Many investors are plagued by contradictory behavior where they adopt a pro-risk attitude with their investments, but when it comes to the strategies we are about to discuss, they take on more of a scarcity mindset.
It is well known that entrepreneurs and real estate investors create the most wealth in the world. I am going to explain how you too can benefit from the same strategies the wealthy use to create wealth.
But first, we need to identify what makes these two categories of people better positioned for wealth creation than others. I believe there are three things that set them apart:
Most often when a real estate investor purchases a property or constructs a building, they acquire a loan from a bank to fund the project. Seldom do they pay for properties in cash. The more resources they tie up in one property, the less cash they have available to acquire other properties. By using the bank’s money to leverage their purchases, they can use the same amount of money to acquire multiple properties. You’ll see why this is important in a moment.
The investor collateralizes the property in exchange for the capital to acquire the property. Say an investor buys a property valued at $100,000. The bank funds 75% of the purchase price and the investor funds 25%. By doing this, the investor now has a property valued at $100,000 that they paid $25,000 out of pocket to acquire.
From a retail perspective, you may point out the fact that there is a loan and the equity position is only 25%. That is true, but there is more to understanding why this is a huge advantage for the investor. Which leads me to the next point.
What many people fail to understand about real estate is that the property is worth the same whether or not it has a mortgage. In our example, even though the investor has a loan of $75,000, the property is still worth $100,000.
This is important as the investor – not the bank – benefits when the property appreciates. The investor gets the benefit of a $100,000 property appreciating with only $25,000 invested. In other words, if the property appreciates by 5%, or $5,000 on the $100,000 property, this is effectively a 20% yield for the investor’s $25,000 investment. This is what is known as an internal return.
Of course, no investment property is acquired without the potential for creating cash flow from the operations. Whether it is a business operating within the property or a rental agreement, the investor has a plan for creating cash flow from the property’s use.
Now, this is where the multiplication occurs, and the idea of internal and external returns is revealed … explaining how this strategy grows wealth.
Continuing with the example of the $100,000 property, let’s assume the property is rented out. Let’s assume the rent collected is $1,200 per month, or $14,400 per year. Using the same math as before, $14,400 would equate to 14% of the value of the property and a whopping 57% on the investor’s $25,000 investment. This is an external return.
After backing out the mortgage payment on the $75,000 of around $6,000 per year, or 6%, the investor’s returns are still above 30%. And when you combine this cash flow with the building’s appreciation, you have a year-over-year return above 50%, all things considered.
This is why an investor often favors using the bank’s money. The returns are higher. And if you multiply this example four times, you can see why using $100,000 to acquire $400,000 worth of properties can be better than using $100,000 on a single property.
Of course, there are risks involved with this, the same as with any investment, and the actual returns on investing in real estate will vary from deal to deal.
This concept of internal and external returns can be applied to anyone who owns real estate, but they also can apply to anyone with a cash value life insurance policy. But before we can discuss how these two assets could help you grow your wealth, it is worth taking a moment to dispel some common myths.
The challenge many people face as it relates to a home mortgage is the misconception of what constitutes sound financial advice. On one hand, an investor believes they can invest in the stock market and earn 8% to 10% over time, while simultaneously holding a conflicting view that having a 3% to 4% mortgage is a bad idea. If this is you, I am sorry to say it, but this mindset fails to support its own logic.
If you believe the potential is there to earn a higher return than what is otherwise being paid to a bank for the mortgage, then there isn’t any mathematical evidence to support accelerating the payoff of a mortgage.
Of course, there are those who simply do not want to have a mortgage — and that is a personal preference, not an economic decision.
There are few subjects more misunderstood than life insurance. With all the uses and applications and multiple types of policies, it is easy to see why the opinions and views of life insurance are all tangled up in a web of confusion.
But let me be clear: When a dividend-paying whole life insurance policy is designed and funded correctly, its benefits mirror those of most real estate. Both are similar in that, they build equity, grow tax deferred, allow for tax-free access to cash, and can be owned free and clear.
With the overlapping characteristics of life insurance and real estate, I see both being used as a conduit for receiving both an internal and external rate of return.
So here is what we know to be true:
The same can be said about a specially designed life insurance policy:
One advantage to a life insurance policy loan over a bank loan is that there are no requirements to pay the loan back. This is a cash flow advantage because you have the ability to set the terms.
Let’s say you have investments and need to make some home improvements. Consider using home equity to make those improvements as opposed to using your investments. There are three benefits to this:
Another example would be using the specially designed life insurance:
Properly utilizing these strategies can be a catalyst for building wealth and increasing cash flow efficiency within your personal economy. To learn more about how to develop this system for yourself, visit BUILDBanking.com.
Founder & President, Skrobonja Financial Group LLC
Brian Skrobonja is an author, blogger, podcaster and speaker. He is the founder of St. Louis Mo.-based wealth management firm Skrobonja Financial Group LLC. His goal is to help his audience discover the root of their beliefs about money and challenge them to think differently. Brian is the author of three books, and his Common Sense podcast was named one of the Top 10 by Forbes. In 2017, 2019, 2020, 2021 and 2022 Brian was awarded Best Wealth Manager, in 2021 received Best in business and the Future 50 in 2018 from St. Louis Small Business.
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