How to Invest in Commercial Real Estate

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Episode #047- How To Pay ZERO Taxes By Investing In Commercial Real Estate!

by Criterion, Braden Cheek, Brian Duck
January 31st 2022

“Ninety percent of all millionaires become so through owning real estate.” -Andrew Carnegie

Today our hosts Brian Duck, Braden Cheek & Joel Thompson from The Criterion Fund talk about th... More

doctors, lawyers, high income earners, ceo? S a lot of times they're making, let's say they're making $800,000 they may pay $400,000 in taxes, Right? So they make $800,000 on paper, but they may take home, you know, $400,000 in cash flow, 400,000 4 50. You got, you have federal at a pretty high tax bracket. You've got state, you've got maybe Social Security, Medicare for some of that. And so that's the hugest expense that they have. And so what real estate does is it allows them to make more money but not be taxed at that high rate for the additional income because of the depreciation and other tax write offs. Mhm. What is up guys welcome back to how to invest in commercial real estate. We are a commercial real estate investment company called the criterion fund, Breaking down how to invest in commercial real estate for the everyday person to understand today is an exciting episode because um, we're talking about Tesla. So what does Tesla have to do with investing in real estate? You might ask. Well Joel is gonna tell us Well, I I thought I was trying to come up with a unique idea for the show today and I wanted to take it back to about a year ago, I'm driving in my car and I'm listening on the radio and I had kind of been trying to learn about crypto and they're like Tesla announces they're taking a billion and a half dollars of cash and they're buying Bitcoin with it and up until then I you know I knew Bitcoin was kind of an emerging thing but I thought man this is a little bit risky and I thought here's a publicly traded company, one of the world's richest people taking a billion and a half dollars and making a bet on Bitcoin.

Yeah, like you said publicly traded company. So like I almost think they didn't get allowed into the S&P. because of that, didn't they? I can't remember the details so I won't I won't comment. But one thing struck me while I was driving is what does that mean? I consider Elon must not only is he now the richest person in the world but one of the smartest to ever ever walk around on this ball of dirt. And so what does he know? Because he has a wealth of advisors, there are huge public trading. What does he know that? I don't know that he's willing to take that bet. And that got me thinking I should learn more about crypto and I started getting into crypto and Crypto is really risky and I don't know very much about it but it piqued my interest of like who else who other big millionaire billionaires are taking large bets on crypto and why are they doing that? They must know something. And so then I just got the thing we run into so many people that have money sitting in the bank earning $0, but they're kind of afraid of investing in, they don't know what to invest in and we can't figure out why they don't see real estate as an avenue or a vehicle for them to invest in.

Yeah, it's, it's mind blowing how people can't trust it. I mean, you take crypto again, for example, and you have this massive emerging asset class, you know, I think total total market cap of Cryptocurrency right now is like, you know, close to $3 trillion. So I mean, I gained a lot of popularity really fast and there's still people out there who don't, aren't investing in traditional, traditional forms of investments. And when you take real estate, for example, I mean, real estate for since inception has been insanely valuable. It's made people money since the beginning of time. I mean, they say that like 90% of millionaires uh made their money or have their money in real estate. Yeah, I mean that's a big stat that people should consider is why is it that all the millionaires, a lot of billionaires hold a lot of their assets in real estate, there must be something to it. Yeah, there's, there's, there's tons of reasons, there's tons of reasons why real estate is an attractive asset class, but mainly for wealthy people, it's a great place to park cash because it gives off these several benefits, you know, it doesn't just make money or keep your money safe, but it there's, there's tons of benefits, you know, one of them, one massive reason the parking money in real estate is, it produces passive cashflow.

And then the original money is still there. That's huge. That's huge. Because you're not forced. Let's say you made $1 million. You created this company, awesome. You sold it, you made $1 million. What are you gonna do with that? Million dollars. Yeah brian, so you sold or part of a sale of a company and got a bunch of money, but that money didn't give you the security to quit your job because it was just in a stock market account or a savings account. That's right. So it was in, I put most of it in the stock market, but it really wasn't paying my bills, right? And so um and you know, stocks are risky and everything. So um I started looking into real estate and investigated what all the reasons are to get in real estate and needed some way to pay my bills. And so um real estate seemed to be the best way to go. Yeah, because a lot of stocks maybe appreciating, but there's, you know, way less stocks that pay out quarterly dividends or, or annual dividends, they're they're they're They're pretty low, so usually it's in the, I don't know, 12, 3% range. So that's not enough for my uh living expenses, right?

But yet I could get into um Real estate. And, and it looked to me like it was paying off, you know, north of 10% on my money. Well, I looked at the, at the numbers there and that could, that could let me quit my job and pay, you know what used to be my W2 job. Okay. Number one reason then is passive cashflow. It's huge. And, and we have probably precision equity probably has almost 20 deals now paying passive cashflow to investors. Once again, like we mentioned last show, I wrote over 160 checks Just last month, over $600,000 in passive cash flow that we paid out on investments. Uh, and so that's every quarter. That's not, that's not in a year, that's every single quarter we're paying out. And our goal on a deal level is 10-20% cash flow. Could be, could be a little lower, it could be a little higher. That's a massive return right there. And it's not the theoretical return. And the value of a stock, it's actually getting sent to investors. It's something you can put in your pocket, It reduces your risk. So more importantly on that, you know, a few million dollars a year that you're distributing.

Are you, are you selling assets and paying taxes to pay out that money constantly? No, that's beautiful. Yeah, we get to keep the assets and continue to pay pay the distributions. So if you've got Amazon stock right? And it's it's sword you know 20% which you know probably been a minute since it's done that. But to get the unrealized gain that you have you've got to sell the stock, you've got to pay the tax on the sale well and the and the dividends that you get from the stocks, you have to pay taxes on those. Yeah. When I'm not supposed to. Yeah and I'm not we won't get into exactly the difference but the investor may have some tax liability on the distributions we pay but like like you're saying brain, they don't have to sell 20% of their stock to get that 20% that it's gone up right. The value of the asset is still going up and you get the distributions which we'll cover here in a second. Alright so number two I have down appreciation. Okay so let's talk about that because it's not magic values go up over time because of things like inflation and right now we're entering into a very high inflationary period where because of all the money getting dumped into the market prices just tend to move upward as the value of the dollar slightly decreases.

And so commercial assets that are based on rent rent and the inter net operating income is what values those and if you can you know charge a little more rent next year because of inflationary pressure or whatever that drives this appreciation appreciation value. Okay. But let's say okay then. Well yeah Joel, but appreciation may only be 3%. I'm gonna try to do quick math for you on 3%. Let's say you've got a million dollar building and uh, it's gonna appreciate 3% in a given year. Okay. So what is that? $30,000. Okay. All right. So you're building one up $30,000 and say, hey, that's a million dollars. 30,000. That's not a huge deal. Well, it is, it is because we didn't pay a million dollars for it. Right? We got a loan and we only paid in cash $200,000. Let's say 20%. Okay, so now I have 20% is is that my investment is 200,000, not a million. So I take that 30,000 and I divided by my investment of 200,000 And that's a that's a theoretical return of 15%.

Just on Appreciation 15%. Now remember we're getting cash flow of 10-20%. Now we're getting appreciation of about could be 15% uh versus our our initial investment that's huge. It's massive. You can also look at it and just sheer replacement cost. I mean 50 years ago, how much would it cost to build a building to build a house? How much were the cost of materials? How much were the cost of labor? Now, I mean, you can you can look at it now if buildings costs You know, $2, a foot sometimes to build and and 50 years ago, it may have been, you know, half that. So that's driving up the price of older ones because hey, it cost me so much new that then that increases the value of existing buildings. Next one is tax benefits, tax benefits. I mean, yeah, so like we've explained earlier, you know, you can, you can get money out of commercial real estate a bunch of different ways without being taxed. Absolutely legally perfectly perfectly find loopholes that they purposely put into commercial real estate.

So you could get cash flow out of real estate without paying taxes on it. Maybe until you sell, it's a very big one because when billionaires are looking at how to make more money, it's not necessarily how to make more money. It's just maybe how to pay less in taxes. Absolutely. So the advice I give people that are asking me about this, especially high income earners, doctors, lawyers, high income earners, ceo s A lot of times they're making, let's say they're making $800,000, They may pay $400,000 in taxes, Right? So they make $800,000 on paper, but they may take home, you know, $400,000 in cash flow, four 4 100,050 you got, you got federal at a pretty high tax bracket, You've got state, you've got maybe Social Security Medicare for some of that. And so that's the hugest expense that they have. And so what real estate does is it allows them to make more money but not be taxed at that high rate for the additional income because of the depreciation and other tax write offs. Now we're not accountants and we're not gonna specifically give advice on this factor. But just the point we want to make is that why millionaires and billionaires invest in real estate is for a lot of reasons.

But one of the reasons is how much, how much less you can pay in taxes per dollar earned even if you're a high income earner. Yeah. We've talked about the compounding when you take out the passive income from real estate, you don't have to pay taxes on it and then you go invest it somewhere else. The tax savings that you don't have to pay is really compounding really quickly. Yeah, so people recommend four oh one K accounts. Let's get investments surely because you invest with with pre tax dollars. So I mean thinking about taxes is an obvious thing, but there's, there's better ways to have investments that are in a more tax favorable environment. It's just a fact. It's your largest for most people, it could be their largest expense more than a mortgage more than once. So, so reducing that should be a priority, especially for high income earners. It should be a main priority, should become a tax expert. Uh And you should learn which investments are going to have the most tax leveraged benefits for you. Let's go back real quick to my example that I was saying before, so if I had just left all my money in the stock market for my living expenses, I would have had to sell uh every year to um get my income and I would have had to pay taxes on that that sale.

Well now I have it coming out of passive income out of real estate tax free. Yeah. Yeah. And the stocks are still on the market appreciation, appreciating without the need to sell them and pay the tax. Yeah. Alright, next we have is leverage and and really this one is it kind of is gives the benefits, some of these other benefits. Yeah, people people may underestimate this one, but this one's huge. Yeah. So that you can borrow up to 80, even 90% sometimes of the value of the real estate that right there should tell you how secure of an investment it is versus other investments. Thanks for willing to do that. They think it's secure, right? That's right. They can secure. I mean just think about other assets and say, hey, I want to buy this asset who's gonna loan me, you know 90% of it or 80% of it. Uh huh. And you're gonna get told no and even if you are like on a business even you may get 70 80% but they're gonna want that paid back in five years or 10 years where real estate the bank said, hey you don't have to pay you back, let's do a 25 year amortization, let's do a 30 year amortization or in the instance of hud Let's do a 35 or 40 year amortization.

And so that is a powerful benefit because it allows you to get more real estate and the more real estate you control. Then that's where the appreciation kicks in. You're earning your appreciation is not on the money you have in its on the total value of the religious right? And and the lender isn't getting a cut of the upside there. They're getting a fixed low interest rate that they're, they're borrowing from somewhere else. And again, just go back to our example if if you're gonna go buy a million dollars worth of Tesla stock, a million dollars worth of amazon stock and you come to me and you say, hey will you buy me $1.8 million of Tesla stock and I'll give you a million let's say no way in hell man, no, no way. And you can definitely trade on margin a big people love crypto trading because you can go in and put these stop limits and trade you know 2030 40 50% margin of using somebody else's money and that's a lot that was a lot compared to the stock market. But in real estate you can buy, you know, a couple million dollars worth of real estate for for way less. Yeah, like I said 20% down usually usually can get you the real estate and so that's 80% leverage and you just can't get that most asset classes.

Okay. Uh let's see, next is principal pay down. And I don't know if if people really appreciate the power of this, because most people equate principal pay down to like the mortgage on their house and so they've got a $200,000 mortgage on their house and they've got a 30 year am which is a long and and and they just never seem, you know that I'm not really paying it off that fast. This isn't a big deal to me, but in commercial real estate, it's super powerful because not only you're not making the payment. Okay, think about that, that's the paradigm shift. People have to have here and I hope they can get it is your mortgage, you gotta pay. And so yo man, I'm not paying this down at all, and then I gotta pay all this interest. But what if I told you you could buy commercial real estate and you wouldn't have to pay the interest, right, you didn't have to pay the principal, somebody else pays that for you. All you gotta do is come up with the down money and and then everybody else takes care of the payment. Well then you'd see that as powerful. And let me give you an example, just year one of a 25 year amortization payment on a commercial note, okay, is a little over 3% of that mortgage.

You're going to pay that that first year or the 3% of the value of the property actually. And, and so once again, not a big deal, but it is because the tenants are paying that, it's not coming out of your pocket. So it's pure upside for you. Take the 3% like we did with the appreciation and put it over the 20% down you have in the asset that's another potential 15% return on your money. Now, you don't get that in your pocket, but it's absolutely real. Uh, we have a portfolio where we have tens of millions of dollars in loans, The tenants are paying those off for me over time. So you can just imagine what's, what's the pay down on, on $70, $80 million of of mortgages. What's that pay down every year that's going into our pocket. My investors pocket. And it's automatic. It's like clockwork. Uh, so I think pay down is a huge benefit with commercial real estate because once again, you're not making that payment. The tenants are and your, if you buy well and you have good real estate, then you're, you're getting cash flow on top of that. You're getting appreciation on top of that. Some of our listeners can relate to that because maybe, um, some of them have rent houses, right?

So they know what it feels like to be able to collect the rent and actually they're uh, not paying the mortgage, right? And so they can kind of relate to that. This is just on a bigger scale. Yes, similar story. But life insurance companies, if you've got life insurance, right? The big fun facts to know insurance, life insurance, life insurance companies love commercial real estate, Why? Why do life insurance companies love commercial real estate? Because it's safe because it's safe and they need somewhere else to invest your money before they have to give it to you because you're gonna die, right? You have life insurance, you're gonna die. So before they pay that out, they want to take a bunch of other people's money and get paid on and get paid on that money. Very similar concept. Very similar concept. Yeah. And they have to have that money to pay out. So they're not going to invest it in something that's risky. Uh, they're gonna invest it, that's something that is safe. But then earned them a return. So they're not just holding in cash. Insurance companies are very conservative and they've got billions of dollars, they may have $10 billion in cash. So when you think about that, they only make, you know, 3% a year on that because they're doing super safe. Super amazing loans on commercial real estate, well 3% on, on $10 billion of somebody else's money is a lot of money.

It's a lot of money for sure. All right. Last one before we wrap it up is the power of refinance and we have covered this a little bit in the past, but we have extensively used this uh, to benefit and grow our real estate portfolio. Is that you get to not, okay, we're paying it down or paying the principal down. We're appreciating in value. So I don't have to wait 25 years to get to the equity and that, that that value of that property we, we can, you can refinance. And now I get to take advantage of both the appreciation and the pay down and I get to take that money out. And the greatest thing is that you're not selling the asset. I get to keep the assets in. The asset keeps going up in value. I get a new loan on it. So now I'm paying down a new loan. So I keep all the benefits of the real estate. Okay. But I get to put the money in our pocket to go reinvest in a new deal and it's completely tax free because it's just loans proceeds from alone. There's no tax free money. What are you talking about? Yeah. That this, this maybe some of the only tax free money is you go borrow money against a value in real estate and you get to put it in your pocket tax free, similar to your house, you may refinance your mortgage and you're not paying tax on that because it's not income, it's just alone.

Well we do that on, on a scale of millions of dollars of commercial real estate and so we take that money tax free. Yeah. Okay. So you didn't have to pay for the original loan? You know, we said, but are we, are we paying for this new one or, or no, the increasing as cash flow increases, you get a bigger loan. The tenants are still paying off the new bigger loan. I don't have to, I'm not paying off the new loan. Uh, we, we've done that so many times with apartments where we'll buy and, and the rents will go up, The occupancy goes up now, it's worth more. We borrow money and our payment goes up. But who cares because the tenants are still paying, still paying that mortgage payment, the cash flow is in excess of that mortgage payment. So then we take all that money and we can distribute it to the investors. We can reinvest it And we're reinvesting tax free dollars. So think about back to the example of high net worth earners, high income earners is they only have what's left after taxes to invest. But what if they could say, Hey, before I get taxed, I'm gonna invest 800,000. Um this big salary that I don't invest all that money.

They can't do that. They have to let the government take half and then they can only invest whatever they don't spend. We're here, you get to take all of it and invest it before it gets taxed. Fantastic. That's that's ridiculous. I mean The refinance is one of the most powerful tools because you don't, you're not forced into selling the asset, you're not even forced to stop it. Just getting your cash out like hey I put $1 million dollars in on the refinance, we're only going to give you that million because that's all you put in a lot of times they don't care. They'll, they'll give you way more than your million because the asset their lending against is still safe enough. It's where if you default and they have to take it back, they can recuperate their position and probably end up making money off of it. They're probably hoping you default some are, there's so many, so many amazing benefits to invest in commercial real estate and I still see and talk to so many people who aren't involved in it but yet you look at at shiba inu you look at at does coin and it's got a market cap of like $80 billion between the two of them. Yeah, yeah $80 billion. So yeah people have decided to invest $80 billion of their hard earned cash into mean coins.

Now there's an expectation that they might they might go up in value. But but what they, what people should really appreciate is that yes, but that's still a very risky position, but people are still unsure about getting uh some of their money invested into real estate there still uh you know when they have money like, hey what do I do with it? How about some real estate? I don't know that, I don't know. It sounds so what we're trying to get people to realize is there's a reason why the world's richest and most influential people hold a lot of their uh net worth in real estate and it's because they don't know what you, they know what you don't know about real estate and we're trying to educate you. Yes. So when you want to go to a place to learn how to make money, you should maybe follow people who have made money and are currently making money and when they're investing in these things or when 90% of the world's millionaires have been made through in real estate or when all of this wealth is being held in real estate, you, you may consider not just, you know, looking out for yourself or deciding for yourself. You know what I decided I'm going to invest in real estate, have a reason, look into it, develop a thought process of why are all of these people doing it and and try to disprove it and then maybe that will make your case to to invest in it.

That's a good point. Yeah I agree. I hope I hope this was helpful. Real estate as we think is one of the most powerful tools and the last thing I'll say about it is yes everything has risk. But the risk reward profile for real estate over the centuries has proven over and over to be a safe bet. Uh there is risk but the rewards outweigh the risk. The risk is relatively low compared to the gains. You can make agree agree. Thanks everyone for joining us on this episode of how to invest in commercial real estate. Like and subscribe comment. If you've got a question, we'll answer it and we will be back next week with another episode. Thanks guys. Thanks.

Episode #047- How To Pay ZERO Taxes By Investing In Commercial Real Estate!
Episode #047- How To Pay ZERO Taxes By Investing In Commercial Real Estate!
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