tell you where they are plan-
ning to build new facilities and where infrastructure is going in. You can also
get good insight from the economic development officials in your city offices.
It’s always interesting to see which projects they are the most excited about
and what they see developing down the road.
Recommendation No. 2: Get to know your city officials and staff.
Find out the projects that are underway that they are the most excited about.
The more you talk with them, the more you’ll come to know where the path
of growth really is.
City officials often can be very excited about urban revitalization projects
that are underway and often help fund projects that jump-start the process.
How exciting it is to think about being part of the solution to violence, crime,
and urban blight! But here’s my caution: These kinds of projects take time, lots
of time. Not only is there the obvious planning, zoning, designing, and entitle-
ment process that must happen; sometimes votes are involved. Then there is
the intangible consumer acceptance variable that can take years. In my home-
town of Phoenix, there were more than $800 million of revitalization projects
built before I considered this area for investment, and the elapsed time to re-
solve them took more than twelve years. So stay cautious for a very long time
because even neighborhoods marked for revitalization may remain in decline
for years.
I should point out that some real estate investors make it their entire business
to seek out declining neighborhoods. People who specialize in urban revital-
ization are just one example. That’s not my area of interest or expertise, so for
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my specialty—commercial office space—I stay clear when I see a lot of graffiti
or closed businesses. That seems obvious, but you’ll be surprised how a quaint
historic home that may have been recently rezoned commercial in a troubled
neighborhood can still be compelling to emotional investors. These buyers can
easily talk themselves into a bad decision by thinking that purchasing this build-
ing will be good for the neighborhood, or by telling themselves they will live
with the location because the building is so perfect. None of these arguments is
good enough. Remember, it’s location first, no matter how difficult the dwelling
is to pass up.
It’s Tough to Grow Your Way
out of a Downhill Slide
The reason I’m such a stickler on this point is that it’s really tough to grow your
way out of a downhill slide. There’s a difference between a declining area and
an area that is going to be revitalized. When you get the feel that a neighborhood
is going downhill, stay away. If it’s on the upswing and that historic building is
right in the center of it, don’t let your preconceived beliefs about the neighbor-
hood hold you back. There may be an opportunity. Understand they call it real
estate for a reason. You’re looking at the real estate first. That’s the key under-
lying truth to all of this. The building is second.
To me an absolute must is to fully understand where the market is going, not
just where it is today. It’s all about feel and not getting in too early. What I mean
by that is unlike some businesses where speed is everything, there is no need to
be on the bleeding edge in real estate. You don’t have to be first. You don’t want
to be first; leave that to the biggest players who can afford the risk. There’s
plenty of opportunity and money to be made by being second, third, and even
twenty-third. Leave the bleeding edge to the big boys. In fact, if you’re a small
investor who is starting out, never be first.
Recommendation No. 3: Do the homework it takes to fully understand
where the market is going, not just where it is at this moment in time. You’re
investing for the future, so see the future as best you can.
Even though time flies, when it comes to real estate, I’ve been surprised by
how long it takes the future to actually arrive. And if you’re in a downhill slide,
the future can’t happen quick enough, believe me. You may find out that your
grand vision for the property isn’t two years away; it’s actually twenty. This has
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happened to many real estate investors. The town of Fountain Hills, Arizona,
was started by a real estate speculator in the 1970s. He built the world’s highest
fountain, which is powered by jet engines and shoots a huge plume of water
560 feet into the air. His goal was to attract curious people to the new commu-
nity that at the time was out in the middle of nowhere. People came and mar-
veled at the fountain, but not enough bought real estate. It took decades for the
real estate in Fountain Hills to really take off. Today it is a thriving community,
but it took almost thirty years for that to happen.
Is your view of the future too far ahead of the curve? My rule is to take my
time and be patient. There’s no need for excessive urgency at this point in the
process. If there’s room for one person to make money in an area, then there’s
room for more. In fact, I’ve found there are very few properties that are so spe-
cial that if you miss them, you miss the deal of the century or even the decade.
While those properties do exist, their owners know it and they typically over-
price the properties anyway, negating the value of the deal. A good example is
the Esplanade and Biltmore Fashion Park, both within the same city block in
the highly sought after Camelback Corridor in Phoenix. Those properties are
the types that are bought by huge institutions who want trophy properties
where the look and the location are more critical than the solidity of the real
estate and the return. For example, General Electric bought Hayden Ferry Lake-
side in a prestigious area of Tempe, Arizona. MetLife bought the Esplanade in
Phoenix. These are called core plus properties and are named such because
they create a portfolio of foundation projects that entice other investors who
are looking for glamorous investments.
Recommendation No. 4: Real estate investing is about patience. There
is no need to rush into an investment in any market.
Keep Your Real Estate Eyes Open
As you look at neighborhoods, don’t overlook the places that you think might
be too expensive, too cheap, or that used to be blighted. Neighborhoods change.
I know one investor who has made a ton of money improving the looks and
performance of less-than-stellar buildings and increasing the property values.
It takes a big commitment to do that, but she’s doing it. Understand, too, that
there are slum lords out there who have made big bucks owning very shabby
properties. That’s not something I encourage; part of what we can do as in-
vestors is create better spaces for all. But with that said, it’s a free country.
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Everyone always asks this: What are the warning signs of a declining neigh-
borhood? That’s easy, and if you go with your feelings, you’ll know them in-
stinctively. True story, I was driving one morning, checking out a few
neighborhoods I hadn’t been through in a while and drove right by a car on
blocks with the tires missing. That’s the classic bad sign, and there it was in all
its glory. Other signs are multiple cars parked in the street at night and a tenant
mix in a building that looks fly-by-night or that are in shady businesses. Finally,
take a look at the general upkeep. If the properties are unkempt, that’s not good
either. You may even want to take a look at the police reports to see how much
crime happens in the area.
The bottom line is you can modify your building, but you alone can’t modify
the neighborhood your building sits in. And about that quaint historic building
in a seedy part of town: Sure it would make great offices for a trendy design
studio, but if your employees are too afraid to work there or stay after hours,
how wise was your decision? Open your eyes and think through what you’re
seeing, and listen to your gut. Write down what you feel—yes, what you feel—
about every neighborhood. On the next page is a form that will not only help
you know important considerations, but also will give you a place to record your
impressions about the area.
Recommendation No. 5: Look for the signs of a declining neighborhood,
and don’t be in denial about them. Unless you want to specialize in renewal
projects, those signs matter.
Let’s Talk Buildings . . . Sort of
As I mentioned, the actual buildings themselves are practically the last things I
look at when I’m getting familiar with a city and its neighborhoods. And even
when it comes to a building, I don’t initially see the vertical structure; I see the
property it’s sitting on. Are there enough parking spaces? Is it easy to get into
and out of? In other words, does the property have good access? And looking at
the building and the site it is sitting on, does it feel right? And can visitors find
the location without getting lost?
From there I take a closer look at who is occupying the building. What are
the tenants like? Are they quality, established companies or a little on the flakey
side? A tenant doesn’t have to be The Home Depot or Taco Bell to be acceptable.
A local plumbing outfit that’s been in a building for ten years is actually a good
tenant—I have one like that—particularly when compared to let’s say a start-up
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Drive Guide – The Neighborhood Environment
Below are the things you need to look for as you drive neighborhoods and look at environments.
(Rating scale: 1 is poor, 2 is fair, 3 is average, 4 is good, 5 is very good.) Add comments to right.
Neighborhood Environment: __________________________________________________ (list area)
Border: N__________________ / S__________________ / E__________________ / W________________
Overall upkeep 1 2 3 4 5 _______________
General condition of buildings 1 2 3 4 5 _______________
Quality/condition of cars in area 1 2 3 4 5 _______________
Quality of businesses in area 1 2 3 4 5 _______________
Traffic patterns 1 2 3 4 5 ______________
Area landscape 1 2 3 4 5 _______________
Overall visual interest 1 2 3 4 5 _______________
Perceived prestige 1 2 3 4 5 _______________
Would I buy here? Yes No
If yes, what product type? _________________________________________________________________
On what street(s) would I own? ____________________________________________________________
Your Feelings and Impressions
High points? Morning Noon Night
____________________ ____________________ ____________________
____________________ ____________________ ____________________
Low points? Morning Noon Night
____________________ ____________________ ____________________
____________________ ____________________ ____________________
Future Outlook
In 5 years: _______________________________________________________________________________
In 10 years: ______________________________________________________________________________
Other impressions: ______________________________________________________________________
Questions I need answered: _______________________________________________________________
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 97
technology company that no one has ever heard of with millions in venture
capital money and a burn rate of a million dollars per month with one customer
and no profits. I also consider the tenant’s position within their industry, the
level of competition, and where the industry is going.
Recommendation No. 6: Consider the building last and look at the
location and property it’s on first.
One afternoon, a friend called me from her car as she was traveling in a small
town some distance from her home. She said, “Hey Craig, I’m looking at a great
building here that’s all set up for a call center. What do you think?” For me the
answer was easy. Call centers are declining in the United States with most com-
panies shipping their operations overseas. I replied, “Unless you’re in India
right now, I’d pass.” Much of this is really common sense and having some
knowledge of where the trends are, not just in real estate, but also in the areas
of business and life that affect real estate.
The tracking form on the next page is a tool you can use to record your first-
glance view and impressions of a property. It’s also a great idea to bring along a
digital camera so you can take photos of buildings and attach them to the Driv-
ing Guide records. Pay special attention to these items and be sure to record
your overall impressions as well.
Commercial Asset Class Options
One of the most important decisions you as a real estate investor will have to
make is in which area of the business you want to specialize. If reading this
book tells you anything, it should tell you that there are a lot of ways to make
and lose money in the world of real estate. Even within the commercial real es-
tate sector, there are a number of different asset class options. You’ll soon dis-
cover that they are each quite specialized with plenty of their own nuances and
requirements. I believe it’s important to see the commercial real estate sector
in its entirety so that you get an accurate picture of how it is all interconnected
because, even though the different asset classes are unique, they all do work to-
gether to create an environment within an area of a city or town. Here are the
asset classes complete with descriptions and the risks and the rewards.
Recommendation No. 7: No one can possibly be an expert in every
commercial asset class. Choose the one you think you’ll enjoy most and
specialize in it.
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Drive Guide – The Building
Below are the things you need to look for as you drive and look at buildings. You’ll want one form
for each building you view. (Rating scale: 1 is poor, 2 is fair, 3 is average, 4 is good, 5 is very good.)
Building Name: __________________________________________________________________________
Building Address: ________________________________________________________________________
Location within area 1 2 3 4 5 ____________________
Curb appeal 1 2 3 4 5 ____________________
General condition 1 2 3 4 5 ____________________
Parking 1 2 3 4 5 ____________________
Lighting 1 2 3 4 5 ____________________
Access/entrance and exit 1 2 3 4 5 ____________________
Tenants 1 2 3 4 5 ____________________
Ease of finding 1 2 3 4 5 ____________________
Landscaping 1 2 3 4 5 ____________________
Fits with your needs/wants 1 2 3 4 5 ____________________
Your Feelings and Impressions
High points? Morning Noon Night
____________________ ____________________ ____________________
____________________ ____________________ ____________________
Low points? Morning Noon Night
____________________ ____________________ ____________________
____________________ ____________________ ____________________
Future Outlook
In 5 years: ______________________________________________________________________________
In 10 years: _____________________________________________________________________________
Other impressions: ______________________________________________________________________
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The multifamily asset class includes everything from small duplex apartment
buildings to entire apartment complexes with eight hundred units or more. The
biggest risk in this asset class is oversupply because when people have lots of
choices, rents can fall, affecting your property’s operating performance and
cash flow. Another risk with multifamily is that when interest rates are low,
more people can afford to buy homes, so they don’t have to rent. That leaves
more apartment units vacant and competing for fewer residents. But on the
plus side, when lending gets tighter and it becomes harder to qualify for a home
mortgage, renting becomes the only option, and the demand for apartment
homes increases. Investors have made a lot of money in this area of commercial
real estate by buying right and managing efficiently. Like all commercial real
estate, the value of a multifamily property increases based on increased operat-
ing performance. In other words, buying a property and then managing it and
filling up the vacant space better than the previous owner can create an auto-
matic bump in value.
Retail commercial space is something you know probably quite well: shopping
centers, strip centers, malls, and stand-alone retailers. The benefit with retail
property is that construction costs are high—often tens to hundreds of millions
of dollars—making for a high barrier to entry by competitors. This keeps de-
mand usually ahead of supply. As an investor, that’s generally a good position
to be in. But it’s not all blue sky. Economic factors such as reports of inflation,
recession, and declining consumer spending trends can trigger retailers to go
out of business, and as a building owner you could lose a retail tenant. Compe-
tition can also turn a favored retail center into one that is second class. That’s
what I mean about knowing the lay of the land and seeing the future. You want
to know what is coming, not just what is.
Commercial Office
Office buildings and office condos are one of the largest real estate asset classes.
Just look around. We all work somewhere, and offices house many of us daily
from eight-to-five. Offices come in many shapes and sizes, so there is diversity
and easy entry for new investors. Some offices are former residential buildings
converted to office space. Others are conventional office buildings of all shapes
and sizes. The benefit of commercial office space is that there is likely something
in your town that will fit your budget whether you are a first-time or a seasoned
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investor and give you plenty of room to grow as you increase your wealth and
your level of investment.
Just like commercial office buildings, industrial spaces tend to have longer
leases and lots of options when it comes to investing. There are giant ware-
houses with upward of five hundred thousand square feet and smaller mixed-
use spaces in the neighborhood of three thousand square feet, along with
everything in between. Because of the many options available, industrial space
is a classic first-time-investor property. One reason for industrial’s popularity
with first-time investors is that many have their own businesses and need this
kind of space.
Health Care
This asset class in commercial real estate includes not just hospitals, but also
nursing homes, medical buildings, and assisted living facilities. The benefit of
this class is that recessions and economic downturns don’t really affect it much.
But it is prone to the ups and downs of the tenant. Medical practices are small
businesses. Hospitals are big businesses. And business can fluctuate. Plus, the
medical profession is one that is in a state of flux, and it will be so for many
years to come. Through my experience in this area I know that not only is it
important to have the right tenants in your space, but it’s important to have the
right mix of tenants in your space—the right practices and the right practition-
ers. Assisted living facilities, on the other hand, rely heavily on good manage-
ment. Having a reputable management company that specializes in these kinds
of communities is a must.
Self Storage
Self storage spaces are those mini-warehouse consumer and commercial facil-
ities that you most likely have seen in your town. You may even have some of
your things stored in one of them. They are seemingly recession resistant, and
that is a big advantage for you as an investor. Generally, the management is rel-
atively easy. Believe it or not, corporations are actually the biggest users of stor-
age facilities, and every year they pay billions to store excess files, records, and
general stuff. The downside is that building self storage facilities is a low-cost
proposition. That means it’s easy for competitors to break into the market,
charge a lower price, and erode your margins. When it comes to self storage, I
always make sure there are lots of rooftops nearby as well.
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This asset class includes hotels, motels, casinos, bed and breakfasts, resorts,
and vacation rentals. And like assisted care facilities, management is impor-
tant. In general, it is the asset class most closely connected with the health of
the economy. In periods of economic decline, travels for business or pleasure
are early casualties of cost-cutting and penny-pinching. That affects the num-
ber of room nights booked, which means per-night room rates can fall as prop-
erties vie for fewer customers. This, in turn, erodes income and profitability,
but in markets with a balanced supply-and-demand ratio, hospitality can be
very lucrative.
Within each of these asset classes are subcategories. All these options may
at first seem overwhelming, but in reality it’s this diversity that makes com-
mercial real estate so lucrative and why smart investors specialize. It’s this spe-
cialization that enables us to have an advantage over other types of investments
and over other types of investors who are trying to do it all.
The ABCs of Commercial Space
Just as you need to know the various asset classes and some of the nuances of
each, it’s a good idea to know the four classes of commercial space that refer to
the quality of the property. Too often I have seen novice investors duped into
believing that an office building is one class, when it is really a lesser class.
Class matters because the better the class of building, the higher the rent per
square foot. Here are the official class guidelines:
Class A+. Landmark quality, high-rise buildings with a central business dis-
trict location. These are the best of the Class A buildings.
Class A. Buildings that are one hundred square feet or larger with at least
five floors. The construction of these buildings is concrete and steel, and they
were built after 1980. Buildings include business/support amenities such as
cafés and banks, and they have strong identifiable locations and accesses.
Class B. Renovated buildings in good locations or newer buildings that are
smaller in size. These can be wood frame construction in nonprime locations.
Most first-time investors invest here.
Class C. Older buildings that are not renovated. They can be of any size, and
are in average to fair condition.
Keep these qualifications in mind as you look at properties. They will help
you know what you are looking at, and they will also help you recognize false
advertising when you see it.
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The Real Estate Cycle Revealed
Although you now know there are more kinds of commercial property than
you could have imagined, you may still be surprised to learn that their perform-
ance over time is cyclical in whole and in part. What I mean by that is that each
asset class runs through a cycle. And each asset class’s cycle either flows before,
flows with, or flows after another asset class’s cycle.
For example, you’ll find that growth in residential housing will fuel a similar
but slightly lagging rise in retail. This pattern makes sense when you consider
that new homeowners will want shopping centers, grocery stores, and other
conveniences near where they live. The surge in retail then drives growth in
the industrial and distribution sectors, so that means warehouse and mixed-
use property development grows. Home development also drives some growth
in commercial office space, but again commercial lags behind. That’s why when
housing development slows, it takes a few years for commercial to slow down,
too. You’ve probably noticed that. When the news is reporting real estate de-
clines, new commercial projects are still getting underway. Now you know why.
Real estate is about cycles and the inevitability of them. Once you know that
and know how to pay attention to the cycles, you’ll know the lay of the land in
this regard, too, and you’ll be in a position to make the best of the cycle by mak-
ing the best decisions along the way.
Recommendation No. 8: Understand the real estate cycle and watch for
the indicators, and you will seldom be surprised.
Cycles are important, but in reality if you buy right, your real estate will do
well, regardless of where in the cycle you bought. But if you are just starting
out, buying right may not be as intuitive to you, so understanding the real estate
cycle becomes golden knowledge. The following diagram shows the typical
commercial real estate cycle and how it affects new construction and vacancy.
Let’s walk through each quadrant. In Phase 1, the lower left quadrant, the
market is in recovery phase. There is declining vacancy and no new construction.
You know the market is in this phase when there is some growth in the market
indicated by properties being rented and properties being sold. This uptrend
can, and often does, last a long time, years in many cases. That’s why I never
feel like I need to rush into an investment. I also don’t like surprises, so I gener-
ally let the bigger guys make the first leaps during this phase. Then I make my
moves with solid knowledge that we are solidly in Phase one—the buying phase.
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Recommendation No. 9: Phase 1 in the real estate cycle is the time to
buy, and Phase 2 and 3 is the time to sell.
As you’ll see in a minute when we talk about Phase 3 and Phase 4, declining
markets aren’t the time to take vacations. Doing lots of homework during those
times will make you smarter and at the ready during a Phase 1 market when it
is time to buy. When the other guys who bought poorly, or bought in the wrong
phase of the market, have thrown in the towel, that’s when I buy.
During Phase 2, you see the occupancy rates move below the Long Term Occu-
pancy (LT Occupancy line on the diagram) for your market. (Long Term Oc-
cupancy means that owners typically need at least a minimum of five years of
term remaining.) Every market is different, but in most cases, vacancy is very
healthy when it is below 10 percent. Understand that new construction tends
to start when vacancy rates drop below 10 and 15 percent, so during this phase
new properties begin to be developed. Again, this phase of the cycle does not
last days, weeks, or months. It tends to last a few years, so there is no hurry
here. If and when I buy during this phase, I really make sure the numbers work
and that the property meets my qualifications. There’s no way of knowing ex-
actly where the top of the market is or how long it will last, so caution is the
rule. If you’re going to sell, Phase 2 is when you do it.
Recommendation No. 10: Phase 3 and Phase 4 are not the times
to buy. They are the times to research and target properties to buy when
Phase 1 kicks in.
Market Cycle Quadrants
Phase II - Expansion Phase III - Hypersupply
Phase I - Recovery
Phase IV - Recession
Declining Vacancy
New Construction
Increasing Vacancy
New Construction
Declining Vacancy
No New Construction
Increasing Vacancy
More Completions
LT Occupancy
FIGURE 5.3 Market Cycle Quadrants
Used with permission by Glenn R. Mueller, Ph.D.
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In Phase 3, the market is in obvious decline. The guessing game, however, is
how far the market will fall and how long it will take. If you bought in Phase 1,
you may have bought yourself some strength. But when you are still seeing new
construction underway and occupancy rates increasing above the LT Occu-
pancy for your market, recognize the signs that you are in Phase 3. This is known
as “hyper supply.” Obviously, I never buy during this phase no matter how badly
I want a building. I am simply not willing to ride the wave to the bottom, not
knowing how far down bottom is. What’s the point when I know that there
will be plenty of time for deals that make sense in Phase 1? In fact, I’ll be buying
at bargain prices the properties others foolishly bought in Phase 3! You’ll hear
people say that there are buying opportunities in every phase. That is true. But
it just depends on how strong your constitution is and how deep your pockets
Finally, Phase 4 signals market bottom. But there’s good news in Phase 4,
too. The darker it gets in Phase 4, the better the buying opportunities will be in
Phase 1. So if you’re on the buying side, relish Phase 4, and take the time to look
at properties. Look a lot, but don’t buy a thing. There’s no way of knowing the
bottom until it makes the turn upward. You’ll know you’re in Phase 4 when va-
cancy hits its high well above the LT Occupancy and buildings are no longer
under construction. The cranes and bulldozers will be replaced by completed
buildings sitting vacant. At this time, I do a lot of research so that when Phase 1
kicks in I have pinpointed some ripe buying opportunities. I have lined up in-
vestors and financing and spoken to lots of people and told them that when the
turnaround happens, I’ll give them a call.
While it is helpful to know that real estate is cyclical and in all cases inter-
connected by asset class, knowing where you are in a market cycle and predict-
ing where it is going is key. Savvy investors can make money anywhere in the
cycle, but it takes great skill and experience to make money on the right side of
the line.
Further, understand that all real estate follows this pattern and that some
asset classes will follow the curve earlier or later than others. For instance, res-
idential real estate is always the first to decline and the first to rebound. Multi-
family follows a little later, and retail and commercial after that. Commercial/
industrial is usually the last asset class to emerge from a down market; however
it is usually the last to enter it. The more familiar you get with watching the
real estate cycles, the better you will get at knowing where you are in them.
Commercial real estate, for me, gives me plenty of warning to buy, sell, and
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The Last Word on Mastery
Well, now you know how critical the lay of the land in terms of neighborhood,
asset class, and the real estate cycle is to the success of your real estate invest-
ment career. But just like in baseball, there’s a huge gap between knowing how
to hit a home run and hitting a home run. That gap, of course, is technique,
practice, and unfortunately, failure. Becoming master of your real estate uni-
verse will take all of those, too. It did for me. I’ve lived in Phoenix for more
than twenty years, and I still drive around the market with real estate eyes.
Things are always changing, and I need to keep up with those changes. I develop
new systems to make me more efficient as I analyze properties and deals. And
I’m not ashamed to say on my first deal I lost $15,000 and didn’t even end up
with the property! It never closed. These kinds of things happen to everyone,
and they are what separate the serious investors from the novices.
The same goes for baseball. Every time the Arcadia Rat Pack stepped out on
the diamond, they expected to win, but they also knew that losing was a possi-
bility. Of course we did everything in our power to increase the odds of winning,
but on those occasions when we didn’t come out on top, our team learned what
didn’t work, what we had to do better next time, and what subtleties we missed.
We didn’t make the same mistakes twice, and that’s the benefit of losing: the
Yes, knowledge is just part of the story. But action is the most critical part.
All the information in this chapter and within this book as a whole is only as
good as your willingness to take action on it. So make a pact with yourself to
become master of your real estate universe. Step up to the plate. That first swing
is yours to take.
Ways to Learn More
CCIM Institute (Certified Commercial Investment Manager)
SIOR (Society of Industrial and Office Realtors)
CRE (Councilors of Real Estate)
NAIOP (National Association of Industrial and Office Properties)
ULI (Urban Land Institute)—a great place to learn about your market and research properties—excellent online glossary of terms
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A forthcoming Rich Dad Advisor book: How to Win in Commercial Real Estate:
Your Guide to Finding, Evaluating, and Purchasing Your First Commercial Prop-
erty in 9 Weeks or Less, by Craig Coppola
One of the premier commercial real estate brokers in the United States,
Craig Coppola has been awarded the Arizona Office Broker of the Year
six times in the past thirteen years by the National Association of Indus-
trial and Office Properties. He has completed more than twenty-five hun-
dred lease and sale transactions over the past twenty-three years, totaling
a value in excess of $2.5 billion. As founding principal of Lee & Associates
Arizona, Craig has earned the top three designations in the real estate industry: CCIM, CRE,
and SIOR. Only thirty-five people worldwide hold all three.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 107
arrett and I share a common love: the love of the game of rugby. Although we
do not remember each other, we played against each other years ago on op-
posing teams at the Monterrey Rugby Festival. He played for the Hastings Rugby
Club of San Francisco, and I played for the Navy/Marine Corps Flight School
team from Pensacola, Florida. Unfortunately, we were not the better team, but it
was a great game.
In 2003, Garrett and I traveled to Sydney, Australia, to watch the Rugby World
Cup. It is in our humble opinion that we witnessed the greatest game of rugby
ever played. It was the final match between England and Australia. For as long as
I live, I will always remember that game and feel honored to have been a spectator
in the stands as we watched England beat Australia in overtime by a score of
twenty to seventeen.
Besides being a rugby player, Garrett is an attorney. He is a very important at-
torney. He specializes in asset protection, which is a vital area of law because in
today’s world there are more attorneys who want to steal your assets than there
are who want to protect them. One of the reasons why Kim and I can sleep soundly
at night is because Garrett is an expert at making sure our assets are protected.
This does not mean we are totally protected. This means Garrett has built legal
firewalls around different assets. It means we might lose one or two properties,
but we will not lose everything.
Garrett SUTTON
10 Rules for Real Estate
Asset Protection
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In today’s litigious world, having a Garrett Sutton on your side is vital for any-
one who wants to grow rich and get a good night’s sleep, too.
—Robert Kiyosaki
s a Rich Dad’s Advisor, one of the questions I am most frequently asked is:
“How can I protect my real estate?”
In answering this key question, a pattern of repetitive follow-up queries al-
ways ensues such that after several years I have been able to distill all of the is-
sues and concerns into what I call the “10 Rules for Protecting Your Real Estate.”
By knowing, following, and implementing these ten rules, you will not only
properly protect your assets, but you will also avoid the many pitfalls placed in
your path by the overpriced asset protection “gurus” and service providers out
there who are more interested in your money than your situation. You will have
the confidence to say “No” to these people because you will know more than
they do.
Your important and easily acquired education lies ahead. Let’s begin.
Rule No. 1: Insurance Is Never a Complete
Asset Protection Strategy
Or: Never let a commissioned salesperson tell you how to protect your assets.
At Rich Dad events around the country I am always confronted by the person
who asserts that his insurance agent has assured him that asset protection is a
hoax and that all that is needed is a good insurance policy. I have to laugh be-
cause there are so many instances of insurance companies failing to cover real
estate investors and others on their coverage policies, that there is a whole area
of law named after the situation. It is called “Bad Faith Litigation,” as in the
bad faith that occurs when insurance companies say they will cover you, collect
your premiums, and then, heaven forbid, a claim arises and they find reasons
not to cover you.
Never forget that insurance companies have an economic incentive not to
cover you. As is clearly obvious, the less they pay out in claims, the more money
they make. Also never forget that insurance agents receive a commission on all
the policies they sell. So when an insurance agent says that all you need is insur-
ance instead of asset protection, please remember where his incentive lies. It is
also important to acknowledge that insurance agents are not licensed to give
legal advice. You would have to question the motives of one who would do so.
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Given my healthy skepticism of the insurance industry, you would think that
I would advocate the exclusive use of asset protection entities without the use
of any insurance at all.
Insurance is the first line of defense when protecting assets. The proper
use of asset protection strategies is this second line of defense.
But to the contrary, I believe that insurance is the first line of defense when
protecting assets. Many insurance companies are forthright in their dealings
and will honor their coverage commitments. Others, with the help of a legal
nudge, will do the right thing. So I always advocate the reasonable use of insur-
ance as a protection strategy. However, because we know that a certain per-
centage of insurance companies will use exclusions and find reasons not to
cover you, you most certainly need another defense mechanism. The proper
use of asset protection strategies is this second line of defense. As we will learn
in this section, asset protection is not difficult or expensive, but it is required if
you are to succeed at building real estate wealth.
Real Life Story: The Plight of “Paul”
client of mine, we’ll call Paul, initially believed in the strident assertions of his
“insurance professional.” Instead of combining insurance with entities for his
Aspen, Colorado, fourplex, he obtained only an insurance policy on the mountain
property. He held title to the fourplex in his individual name.
Despite the 100 percent insurance protection guarantees of his agent, the policy
was very clear that the company would not cover any claims related to an avalanche.
Sure enough, Paul’s fourplex was greatly damaged in a swift and freakish ava-
lanche. The insurance company quite correctly refused to cover the claim. Its policy
expressly excluded avalanche damage.
Paul was furious at his agent who, besides assuring that the pricey policy covered
everything and that no other protection was needed, had never pointed out the
very clear policy exclusions. By relying on his agent and not taking any other pro-
tective steps, all of Paul’s assets were exposed to the avalanche claim.
Paul’s problem was completely avoidable. If he had relied on a team of advisors,
including an asset protection attorney, the situation where a highly commissioned
salesperson got away with giving legal advice would never have occurred.
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Now that we know that insurance alone will not completely protect us, let’s
review further ways to not protect your real estate before we get to the promised
land of beneficial strategies in later rules.
Rule No. 2: The Two Most Common Ways of
Taking Title to Your Real Estate Do Not
Provide Asset Protection
Or: Why to avoid joint tenancies and tenants in common.
It is indeed ironic that the two most common and popular methods of taking ti-
tle to your real estate provide you with the least protection. Joint tenancy is
one of the most popular forms of holding title because it provides for a right of
survivorship. This works such that if one party dies the other joint tenant be-
comes the sole owner by operation of law, meaning it happens automatically.
Joint tenancy is popular with husband and wife couples. If the husband, for ex-
ample, passes away first, then the wife has complete control of the property
without having to go to court or file new deeds.
The problem for real estate investors is twofold. First, joint tenancies offer
no asset protection. Suppose Peter, Paul, and Coco own a sixplex as joint tenants.
If Paul gets sued, his creditor can reach Paul’s joint tenancy interest. Peter and
Coco now have a new partner in the sixplex, most likely someone, who after
suing their friend and barging their way in, they don’t like right off the bat. As
well, this new partner can bring a partition lawsuit to force a sale of the property.
It can get expensive in legal fees and messy in court.
Secondly, the right of survivorship feature that makes joint tenancies easy
and attractive to married couples is the same feature that makes them so scary
and abhorrent to investors. Let’s take another look at the joint tenancy that
holds Peter, Paul, and Coco’s sixplex. Suppose Coco were to die in a fashion in-
dustry disaster. Her interest in the sixplex is automatically terminated. She
can’t pass her interest on to her heirs because Peter and Paul, by operation of
law, are now the two remaining joint tenants on title.
Savvy investors will not invest with you if you propose taking title as joint
tenants. The good ones know that you should never put yourself in a position
where someone will benefit from your demise. That’s what you are doing with
joint tenancies. I will withhold comment on the state of marriage today and
why so many knowledgeable spouses continue to use joint tenancies. But for
investors it is not the right choice.
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Savvy investors will not invest with you if you propose taking title
as joint tenants.
Similarly, but with one exception, taking title as tenants in common is not
the best course, either. Again, there is no asset protection. In our example, if
Peter gets sued, Paul and Coco can find themselves with a new and unwanted
partner. Once again, the partner can bring a partition suit to force a sale of the
property. As well, if there is a lawsuit involving the property (i.e., a tenant sues
over a defective water heater) the individual tenants in common (or individual
joint tenants, for that matter) can be held personally responsible. All of their
personal assets can be exposed to such a claim. Holding title to any property as
individual tenants in common does not make good sense in our very litigious
world. In fact, it can make you more of a target.
The one exception for using tenants in common to hold title is when investors
take their interest not as exposed individuals but with protected entities. In a
TiC situation (“TiC” stands for tenants in common) investors come together
from 1031 exchanges or with investment money to buy a large property. The
large property is held as a tenancy in common with all the various investors
holding their specific TiC interest through a protective entity such as a LLC
(limited liability company).
A chart helps to illustrate:
While I may have let the cat out of the bag (that LLCs are good entities for
real estate), it is my belief that most of you may have already known this. Still,
there are a few more rules involving what not to use before we get to positive
asset protection territory.
The Difference Between Individual Tenants in Common
and Tenants in Common (TiC)
as individual
as individual
Tenants in Common
4 Plex
4 Plex
Outside assets protected from all claimsAll assets personally exposed to all claims
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Rule No. 3: Never Hold Real Estate
in a C Corporation
Or: Fire the professional who even suggests such a thing.
One of the cardinal sins of real estate asset protection is to take title in the name
of a C corporation. While there are certainly advantages to using a C corporation
in business (which are discussed in my Rich Dad’s Advisor book Own Your Own
Corporation) there is a huge disadvantage to using a C corporation for real es-
tate, which can be expressed in one word: taxes.
As you probably know, C corporations face a double tax. You pay taxes once
at the company level and then again when dividends are distributed to share-
holders. With an S corporation, LLC, or LP you pay tax only once at the com-
pany level. A chart graphically illustrates the difference between double
taxation and flow-through taxation.
So what happens when you have a capital gain on the sale of real estate held
by a C corporation? You pay a lot more in taxes.
Consider the situation in which a $500,000 long-term capital gain is realized
on the sale of real estate held for longer than one year.
As the chart on p. 114 indicates, you will pay $144,500 more in federal taxes
by using a C corporation instead of an LLC. Does Uncle Sam want you to use a
C corporation? Of course. Will any investors join your deal if you propose using
a C corporation? Of course not. They’ll know you don’t know what you are do-
ing. Avoid the professional who advises you to use a C corporation to hold any
interest in real estate. They just don’t know what they are doing—to your later
No Entity Tax
Flow-Through Profits
After Tax Profits
Corporate Tax
Taxes Paid Once
Taxes Paid Twice
Taxes Paid Once
Dividends to
Dividends to
LLC, LP, or Sub S
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 113
Avoid the professional who advises you to use a C corporation to hold
any interest in real estate.
We frequently have clients discuss how some asset protection “guru” or other
promoter advised them to set up their structure as follows:
The rationale is that the two pieces of rental property are owned by the LLCs
and each LLC is in turn owned by a C corporation. The gurus will state that all
kinds of deductions can be taken with a C corporation. The problem is that, as
flow-through entities, the profits flow from the LLCs to a double tax C corpo-
ration. You are still in a bad tax position.
If you are intent on using a C corporation in your entity mix (and please be
cautious of promoters who overly tout the supposed glorious benefits of the C
corporation) a better scenario is the following:
4 plex
C Corporation
C Corporation
$500,000 Gain
−170,000 Less 34% corporate tax (35% for larger corporations)
− 49,500 Less 15% tax to shareholder on distributions
$280,500 Amount after tax
$500,000 Gain
− 75,000 Less 15% capital gain tax
$425,000 Amount after tax
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 114
In the structure above, the title-holding LLCs are held by an asset protecting
Wyoming or Nevada LLC, thus providing flow-through taxation throughout
the structure. For those desiring the write-offs of a C corporation, a manage-
ment C corporation is used. Each title-holding LLC pays a management fee to
the corporation so their benefits are obtained. But there is no ownership of real
estate through the C corporation, thus avoiding the double taxation of profits
we had in the first instance.
Please also beware of promoters who would have you set up more entities
than you need. The management corporation may provide some benefits in
later years when there is plenty of cash flow. But at the start, do you really need
one? Probably not. So be very cautious of those promoters who want what is in
their best interest and not yours.
Rule No. 4: Offshore Strategies Do Not
Work for Onshore Real Estate
Or: What have you been smoking?
As you have probably noticed, throughout this chapter and in my other writings
I have found the need to warn against the slick and salesy gurus and promoters
with their incredible claims and come-ons. Certainly some of the most outra-
geous claims come from the offshore promoters who offer tax savings and ab-
solute privacy. Of course, they never mention the existing United States rules
and regulations that do, in fact, run contrary to their claims. In most cases,
these people actually live on small Caribbean Islands or in European principal-
ities beyond the reach of U.S. authorities. They can say what they want.
4 plex
C Corporation
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 115
But as a U.S. citizen, can you afford to listen to those who intentionally mis-
represent U.S. laws? Or course not.
To further your caution, let’s review what can happen when offshore asset
protection is used in attempt to protect U.S. real estate.
Real Life Story: John’s Bad Day
ohn was a doctor in California. He had worked hard and paid his taxes. He owned
a twenty-unit Roseville apartment building free and clear and a significant bro-
kerage account. He felt as if he were doing well, but the combination of the mal-
practice and real estate litigation explosion and the ravenous demands of both the
IRS and California’s notorious state tax collector—the Franchise Tax Board—had
led John down the path of considering offshore options.
A promoter from the Caribbean Island of Nevis held a seminar for doctors and
dentists in John’s hometown. The self-styled asset protection man with glowing
testimonials and advanced degrees from schools John had not heard of, laid out a
comprehensive and seamless case for using Nevis structures to protect assets.
The promoter boldly claimed that by using offshore trusts John could obtain com-
plete privacy and incredible tax savings. His strategy was graphically represented
as follows:
The promoter indicated that John would not have to pay any taxes. Because the
apartment building LLC was owned by the Nevis APT (“asset protection trust”),
profits generated from rents could pass offshore without taxes. The domestic LLC
would simply file zero return. The promoter further stated that insurance was not
needed on the apartment building because it was now in a bulletproof structure. As
well, by moving John’s significant brokerage account into the second APT, profits
could be generated offshore without U.S. or California taxes. Better yet, the monies
could be accessed by John, tax free, into the United States by simply requesting
the Nevis trustee—who received $3,000 a year for the service—wire the money.
Roseville, LLC
20 unit apt. building
Nevis APT, I
Nevis APT II
Offshore brokerage
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 116
John followed the promoter’s advice, paid the $25,000 for setting it all up, and
in the first year his financial condition greatly improved. With his assets offshore
and no onshore taxes paid, he was doing really well. He wondered why everyone
didn’t do this. Then, in one day, two problems arose. He was sued for malpractice
by a patient and a tenant fell at the apartment building.
When the tenant’s claim was made, John informed the claimants that there was
no insurance. When the tenant’s lawyer indicated they would sue anyway, John calmly
replied that the building was owned by a bulletproof offshore asset protection trust.
The lawyer laughed and said John needed to get a local attorney to advise him.
When John did so he learned the bitter truth: You can’t protect U.S. real estate with
offshore entities. The apartment building was located in California and, as such, Cali-
fornia courts had jurisdiction. This was the law in all fifty states. The tenant could bring
a claim against the LLC, and with no insurance in place, the tenant could reach the en-
tire free-and-clear equity in the apartment building. The fact that the LLC was owned
by an offshore APT was of absolutely no consequence and offered zero protection.
John also spoke to his new lawyer about the malpractice claim. As a doctor, John
was sued individually. But he felt protected because his brokerage assets were pri-
vately all held offshore. This was when the second shoe dropped.
The lawyer explained that if John had followed all the tax reporting requirements
associated with offshore entities, a creditor could easily learn what John owned.
John was incredulous. The promoter had assured him that he had bulletproof
privacy and asset protection without the requirement of taxes or even tax reporting.
The lawyer had seen other professionals lured in before. He presented John with
the following chart detailing all the reporting requirements:
IRS Requirement IRS Rule
U.S. persons must report all gratuitous and nongratuitous transfers
to a foreign trust.
Section 6048,
Section 1494
Foreign trusts owned by U.S. persons must file an annual tax return
on IRS Form 3520-A. U.S. persons are subject to a 5% penalty against
the value of offshore assets each year for failure to file.
671 to 679
U.S. persons receiving offshore distributions, whether taxable or
nontaxable, must report them or pay 35% penalty.
Section 6677(a)
Foreign trusts owned by U.S. persons must appoint a U.S. agent so
that the IRS may examine offshore records.
7602 to 7604
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 117
John now realized that everything the promoter said was false. Given the IRS
rules, there was no privacy, no tax savings, and no bulletproof protection. With the
help of his new lawyer, John cleaned up the offshore mess by paying significant IRS
penalties and fees. A demand to the Nevis promoter for the $25,000 John was lured
into paying for worthless strategies and documents went unanswered.
Offshore strategies do not work for onshore real estate.
Rule No. 5: Living Trusts Offer
No Asset Protection
Or: Will you please stop listening to these guys?
Many of you have seen the ads touting the significant benefits of living trusts.
Invariably, one of the great features mentioned is the ability of these trusts to
protect your assets.
While living trusts do offer certain advantages it is very important to clearly
recognize the one benefit they do not offer: asset protection.
Let’s take a closer look.
Primarily used for estate planning, the key benefit of a living trust is to avoid
probate. If you have only a will, or pass without a will, the distribution of your
estate is supervised by a local probate court. The probate process is long and
time consuming and a matter of public record, meaning that anyone can view
the file to see what assets are involved, and perhaps challenge the distribution.
As well, the attorney’s fees awarded for probate proceedings can be quite lu-
crative for the lawyers involved. For example, with a $1 million primary resi-
dence passing through a California probate, the court awards a statutorily set
attorney’s fee of $23,000. An executor is entitled to the same amount. These
fees are due, even if the home is fully encumbered by loans, and thus without
equity to pay the fees.
The solution is to set up a living trust, which is a trust document allowing
you to use an appointed trustee, typically a surviving spouse or other family
member, to distribute your assets without the need for probate court assistance
or review. The several thousand dollars spent on a living trust can easily save
many more thousands of dollars in probate fees.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 118
The living trust also features a great deal
of flexibility. It is a revocable trust, meaning
you can change its terms and/or benefici-
aries at any time. But that also means it
does not offer any asset protection. Because
it can be easily altered, a judgment creditor
can get a court order forcing a transfer of
any property from the trust to the litigation
Despite this factual lack of asset protec-
tion, living trust promoters continue to sell
their services as offering such protection.
When challenged, they will parse and nar-
row their overly broad claims to suggest
that their living trusts help protect against creditor claims because they avoid
the very public probate process. And this is true. But just as deciding not to
sunbathe completely in the nude is not the same as the judicious use of sun-
screen, avoiding a fully public probate is not the same as proper asset protection.
By relying only on the former examples, you are going to get burned.
Real Life Story: Mario’s Mistake
client of mine named Mario came to me after titling all of his assets—his house,
a rental fourplex, and a significant brokerage account—in the name of his living
trust. The formal name for the trust—The Mario T. and Carmen O. Sanchez Revoca-
ble Trust dated June 10, 2004—was given to the county recorder and assessor for
taking title to the two real estate properties. The Smith Barney broker took the
same name for the Sanchez’s brokerage account.
Mario indicated that the seminar promoter who set up his living trust assured
him that his assets were now fully protected. But now he was being sued by a tenant
who fell at the fourplex, and he wanted a second opinion.
It was not pleasant to inform Mario that his assets were not protected. By titling
everything in his living trust’s name, all of his assets were exposed to the tenant’s
When Mario asked if he could re-title everything into a more protective structure,
it was even more difficult to explain that it was now too late to do so. Once you’ve
been sued, or even threatened with suit, it is too late for asset protection.
Sanchez Living Trust
Owns LLC
Owns 4plex
Asset Protection
Probate Avoidance
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 119
The next question clients always have is: How do they combine the benefit of
a living trust’s probate avoidance with the necessity of asset protection? The an-
swer is simple, and it is graphically charted in Figure 6.7: The LLC is on title
with the county recorder as owning the fourplex. We have asset protection at
this level. The living trust owns the membership interests in XYZ, LLC. If both
Mario and Carmen die, the living trust document will dictate who owns the LLC
without the need for court supervision. At this level we have probate avoidance.
You can’t rely on the LLC for probate avoidance, and you can never
count on the living trust for asset protection, but in concert you can get both.
Properly structured LLCs and living trusts work well together and comple-
ment each other. You can’t rely on the LLC for probate avoidance, and you can
never count on the living trust for asset protection, but in concert you can get
Rule No. 6: Land Trusts Offer Privacy
But Not Asset Protection
Or: Why privacy is not enough.
For many of the same reasons a living trust offers no asset protection, neither
does a land trust offer asset protection. In fact, a land trust is very similar to a
living trust. In both, you are transferring assets to a trust administered by a
trustee for your benefit.
According to the seminar promoters, the big benefit of a land trust is its pri-
vacy. By using a trustee other than yourself, your name can be kept off the chain
of title and public records. And while privacy is a good thing in this day and age,
it is not a perfect substitute for asset protection.
It is important to understand the structure of a
land trust in order to appreciate why asset pro-
tection is not inherent.
In our chart, Joe is identified on public records
as being the trustee, but Jane, as beneficiary, is not
anywhere identified. In this manner, privacy can
be achieved.
But the land trust, like the living trust, does not
protect Jane. If there is a lawsuit involving the
fourplex, a judgment rendered is against the ben-
Land Trust
owns 4 plex
Jane, an individual
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 120
eficiary. If Jane, as an individual, is the beneficiary, then any judgment is against
her personally, and all of her personally held assets are exposed.
There are two better ways to handle it. In example A, we show the beneficiary
to be an LLC.
In this way, a judgment attained against the beneficiary is rendered against a
limited liability entity. James’s personal assets are not exposed.
Of course, this structure entails setting up two structures—the land trust and
the LLC—as well as paying the trustee to serve every year. The same asset pro-
tection is attained by just setting up one entity, the LLC, as in example B.
If privacy is important you can certainly have the manager of the
LLC be a nominee, a person other than yourself.
If privacy is important you can certainly have the manager of the LLC be a
nominee, a person other than yourself. Our firm charges $650 a year for this
service. Others may charge more or less. But in this way you can achieve asset
protection and privacy, without the need to set up a land trust.
Rule No. 7: LLCs and LPs Are Excellent Asset
Protection Entities
Or: Why you want the charging order.
So, finally at rule seven we are getting to the good stuff. But as I mentioned,
there is so much misinformation out there that I felt it was important to first
dispel the myths and outright lies. With all that completed, I can now state that
LLCs and LPs offer excellent asset protection via the charging order.
Before reviewing the charging order, the difference between LLCs and LPs
must be explained. With an LP you must have at least one general partner and
ABC Land Trust
owns 4 plex
James’s LLC Beneficiary
Joe, Trustee
James’s LLC
owns 4 plex
Example A Example B
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 121
one limited partner. The general partner, if an individual, is personally respon-
sible for the LP’s activities. To encapsulate that unlimited liability you must
form a limited liability entity—a corporation or an LLC—to be the general part-
ner. While you are now fully protected, it is important to remember that you
have had to form two entities: first, the LP, and then second, a corporation or
LLC to be the general partner of the LP. With the LLC you need to form only
one entity, the LLC. Everyone is protected within the LLC. While LPs certainly
have their place, due to the need for only one entity instead of two, we shall use
the LLC example from here on out.
When it comes to protecting your real estate, we must also distinguish be-
tween attacks. A chart helps to explain:
In Attack No. 1, a tenant sues the LLC over a broken stairway. If successful,
the tenant can get what is inside the LLC—the fourplex—subject to any deeds
of trusts against the property.
But if the tenant can get the equity in the property, you ask, why even bother
with an LLC? Because without the LLC, the tenant could get everything John
owns—his house and bank account and everything else. The LLC limits the ten-
ant to just what’s in the LLC and shields your outside assets from attack.
In Attack No. 2, John gets in a car wreck, his insurance company won’t cover
him, and a judgment creditor (the person who won in court; we’ll call him Nate)
is seeking to get paid. Because the car wreck had nothing to do with the real es-
tate, Nate, the judgment creditor, can’t sue John’s LLC directly. Instead, Nate
must go after John’s membership interest in the LLC.
This is where the charging order comes into play. The charging order rule
provides that Nate can’t take possession of John’s membership interest, his own-
ership in the LLC. If Nate could, he could then sell the fourplex and get paid.
(And please note, this is what can happen with a corporation. The judgment cred-
itor gets the shares and takes control and sells all the corporate assets. Nevada, to
date, is the only state that has extended charging order protections to corporate
shares in corporations with between two and seventy-five shareholders.)
John, Member
John’s LLC
4 plex
Attack #1
Attack #2
Car Wreck
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 122
The charging order instead allows Nate to stand in John’s shoes as a member
and receive distributions.
But what if no distributions are made? Then Nate gets nothing. He has to
wait to be paid. But what if money is made, there are taxes due, but no money is
distributed to even pay the taxes? This is called phantom income, and is frus-
trating to creditors. Under the charging order, Nate is standing in John’s shoes.
So he must pay the taxes on money he did not receive.
Most people do not want to be put in this position, which is why the proper
use of LLCs and LPs is an excellent deterrent to frivolous litigation. Not many
people want to fight it out in court to not receive any money and have to pay
taxes on the money they didn’t receive. Using LLCs and LPs can be an aid in
settlement discussions. They can even prevent a lawsuit from being filed in the
first place.
Using LLCs and LPs can be an aid in settlement discussions. They can
even prevent a lawsuit from being filed in the first place.
Charging order rules vary from state to state. Nevada and Wyoming have the
strongest laws. In those states, the exclusive creditor remedy is the charging
order. California has the weakest law. There are two California court cases al-
lowing creditors to pierce through and sell off LLC and LP assets to pay the
So if you are going to buy property in California or one of the many other
states with weak asset protection laws (including Georgia), you have the choice
of setting up your LLC or LP in the state where the property is located or form-
ing in Nevada or Wyoming, and then qualifying in the state where the property
is located. The process of qualifying involves submitting, for example, the
Wyoming LLC papers and appropriate fees to the California secretary of state’s
office. If properly done it is always granted and keeps you within the law.
But the benefit is that if you get sued as in Attack No. 2, Wyoming or Nevada
law applies, not California law. A judgment creditor has to hire a Wyoming or
Nevada lawyer to fight a very uphill battle. This is what you want: a very strong
reason for predators to leave you alone.
More information on this is found in my book, How to Use Limited Liability
Companies and Limited Partnerships (SuccessDNA, 2009).
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 123
Rule No. 8: Segregation of Assets Is Good
Or: Let’s not put all of our eggs in one basket.
Since we’ve learned that LLCs and LPs are good entities for holding and pro-
tecting our real estate, the question then becomes: How many properties do I
put in each entity?
This is a judgment call on your part. But consider these scenarios involving
Liz, who owns twelve properties:
In Scenario 1, if a tenant sues over a problem at one property, the other eleven
properties are exposed to the attack. In Scenario 2, with three properties in
each LLC, only two additional properties are exposed if Liz is sued. Of course,
in Scenario 3 with only one property in each LLC, only one property is exposed.
I would never suggest a client hold twelve properties in one LLC. With that
many properties, your LLC is a rich target. In my experience, most of my clients
12 properties
Scenario #1
3 properties
3 properties
3 properties
3 properties
Scenario #2
1 property
1 property
1 property
1 property
1 property
1 property
1 property
1 property
1 property
1 property
1 property
1 property
Scenario #3
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 124
choose somewhere between Scenario 2 and 3. As is evident, the best asset pro-
tection is obtained through Scenario 3. Only one property is exposed to any one
But some clients don’t want to pay the one time initial set-up fees and con-
tinuing annual fees for twelve entities. In a state like California, where the an-
nual fee is $800 per entity, $9,600 a year for twelve entities is rather daunting.
So the choice of using one LLC to hold three properties is an option. It is your
call. But once again, the fewer properties you hold in each entity, the better
protected you will be.
Due to these issues, a new type of LLC is being touted to help reduce the
number of LLCs you need to form, called the “Series LLC.” Unfortunately, I
cannot recommend this new creature. It attempts to place separate properties
into separate series under one LLC, as follows:
The supposed benefit is that by setting up one LLC you can independently
protect two properties. The idea is that within the Series LLC there is an inter-
nal liabilities shield whereby a claim against the duplex in Series 1 does not
affect the fourplex in Series 2. The problem is there is no guidance whether or
not this supposed internal liability shield will be upheld. There are no court
cases in the subject, and conceptually the strategy may be difficult for a court
to uphold. Can two properties in the same state-chartered entity be protected
from each other? As well, what if one series goes bankrupt? Will the other series
be protected? No one knows.
The California tax authorities (the very aggressive Franchise Tax Board)
have their opinion. If you are going to try and set up one series to hold two
properties, they are going to charge you $800 per series, the same as if you had
set up two separate LLCs to begin with.
Of course, by setting up two separate LLCs you have the certainty of sepa-
rateness, rather than hoping that someday a court will miraculously rule that
Series #1
Series #2
Series LLC
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 125
the muddled and imperfect concept of an internal liability shield actually makes
Stay away from promoters who would put you into this untested entity
called the Series LLC.
Interestingly, the American Bar Association brought together the nation’s
brightest lawyers to review LLC developments. After looking at the Series LLC
they declined to endorse the whole concept. Stay away from promoters who
would put you into this untested entity called the Series LLC.
Rule No. 9: Transfer Title into Your Entity
Or: What’s the point if you don’t?
All right, so you have set up one or more LLCs to protect your real estate. You
have the articles properly filed with the state. You have approved and signed
the operating agreement governing how the LLC will run. You have signed the
minutes of the first meeting and issued the membership certificates. All the im-
portant documents are in one binder in a safe place.
And remember, if all these steps are not taken, you are not ready. Beware of
promoters who will sell you the articles for just $99 but will not provide you
with an operating agreement, meeting minutes, and membership certificates.
Our firm charges $695 (or less if you are with Rich Dad) plus state filing fees
for the complete package—binder and all—with all your documents prepared
and finalized according to your specific needs, along with live phone support
through the whole process. You have the certainty of knowing that everything
is in order.
You’ve formed the asset protection entity. The next step is to transfer
title to the property into the LLC.
So assuming that everything is in order, now what?
Just because you have your asset protection entity in place, are your real es-
tate assets now protected? No, not yet. You must take the next step, which is to
transfer title to the property into the name of the LLC.
You must prepare a grant deed transferring ownership of your fourplex, for
example, from John Jones, as an individual, to the Jones Real Estate, LLC.
Several questions arise during this process.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 126
First, is this a taxable event? Will the IRS or my state taxing authority assess
taxes when this happens? The answer is no. This is not a sale of the property—
you are not receiving any money in this transaction. Instead, it is a transfer. You
are transferring the property from yourself (as an individual) to yourself (your
new 100-percent-owned LLC).
The property goes into the LLC at its basis, which is the amount you paid for
the property originally. That basis, for tax purposes, remains the same once the
property is in the LLC. So, for example, if you paid $250,000 for your fourplex,
the basis of $250,000 remains once it is titled in the LLC’s name. There is no
gain in the transaction, and with no gain there are no capital gain or ordinary
income taxes.
If John Jones added new members (owners) into Jones Real Estate, LLC be-
fore or after the transfer, there could be a taxable event. Be sure to consult with
your advisors prior to any change in ownership.
The next question is: Are there any transfer taxes? The answer is: It depends.
Transfer taxes, a tax based upon the value of the property being transferred,
vary from state to state. Many states have an exception to their transfer taxes.
If you are transferring the property from yourself as an individual to yourself
as an LLC, there is no tax. Check with your local advisors to understand your
local rules.
Some states are very tricky, though. In Nevada, you are free to transfer title
into your LLC. But if you transfer it from the LLC back to yourself there is a
transfer tax. This situation occurs when you are refinancing and the lender
wants title to be in your name when the new first deed of trust attaches. Resist
the lender’s attempts to require this. He will argue that he doesn’t have security
if title is in the LLC. That is nonsense. With title in the LLC, he will have your
personal guarantee for the loan and a first deed of trust against the property,
the same as if it was in your individual name. He is equally protected in either
situation. Seek out lenders who are enlightened as to asset protection. They do
One state is very costly when it comes to transfer taxes. Pennsylvania charges
a 2 percent tax on the value of the property. So if you have a million dollar property
Jones Real Estate, LLC
John Jones,
An individual
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 127
with a mortgage of $950,000, you will still pay $20,000 (2 percent of $1 million)
for the privilege of holding title in the name of your LLC. Ouch.
The best course in all of this is to take title in the name of your LLC when
you first buy the property. With title in the proper entity at the start there is no
need for a later transfer, thus no issue of transfer taxes. There are lenders who
will let you take title at closing in the name of the LLC (or your LP). You can
view the Web site for more information.
Speaking of banks and lenders, the next questions is: Will they call the loan
if I transfer title? In dealing with clients, I have heard numerous times about
the attitude of lenders regarding transferring title into an LLC. In their reptilian
mind-set, they feel as if you are trying to hide assets from them and deny them
their due. Of course, as mentioned, if the lender has your personal guarantee
and a first deed of trust on the property, he is protected whether it is in your
name or the LLC’s name.
But that logic is lost on the functionaries at most lenders. They will argue
that if you make the transfer they will enforce the due-on-sale clause, which
states that the loan is due when you sell the property. Of course you haven’t
sold the property; you transferred it to yourself.
So what do you do?
In my experience it comes down to: Is it better to ask for permission or for-
giveness? If you ask most lenders, as if by reflex, they will say no. But if you just
go ahead and make the transfer without asking you can always say you are sorry
later. The chances are good you will never have such a conversation. In my
dealings, the lenders have never called a note. Will you be the first one? I don’t
know. But as long as you keep making the monthly payments, there is a very
good chance that they are not going to call the loan. Why would they want to
create such trouble for themselves, especially when they are being paid? If in
some bizarre case they do, refinance with a lender comfortable with LLCs. It’s
not as if you are going to lose your property if they call the note.
But some of you may be overly cautious in this realm, which is fine. If you
are willing to spend a little more money, there is another way to skin the cat.
Federal law holds that a lender can’t prevent you from transferring title from
your individual name to your living trust. Land trusts look like, and can be
named like, a living trust. So by forming a land trust and transferring title into
it, you may be able to accomplish your goals.
The extra money involved is the preparation of a land trust. Our firm charges
$395 for such a document; others may charge more or less. But remember, as
discussed in Rules 5 and 6, neither land trusts nor living trusts offer asset pro-
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 128
tection. So when utilizing this strategy you still need to form that LLC and
name the LLC as beneficiary of the land trust.
With the title transferred to the land trust and an LLC as beneficiary of the
land trust you may be able to get the protection you need without irrational
lender interference.
The only group you do need to notify when you transfer title is your insurance
company. It needs to know the policy is in your LLC name and not in your per-
sonal name. Otherwise, and this does happen, your friendly insurance company
may claim it was insuring you as an individual, not your LLC, and use that as an
excuse to deny any coverage in the event of a problem at the property. And
while the insurance company may notify the lender of the change in insureds,
that usually does not lead to due-on-sale threats.
A final question always arises as to why to use a grant deed instead of a quit
claim deed to transfer the title. A quit claim deed merely transfers everything
you claim you may own to the next party. A grant deed is a much more affirma-
tive grant of property rights. As such, in many cases, title insurance coverage
flows to the next party with a grant deed. Since you are essentially transferring
property from yourself to yourself, it makes sense to give yourself the most
complete rights you can. Use a grant deed.
Rule No. 10: Don’t Set Up More
Entities Than Necessary
Or: Beware of promoters telling you otherwise.
Several years ago I was at a real estate event in San Francisco. A lady approached
me after hearing my speech, in which I argued that people should not go over-
board and set up more entities than are needed.
I was shocked by her story.
Jane was looking to invest in her first duplex. She had previously attended a
seminar on asset protection given by a self-styled asset protection guru. The
seminar had been sponsored by a local real estate organization. She trusted that
the group would provide her only with competent service providers.
The asset protection guy indicated that she needed the following structure
for protection: (See Figure 6.14.)
Jane stated that the man convinced her that for the necessary protection she:
1.Needed the LP to hold her LLC. The LP was then, in turn, owned by the Ne-
vada Asset Protection Trust and the Offshore Asset Protection Trust. These
structures gave her extra layers of protection.
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 129
2.Needed an S corporation to manage the LP in order to achieve necessary as-
set protection.
3.Needed the C corporation to manage the LLC in order to achieve significant
tax savings.
The cost of this structure was $20,000. The annual fees were more than $5,000
to maintain all the entities. Jane was in tears because after spending such a
large sum of money for asset protection, she no longer had enough money for
the down payment on her duplex.
I told her the truth. She had spent way too much money. The asset protection
man’s arguments were false. Extra layers of entities do not necessarily provide
extra layers of protection. If you aren’t making any money yet, you don’t really
need a C corporation to save on taxes. The structure they created was designed
for their profit, not her needs. Jane asked me to give her a chart of what she
needed to protect her duplex. It took five seconds to chart her strategy:
Holds Duplex
C Corporation
Co./Tax Savings
S Corporation
General Partner
of L.P.
Holds Duplex
Limited Partnership
Holds LLC interest
Nevada Asset
Protection Trust
Offshore Asset
Protection Trust
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 130
Jane was in shock. She asked how the local real estate group promoter, a
person she trusted, could let such a snake in the door to present to them. I told
her something that was an open secret in that business. The local promoter in
many cases receives 50 percent of what the service provider sells. As such, there
is a powerful economic incentive for local promoters to tout the value, integrity,
and importance of the service provider, as well as the urgent need for the serv-
ices offered. In Jane’s case, the local promoter may have made as much as
$10,000 for doing so.
Jane calculated that fifteen people had signed up for all this and figured the
promoter must have cleared a total of $150,000 at the one asset protection event.
She was furious and sickened by what had happened. She vowed never to invest
in real estate. I tried to counsel her but could not. She had gone through a hor-
rible experience and was adamant that her decision was final.
Do not let Jane’s experience be yours. Real estate is an excellent way to build
wealth, but at some points during your journey you will need to be able to nav-
igate through shark-infested waters.
Important Tips
• Engage in critical thinking.
• Ask yourself if the “expert” really is such an expert.
• Ask yourself if the services are for your legal benefit or the expert’s financial
• Use healthy skepticism and old-fashioned due diligence.
• Check around, and don’t bite at the first supposedly “discounted” offer.
These tips will work out to your advantage.
That said, asset protection, as we have seen, is important. You want to take
the necessary steps to protect your real estate assets and your financial future.
The correct use of entities will greatly assist you in achieving this goal.
Remember, asset protection is neither overly difficult nor outrageously ex-
pensive. And with critical thinking, never allow someone to tell you it is.
Good luck in all your asset-protected real estate investing.
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Where to Learn More
Garrett Sutton is a Rich Dad’s Advisor and is the author of Own Your
Own Corporation, The ABC’s of Getting Out of Debt, The ABC’s of Writing
Winning Business Plans, and How to Buy and Sell a Business. He is also
the co-author of Real Estate Advantages. Garrett is an attorney with more
than twenty-five years experience in assisting individuals and businesses
to determine their appropriate corporate structure, limit their liability,
protect their assets, and advance their financial, personal, and credit success goals. He has
been featured in the Wall Street Journal and the New York Times, among others. His firm,
Sutton Law Center, has offices in Reno, Nevada; Jackson Hole, Wyoming; and Rocklin, Cali-
fornia, and accepts new clients at (800) 700-1430.
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his book is called The Real Book of Real Estate because the people I chose to
be a part of it are real-life real estate investors. They are not people who just
teach real estate and make their money teaching. Wayne like the others who I
asked to be part of this book, makes his money doing what he teaches. He is one of
the best real estate investors and one of the best finance guys I know. He is, like all
of the advisors in this book, doing his own deals while teaching others how to be
rich using the same methods and formulas he uses himself. I am always leery of
people who give advice and say, “Trust me.” Then they don’t do what they are
telling me to do. Those are not the kind of teachers I want around me. And they
are not the kind of teachers who are in this book. This book is real people and real-
life real estate strategies that they use to build wealth.
One of the things I like most about Wayne is how his brain goes into overdrive
whenever he sees a roadblock in the way of his or one of his client’s goals. When it
comes to finance, nothing stops Wayne’s creative mind. Obstacles become excuses
for Wayne to find innovative ways to get around them.
Wayne is an excellent teacher, and he has taught me more through example
and through the deals we do together than even he probably knows. He can take
things that are very complex and make them simple so that I can understand
Of Marbles and Capital
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them. When I first met Wayne, I could tell from the way he talked and the way he
carried himself that he spoke from years of experience, successes, and failures.
Life is the best teacher, and that’s why Wayne’s chapters and the others in this
book are so powerful. They are full of stories and experiences that are entertaining
and educational. Education should be fun. If it isn’t, I’m not interested. Wayne is
a great communicator. He has a way of telling a story and teaching a lesson that
keeps you wanting more. Read this chapter, and you’ll see what I mean.
—Robert Kiyosaki
n the bookshelf opposite the desk in my office sits an antique jar filled
with marbles. It is there to remind me of the importance of capital. As a
fourth grader, I didn’t call it capital, and I surely didn’t realize the role that
capital plays in business. I just knew I wanted to play marbles with the other
kids, and I couldn’t get in the game unless I owned some marbles, or at least
one marble.
Coming from a family of modest means, it was out of the question to ask for
money for marbles. I accepted that I should expect only a few new toys on my
birthday and on Christmas. If I didn’t take care of the toys I received twice a
year, I would go without or make my own. I made trucks out of scrap lumber,
bows and arrows out of whittled sticks, and forts out of haystacks, but I could
think of no way to make a marble. Every day I watched with envy as other boys,
and a few bold girls, played with those flashing glass spheres on the playground.
I studied their techniques and strategies. I ached to get in the game. I had a
plan as to how I would approach the game if I could find a way to play, but I
was locked out. I had no “taw.”
Where I come from, a taw is that one precious marble that each player selects
in order to play with the greatest skill. It is the perfect weight. It fits the thumb
just so. It is the single marble out of the entire bag that the player feels will give
him or her the greatest advantage in a particular game. I knew if I could just
find a taw, I could get in the game.
“FIND A TAW!” That was it! I suddenly remembered playing along the side
of our home as a five-year-old. While digging in the dirt to build roads for my
toy cars, I had unearthed a white marble. Having no value to me at the time, I
left it lying in my diggings where I had found it. I wondered if it was still there.
I rushed to the barn and grabbed a shovel. I turned up the dirt and carefully
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 134
chopped through the overturned earth to loosen it. I got down on my hands
and knees and sifted through the soil with a spoon. After a few minutes of min-
ing, I felt and heard a click on the end of the spoon. My heart jumped into my
throat. I felt a burst of excitement tingling in my temples. I brushed back the
soil, and there it was—a somewhat dirty, but perfectly formed, ivory-colored
Something shifted within me at that moment. I felt a rush of freedom and
opportunity. I was wild with excitement that I could finally get in the game on
the playground. It was as if I had come of age or had been declared worthy to
be a real boy. The doors to my future opened wide. I was prepared to be a marble
master, or so I thought. Owning my own taw became a right of passage for me.
Suddenly, my jubilation was cut short by a flood of fears that crowded my
thoughts. In every game of marbles, like battles in a war, someone wins and
someone loses. What if I lose my only marble? Where will I find another one?
Who am I to think I could win when the other kids have been playing for
months or years? What if I get totally embarrassed? What if I start crying right
there in front of the toughest guys and the bravest girls? What will they say
about me? What if they make fun of me? I was petrified.
As I clutched the marble in my hand, I realized how critical it was to my
game and yet knew I couldn’t play without risking it. Finally, I decided that if I
must take the chance, I would take the smallest risk possible. I would challenge
someone of the lowest skill level. Because I had been watching others play mar-
bles for months, I knew who the champions were and who to avoid. Even if
they called me out and teased me for being too chicken to play them, I would
refuse to risk my taw on a game I couldn’t win. I would play to win by carefully
choosing the first games I entered and the opponents I faced.
I took my chances and got in the game. By the end of fourth grade, my shoot-
ing skills had improved considerably. I dared to play anyone in the school under
the right conditions, and I had a gallon can full of marbles as proof of my
progress. They were treasure to me. Each one held a memory, and each had a
story of how it had been won. I kept my original white taw safely in a smaller
pouch to remind me of how far I had come. It was no longer my best marble for
play, but would always be my favorite, for sentimental reasons.
Sometimes when I teach seminars, I ask which of the attendees consider
themselves to be capitalists. Almost every hand in the room goes up. Then I ask
how many have capital. Most of the hands go down. To play in the game of cap-
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 135
italism, one must own or control some capital. Like marbles, capital is the “taw”
that allows us to play the game. Raising capital is a vital skill for anyone who
wants to get out of the rat race, as taught by the Rich Dad CASHFLOW game.
Louis Kelso, the father of the Employee Stock Option Plan in the
United States said, “The right to life implies the right to earn a good income.
When 90 percent of the goods and services are produced by capital workers—
people who own capital—as it is in an industrial society like ours, you can’t
earn a good income without owning capital.”
Robert Kiyosaki expressed the same principle in one of the Rich Dad business
schools, showing the hierarchy of the economic food chain:
You may notice that those who work for money are on the bottom of the
food chain. They get only crumbs, after everyone else has taken the best returns.
Also notice that the capitalists are at the top of the food chain. Everyone works
for the capitalists. Capitalists fund all enterprises. The capitalists own and con-
trol the majority of the wealth. The biggest returns, the best leverage, and the
greatest tax advantages go to the capitalists. The capitalists are also those who
take the biggest risks. Still, given a choice, why would anyone want to remain
an employee, rather than becoming a capitalist?
Working for money is an arduous way to move up the economic food chain.
If you continue to work only for money you will never escape the trap of the rat
race. What is the key to economic freedom? It is the ownership or control of
Investment Bankers
Mutual Funds
9781593155322_1:real estate_new 3/25/09 4:04 PM Page 136
capital. If you want to be a capitalist instead of an employee, capital is the key.
Capital is your taw. It empowers you to leverage and move ahead faster.
So how does someone who has no capital get started? Where do you go to
get your first marble?
There are three basic ways:
1.Save it from your earnings
2.Borrow it from someone else
3.Trade ownership (equity) for capital
Let’s look at each of these methods in more detail.
Accumulating seed capital by saving money is the long, hard way to get your
taw, but it has been proven viable by fledgling capitalists since ancient times. In
his classic book The Richest Man in Babylon, George S. Clason shares a fable
that clearly shows how one can go from the Rich Dad E quadrant (employee)
to the S quadrant (specialist/self-employed), and even to the I quadrant (in-
vestor), by frugality and sacrifice. In America and other capitalist countries,
immigrants prove over and over again that by working hard—sometimes even
for subsistence wages—and by saving part of what they earn, individuals or
families can rise quickly to capital ownership and wealth. Setting aside a portion
of one’s labor to accumulate an initial capital stake is within everyone’s reach,
just as I employed my own labor to dig in the dirt until I found my first marble.
However, no matter how much capital you acquire by your own labor, your
earnings will always be limited by the hours you can spend at work. Using only
the capital you can save from your own earnings means that you will be severely
restricted in growth and income.
FIGURE 7.2 Rich Dad CASHFLOW® Quadrant
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Back in fourth grade, I may have been able to get into a game of marbles sooner
if I had thought to borrow a taw from someone else. But how would I have re-
paid the debt if I had lost? These are the kinds of risks we must consider when
borrowing capital as well. As my grandpa Palmer used to say, “Any damn fool
can run into debt, but everyone will crawl out!” In other words, it is easy to go
into debt, but not usually so easy to get back out. Borrowing money has conse-
quences, and it is wise to fully consider those consequences before signing for
the debt. Under most market conditions, borrowing money is relatively easy
for strong investors with viable collateral. Paying it back as agreed will deter-
mine the true nature of your character and business skills. If you become good
at taking care of Other People’s Money (OPM), you will likely have plenty of
capital with which to pursue your investment opportunities.
Bad deals chase the money, while the money chases good ones.
The term OPM has become a popular acronym for the concept of raising
capital. OPM can refer to borrowed capital as well as equity capital. It is some-
times spoken of with reckless abandon, as though getting others to back your
idea is as easy as asking. As simple as some might make it appear, there are
proven guidelines and important legalities for qualifying yourself and your proj-
ect to attract the capital of others. I have often heard this said by lenders: “Bad
deals chase the money, while the money chases good ones.” In the end, how
successful you are at borrowing will be largely determined by the answers to
these two questions:
1.How viable is the opportunity?
2.How clear, concise, complete, compelling, and convincing is the communi-
cation contained in your loan package?
Let’s consider these questions one at a time.
Viable Opportunity
First and foremost, what you propose must be viable—it must make sense. How
do we define a viable opportunity? It is something that the average lender could
look at and say, “Wow, I believe that will work.” The projections of profit are
based on reasonably probable outcomes, not on pie-in-the-sky dreams. The as-
sumptions that lead to the bottom line are in harmony with the way things
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work in the real world. The outcome is not dependent upon anyone turning
back the tides or walking on water or otherwise doing things that mere humans
have never done before. More importantly, the lender must believe that you can
do it. Just because Donald Trump did it doesn’t mean the average Joe can pull
it off. The outcome must be highly likely, given the skills, experience, and re-
sources of your team. Above all, it must be economic, which means it must
make money. Why else would a lender risk capital on your idea?
Loan Package
Two of our companies do real estate lending. As lenders, we see and hear dozens
of loan requests each week. Not long ago I received an e-mail from a would-be
borrower that consisted of merely six line items, each with a large number at
the end of the line, all totaling $2.44 million. There was nothing else in the e-
mail. No borrower information, no outline of the ownership entity, no informa-
tion about the structure of the proposed loan, no indication of the value of the
properties that were to be pledged as collateral. Frankly, such a proposal is an
insult to a lender. Underwriters rarely have enough time to sort through the
mountains of paper and electronic packages that end up on their desks each
day. To have borrowers suppose that, as a lender, I am going to hold their hand,
do their work for them, beg for the documents that are needed to underwrite
the loan, or spend hours on the phone with them, educating them in the busi-
ness of borrowing, communicates to me only how naïve, or perhaps lazy, the
borrower must be. We do not risk our capital on naïve or lazy people. We prefer
hardworking, well-informed, and experienced borrowers. They have a better
track record of paying us back. To avoid making a complete fool of yourself,
wasting everyone’s time, and killing your chances of getting a loan, take the
time to compile a complete and easy-to-read loan package. In other words, be
How to Prepare a Loan Package
At a minimum, a good commercial real estate loan package includes the follow-
ing twelve items:
1.A brief Executive Summary: This is a one-page concise summary of the
loan request in outline form. An executive summary typically includes:
a. Name and contact information of the borrower;
b. A description of the collateral property (address, type, age);
c. The requested loan amount; and
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d. The proposed terms of the loan (loan to value, interest rate, maturity
date, and balloon or call date, if any).
2.A Table of Contents for the remainder of the package: This allows the
Lender to quickly and conveniently find any information that may be of in-
terest without reading the entire binder. It is also in your best interest to in-
sert tabs at the front of each section to make the package easy to navigate.
The more convenient it is to access the information, the more likely it is that
your loan proposal will receive full consideration.
3.Maps: Include in the map section a state map, a city map, and a plat map of
the subject property/site.
4.Photos: Include a small group of pictures that give a good idea of the prop-
erty, its condition, and a sense of the neighborhood.
5.Appraisal: If you’ve had a professional appraisal done on the property, in-
clude the full document, or at a minimum, the summary pages. If there is no
appraisal, provide some estimation of value, based on cost, comparative mar-
ket analysis, or a list of comparable sales in the marketplace.
6.Environmental Study: Because environmental contamination is almost al-
ways an automatic deal killer, it is in your best interest to pay for a Phase One
Environmental Report and include it in the package. Such reports are com-
piled by environmental engineering firms. The only exception may be when
the property is known to have had zero exposure to contaminants, such as
might likely be the case with raw farm land or mountaintop property.
7.Operating Statement and/or Projections (“Pro forma”): The operating
statement sets forth the historic annual income and expenses on the prop-
erty, usually for the past two to three years. This is one of the most important
parts of the package so take extra care to make sure you compile and report
this information accurately. Perhaps nothing will destroy the credibility of
your proposal faster than a misstatement of the income or expenses on the
property. The Pro forma is a projection of future income and expenses related
to the property. An inaccurate or incomplete Pro forma is evidence that you,
the borrower, have not entirely thought through the financial future of the
project. That will likely result in the loan being declined.
8.Borrower Financial Information and Credit: This section will typically in-
clude the balance sheets and income statements on you, the borrower, and
Guarantors, as well as tax returns for the prior two years. Each borrower
and Guarantor will likely be required to submit a credit report or allow the
lender to pull one.
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9.Management Experience: Make sure that you have a person on your team
with the experience to manage the kind of project you are proposing. Include
in the loan package a copy of his or her résumé or professional qualifications
and experience.
10.Use of Funds Statement: The use of funds statement is a one-page (or less)
description of how you will use the borrowed funds. If the proposed loan is
intended to be a purchase money mortgage, which is a term used to describe
any mortgage that is taken out to pay for a property at the time of purchase,
also include a statement of the source of the down payment.
11.Title Report: Provide a title report on the property from a local title com-
pany. Such a report is generally called a PR (Preliminary Report) or a Title
12.Ask in advance about any submission guidelines your lender might have
and if he would prefer to have you submit your package electronically or in
hard copy.
Perhaps most importantly, once your loan is approved and closed, pay it back
on time. Nothing will enhance your status with lenders or do more to encourage
additional funding of your investments than precise performance on your part.
I relish the comment Lee Iacocca made when he was chairman of Chrysler
Corporation. He said, “We borrow money the old-fashioned way; we pay it
Raising equity capital is another matter altogether. First of all, there are very
stringent securities laws that govern the raising of capital. Do not start soliciting
funds for your business without consulting a good lawyer to make sure you are
within legal guidelines. The penalties for breaking securities laws can be severe.
Whereas lenders primarily look at collateral values, cash flows, and the
strength of the borrower to repay his loans, venture capitalists who may con-
sider investing in your enterprise additionally look to management expertise
and a solid business plan. Raising capital for real estate can take on elements of
both borrowing and venture capital. When others approach me to be their po-
tential joint venture partner, I want to see all of the information contained in
the loan packaging above. Additionally, I must also be satisfied concerning the
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Who is providing what to the venture? A real estate investment is made up
of two basic parts: money and management. Who will provide the money
and in what increments? And who will do the work of managing the project?
Some investments require more money than work, and some require more
work than money. Our companies generally negotiate to provide debt or eq-
uity. We may also sometimes choose to structure a combination of both. As
equity investors, or venture capitalists, we will require our potential partners
to answer these questions:
• How much capital are we being asked to risk?
• For how long will it be at risk?
• Will our rate of return be based on an interest rate paid periodically, with an
equity kicker in the end, or will it be based solely on the upside equity and
cash flow?
What management skills are required to protect the capital and deliver the
projected returns?
• Does anyone on the team possess these skills or will they be contracted from
outside of the ownership group?
• How much of our time and expertise will be required?
How will those who contribute their time to the project be compensated?
Will they receive money or additional equity in the property?
What is the order of priority for each team member in the disbursement of
funds? Most of the time, a venture is structured to first pay expenses, includ-
ing interest and personnel costs; second, the costs of sale; third, a payment
of the remaining principal balance on the debt; fourth, a return of the initial
joint venture (equity) capital; and finally, the disbursement of profits to each
partner at the pre-agreed percentages. As sponsors of an opportunity, we
sometimes agree to disburse profits to our money partners as a first priority,
until they have achieved a predetermined rate of return, with remaining
profits going to ourselves or to the group at large.
A Word About Legal Compliance
I have learned just enough about securities laws to know that they are compli-
cated, diverse, and generally unforgiving. Inasmuch as I am not qualified or
willing to give anyone legal advice, the only guidance I will venture to suggest
is this: Make sure you get competent legal counsel if you are going to ask anyone
else to participate in your projects with you. Do not underestimate the serious-
ness of even unintentional violations of securities regulations. The Securities
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and Exchange Commission (SEC) is the regulator of securities issues on the
federal level in the United States. Each state also has wide-ranging, and some-
times peculiar regulations for the issuance and governance of securities within
its respective boundaries. You are well advised to stay in compliance with the
rules and regulations they administer, when your venture falls within the defi-
nition of a securities transaction.
A Word About Entity Structure
It is critical to consider what legal structure will best serve the ownership group
and its purposes. Will it be a corporation, a general partnership, a limited part-
nership, or a limited liability company? The structure chosen is more important
than it may appear on the surface, especially when the tax position of each in-
vestor is taken into consideration. Once again, seek competent legal advice in
forming the entity that will own and manage the investment. Garrett Sutton’s
chapter in this book is a great source of information, as is Garrett himself.
If I had been more astute at age ten, perhaps I could have convinced another
player to spot me some marbles from his bag, with an agreement to share my
winnings with him. In the end, I may have had fewer marbles, or I may have
had more. My treasure would clearly have been reduced by the profits I shared
with my partner, while on the other hand, getting in the game earlier may have
resulted in more winnings over a longer period of time. You will face similar
decisions as you decide how you will raise capital.
Regardless of which method you use to capitalize your investments—saving,
borrowing, or equity—please consider the following perspective on money. If
you use your own capital, it is probably painfully clear that it represents months,
perhaps years, of work, sacrifice, and discipline on your part. Until we have a
grubstake of our own we are stuck in the rat race. As employees, we trade our
time for money. Our time is largely someone else’s capital as long as we are
stuck in the E quadrant.
In the end, the time we spend on this planet equals life. Most people
would agree that a human life is sacred and carries a higher value than almost
anything else on earth. Since we trade our time—our very lives—for money or
capital, I conclude that capital equals life. If that is the case, then capital, like
life, is sacred and should be treated as such.
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How much different would the annals of business history read if executives
regarded Other People’s Money as a sacred trust, akin to life itself? When an
investor has worked all of his or her life to accumulate capital, then invests in a
venture that is mismanaged or illegally operated and the capital is lost, a very
real part of that investor’s life is destroyed. For the elderly, in particular, the
hours, days, weeks, and years are irreplaceable. Risking your own marbles,
your own time, your own life capital, is one thing. Taking upon yourself the
moral responsibility of safeguarding someone else’s capital is another. I en-
courage you to approach the use of OPM with this kind of serious moral
grounding. There is nothing else you can do that will have a more positive in-
fluence on your success. If you conduct yourself with integrity not only in
word, but in deed, and keep the capital entrusted to you secure and productive,
a time will soon come when you will likely have more capital than you can put
to use. As suggested earlier in this chapter, the money will begin to chase you,
which is perhaps a crude way of saying that as you respect capital, you will at-
tract capital.
Think of all the capital that exists in the world. Land, minerals, timber, plants,
animals, fish, and even some insects and reptiles have capital value. In addition,
tools, equipment, machinery, processes, intangibles (such as intellectual assets
like software and know-how), and all forms of money and securities represent
capital. Various forms of naturally occurring energy, such as solar, wind, tidal,
gravitational, geothermal, human labor, and animal labor (horsepower) consti-
tute capital as well.
The reason I ask you to consider this enormous supply of capital is to em-
power you to overcome any thoughts of scarcity. The more we need the money,
the less likely we are to believe that it exists in abundance. Under such circum-
stances, fear overpowers faith that money is available in ample supply.
Even in difficult economic times, capital is rarely destroyed. It only
changes hands or changes forms.
Consider how capital flows around the world. It is mind-boggling to ponder
the number of individual transactions that take place every day. From the child
buying penny candy at the grocery store, to international banks moving moun-
tains of money, to balancing government currency accounts, there are billions
of individual capital flows that take place every day. In its most basic definition,
capital is either energy or a symbol of energy. Capital is the energy that flows
through each economic transaction, not the money itself. The money is only a
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symbol of the energy, the value, the increment of human life (time) that is in-
herent in the underlying asset, process, or function.
When we start to see these countless transactions as flows of economic en-
ergy, having real value, instead of as merely the exchange of money, the true
nature of capital is revealed. It is not in scarce supply. It is, in fact, infinitely
abundant. It is not all locked up in vaults where you cannot get to it. You already
possess a great deal of it in your time, your talent, your knowledge, and in your
ability to start where you are to increase your stock of capital. One buried marble
properly played soon becomes a bag of marbles and perhaps even a barrel. You
need not wait for anyone else to begin growing your capital. You already have
the power to start where you are to increase your holdings.
What, then, is the trigger that causes capital to flow in each of these individ-
ual transactions? I believe it is human emotion that drives each exchange. Com-
merce is driven by emotions such as need, greed, desire, trust, or confidence.
Someone once told me that “emotion” is energy in motion. See if this is true by
considering the following: If a person needs an expensive operation to preserve
health and life, he will do all in his power to gather the money to pay for it. If
someone is hungry, he will move what capital he has to someone who has food
for sale. If I believe you can teach me something of value, I may direct some of
my personal resources to you for books or seminars or personal coaching. If
you decide to visit your grandma in a distant place, you will most likely pay for
transportation to get from where you are to where you want to go. Notice how
in each of these examples the influence of human desires causes the economic
energy (money) to move.
My family once took a chartered bus trip across the United States. As I sat
on the bus, gazing out the window, I came to a profound realization. Somewhere
in the middle of Nebraska, while seeing farm after farm and wondering about
the people who lived on each one, it struck me. I imagined a couple of people
living in each farmhouse who had fallen in love and married. Their love brought
children into the family. Every day they worked the farm to provide for their
loved ones. It was then that I suspected the lyrics to the old song that my dad
sang to my mother were true, “Love Makes the World Go ’Round.” I realized in
that moment that the economy was actually the energy of human love and other
human desires that spur us to creation and consumption of various kinds.
As we continued down Interstate 80 on the same bus, I noticed all the trucks
passing by me in both directions, carrying the freight produced in the factories
and foundries of America. It was then that I first knew that all would be well
and that the economy would go on because people would keep falling in love,
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keep having children, and keep working hard to give them a good life. The
trucks would keep running, and capital would continue to be exchanged in
countless daily transactions that support the needs and desires of human beings.
No force on earth, no government blunder, could bring the real economy to a
halt. It was energy in motion and would remain in motion as long as individual
human beings had any desires for a better life.
So, since capital exists in abundance all around you, how do you cause it to
move from wherever it is now to where you want it to be?
1.First, establish the mind-set of abundance. Ask yourself if you are operating
from fear or from trust, from doubt or from confidence. Be constantly mind-
ful that there is no shortage of capital and that it is eager to flow to you, if
you do what is necessary to attract it and safeguard it. A dear friend of mine
shared with me that her family loves blueberries. She had the feeling blue-
berries were scarce because they were quite expensive at the grocery store.
One day she had the chance to take her boys to the country and pick blue-
berries on a farm. For the same price she paid for a small box at the store,
she could buy two big flats from the farmer, and he let them eat all they
wanted while they picked. She realized that blueberries were in abundant
supply once she had a change of perspective.
2.Qualify yourself to attract capital flows. Make a conscious choice to adopt
an energy within and around yourself that is harmonious with the energy of
the capital you wish to attract. What kind of energy attracts capital? Read on!
3.Practice full accountability. Take the committed stand that Gene Kranz,
Apollo 13 mission control director (played by the actor Ed Harris in the
movie) took during that fated mission. If you saw the movie, you may re-
member that there was an explosion that damaged the command module
while on its journey to the moon, threatening its ability to return to earth.
The astronauts had to extend their supplies of oxygen and electricity to sur-
vive. On the ground in Houston, Kranz pulled his team together and declared,
“We never lost an American in space. We’re sure as hell not going to lose one
on my watch. Failure is not an option.” He demanded that his engineers find
a way to bring the crew home safely, using only the resources the astronauts
had on board. Capital rushes toward that kind of commitment because com-
plete accountability inspires confidence, creativity, and can-do attitudes. To
the total extent of your ability and capacity take personal responsibility to
make sure that no one ever loses a nickel on your watch.
4.Work with integrity. To me, the meaning of integrity is clear. It is simply to
do what you say you will do, when you say you will do it, and to tell the truth
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in all things and under all conditions. Integrity is what integrity does. Being
reliable will set you apart from most of your competition. People want to do
business with those who are dependable.
5.Disclose. Provide your potential lenders or investors with all of the infor-
mation you would want to know if you were in their shoes and were consid-
ering placing capital with you.
6.Establish the habit of over-communicating. Keep your lenders and in-
vestors constantly informed of important details. This attention shows re-
spect and accountability.
7.Prepare yourself to attract capital flows. You will notice I differentiate be-
tween qualification and preparation. Qualification is about energy, compe-
tency and your state of being. Preparation is the act of taking care of the
mechanics and the details, where the rubber meets the road. My experience
tells me these are the key areas of preparation.
8.Know your business. Know a good deal from a bad one. Drive yourself to
constantly study and stay abreast of the real estate industry. What are the
trends in financing, demographics, product types, customer preferences,
building materials and methods, technology, municipal codes, taxation, reg-
ulations, and risk management, to name but a few.
9.Write a business plan. Create a comprehensive plan that fully explores the
risks and responses that will be required to generate a profit.
10.Have multiple exit strategies. Do you have enough confidence in your pro-
posed investment, based on solid economic principles and potentially chang-
ing conditions, to absolutely believe that you can achieve the projected
results? Have you run different scenarios? Do you have multiple exit strate-
gies? If the worst happens, how will you protect the capital that your in-
vestors have entrusted to you?
11.Define and staff up to provide core competencies. Do you, or does your
team, have the skills, the core competencies, needed to fully execute your
business plan? If something is lacking, are you realistically addressing it?
How will you compensate for the weakness? Will you hire someone with
that skill? Will you take on another partner who has the talent? Just imagine
trying to drive your car with one flat tire! Your business won’t run smoothly
if there is a “flat” on the team. An abundance of talent will overcome a mul-
titude of challenges.
12.Develop a stellar track record. Protect your reputation by over-performing.
If you are just starting out and have no track record, be honest about it, and
clearly communicate to potential lenders and investors that you are aware
of your lack of experience. Be prepared to show them how you will deal with
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any shortfall in your experience. Remember, experience and expertise can
be hired, too. Robert Kiyosaki continually emphasizes that he isn’t the
smartest guy in every situation, so he surrounds himself with those who un-
derstand certain things better than he does. I can’t think of a time that I was
unable to find the talent I needed. People of extreme capability love the game
and are usually eager to play with a quality team, even if it is their experience
the team must rely upon.
13.Take care of business. It has been my experience that my JOB ONE is to
fully focus on whatever business I am operating. Businesses don’t run them-
selves. Running a viable business requires the best energy and efforts of the
team. Rich rewards are in store for those who give their all to protect busi-
ness operations and to provide all it takes to prosper and turn a profit.
When a business does well, everyone wants to be a part of it. Wall Street clamors
to buy shares in any enterprise that is producing a healthy return on investment.
On the other hand, you have likely seen the statistics that suggest as many as 90
percent of small businesses fail within the first five years. People and companies
squander billions of dollars in investment capital on poor business investments.
If you want to attract capital to your business, make your business work. Make
it profitable. Infuse it with passion and the prospect of continued success. Peo-
ple invest in real estate ventures to make money. If you develop a proven talent
for generating solid returns and offer such an opportunity to others with proper
disclosures, they will naturally want to be a part of your enterprise.
As you attract the capital of others, no matter how small-scale at first, and
take exquisite care of that capital, your investors will spread the word. Others
will be knocking on your door to become part of a good thing. It is almost as if
the only thing you need to do is to prove your ability to run your company hon-
orably and profitably. If you do that in the face of the corporate corruption that
seems to be more and more prevalent, capital will seek a home in your enter-
prise. However, remember that even when potential investors come to you
through referrals, you still have the same responsibility to provide all of the
disclosures required by law.
I know these principles work because I applied them to build my own group
of companies from zero to millions in assets over a sixteen-year period. What I
am sharing with you I have learned from firsthand experience. Business school
baloney would have you believe that there is some magical formula, some sci-
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entific certainty that makes success in business predictable and fail-safe. Non-
sense. There is much value in the average college curriculum, but it is mostly
theory. A college degree is the beginning of the journey, not the end. A diploma
is only a way of qualifying yourself for a position on a team in the real world
where you will work for money.
It is no mistake that the metaphor of war is so often chosen to describe the
dynamics of business. Once graduation is over, every student must meet the
competition on the corporate battlefield. Out there, no one is taken prisoner.
Economically speaking, everyone lives or dies by his own ability to recognize
the opportunity, strategize the attack, and execute the plan under the ever-
changing conditions of battle. When I started the company National Note in
December of 1992, my vision for it was very different than it is today. I originally
intended to broker notes to institutional buyers for a commission. That put me
squarely in the “S” corner of the Rich Dad CASHFLOW Quadrant. I soon found
that many institutional note buyers were often too subjective and sometimes
even fickle, I tired of seeing perfectly good proposals turned down for reasons
that seemed capricious to me.
With IRA funds of my own and limited money from family, friends, and
clients I had known for years, I started buying the notes myself with private
capital. I soon realized that I was building assets and equity in my company at a
rather rapid rate. My balance sheet was improving dramatically from year-to-
year. It wasn’t until I read Robert Kiyosaki’s book, The CASHFLOW Quadrant,
that I realized I had become an investor (“I” quadrant), instead of merely self-
employed (“S” quadrant).
Years later, while teaching a seminar with Robert, I was stunned to learn
that the rapid growth of my company was primarily because I had inadvertently
managed to structure it in harmony with the Rich Dad philosophy. Not being
sophisticated in any sense of the word, I simply kept my head down and focused
on managing my business as best I knew how. Others came to me with various
ideas and wanted to be part of National Note. Rather than share equity, I joint-
ventured new business opportunities with a few of the best people. These en-
terprises, funded by National Note, prospered because of my partners’ talents
and National Note’s capital. I split profits with my partners at pre-agreed per-
centages, as the companies grow and prosper.
Somewhere along the way, something phenomenal started to happen. Those
to whom we had been faithfully sending checks each month, with never a delin-
quency, began to tell their family and friends about us. Our business has grown
every year for the past sixteen years and is ten times larger today than it was
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four years ago. We simply “stuck to our knitting,” as the saying goes, and man-
aged the company in such a way as to make it stronger and stronger to assure
the safety of the capital entrusted to us.
What is the key to such growth? The very principles I am sharing with you
now. By focusing on acquiring quality assets, running our business, telling the
truth, making the required disclosures, under-promising, and over-performing,
capital continues to be available to our companies.
From among the people who do business with us today, there are dozens of
inspiring personal stories of how debts were liquidated, stock market losses re-
covered, retirements funded, tuition paid, and moms who quit work to stay at
home with their babies. These private victories were possible because of the
careful deployment of their capital in real estate and real estate paper. For me,
seeing our clients achieve such milestones is the most rewarding aspect of being
a capitalist.
There is no way I could have known when I was ten years old how important
that white marble would become to me. I trust you now understand why I keep
a jar of marbles in my office. Growing a business does not need to be difficult or
highly technical. By gaining some proficiency in the practice of capitalism, just
like learning to shoot marbles, you, too, can build a machine that will crank out
profits for you and those who are fortunate enough to be in business with you.
There is no need to gamble or speculate, as so many do when investing. Find
a simple system that works, and work it! Attend to your game of marbles. Pick
your matches (investments) carefully, and celebrate as treasure fills first a bag,
then a barrel, and perhaps even a bank vault. I am astonished at how far our
companies have come. What a fabulous experience it is to be a capitalist! What
a ride it has been! What a joy it is to look back and relish the journey and to
look ahead with eager anticipation of an exciting future!
Now, could it be your turn? Where will you find your “taw”? When will you
enter your first game? How long will it take you to acquire more marbles than
you ever dreamed possible? Those questions are yours to answer, and the jour-
ney ahead is yours to begin. Good luck!
Ways to Learn More
A soon-to-be published book on real estate formulas, by Wayne Palmer
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Wayne Palmer is widely regarded as a master in the creative structuring
of real estate acquisitions and financing, using notes and other forms of
real estate paper, together with 1031 Equity Marketing formulas. His skills
come from thirty years of daily practice of his trade, as the owner and
manager of National Note of Utah, LC and several other companies. He
has been involved in real estate development since 1978, in Utah, Idaho,
Arizona, Hawai’i, and Minnesota. By way of industry credentials, Wayne is a Licensed Princi-
pal Real Estate Broker, a Certified Real Estate Note Appraiser, a Certified Cash Flow Master
Broker, a Licensed Continuing Education Provider, and holds the Equity Marketing Specialist
(EMS) designation with the National Council of Exchangors.
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ernie Bays has been a friend of mine since the mid-1970s. He is also a fellow
marine and rugby team member. If you go over his record, you can tell he is
no ordinary marine, but a Force Recon Marine, the toughest of the tough. He is
also no ordinary rugby player, playing for USC and for Stanford University on a
national championship team. Small wonder he is such a smart and respected real
estate attorney.
When I first started out in real estate, my deals were small, and I thought I did
not need an attorney. Being naïve, I thought a real estate broker and a good ap-
praiser were enough. On my first investment property—a small one bedroom, one
bath condo on the island of Maui—my little dream bubble was popped. A few
months after acquiring the property and putting a tenant in it, net