Episode 138: Real Estate Expert [3/7 Series] with Dr. Tom Burns

Description:

The WealthAbility Show #138: Have you wanted to invest in Real Estate but are discouraged and don’t know where to start? Or are you already well versed in the world of investing and are exploring a deeper understanding in an uncertain economy? In this episode, Dr. Tom Burns joins Tom in discovering how to successfully invest in Real Estate by utilizing the government’s incentives, and the importance of seeking knowledge within your community and beyond.

 

Order Tom’s new book, “The Win-Win Wealth Strategy: 7 Investments the Government Will Pay You to Make” at: https://winwinwealthstrategy.com/

 

Looking for more on Dr. Tom Burns?

Website: https://richdoctor.com/

Book: “Why Doctors Don’t Get Rich: How YOU Can Create Freedom with Passive Income Investing”

SHOW NOTES:

00:00 – Intro

06:22 – Can you start small in Real Estate? What are some setbacks to prepare for?

12:13 – Why is it critical to seek mentorship and coaching even when you are successful?

17:20 – Breaking down an example to purchasing real estate and why cap rates are so important.

22:20 – To use debt or not to use debt?

27:38 – Can Real Estate investors remain realistic, but confident, in an uncertain economy?

30:50 – What is “Bonus Depreciation”?

37:20 – How important is the tax side for Real Estate investors? Why?

42:00 – What’s going on in the market right now – from capital calls, interest rates, loan caps, etc.?

Transcript

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to The WealthAbility Show, where we're always discovering how to make way more money and pay way less tax. This is Tom Wheelwright, your host, founder, and CEO of WealthAbility. So for several years now, the government has very heavily incentivized real estate. And so today we're actually going to discover how to double, triple, even quadruple your returns on real estate, really through debt and taxes and why real estate can be such a powerful passive income producing investment. And I have my good, good friend and expert, absolute expert in real estate and learned it the hard way, learned it by doing it. Dr. Tom Burns. Tom, welcome.

Dr. Tom Burns:

Hi. Thank you Tom. Happy to be here. Thank you very much.

Tom Wheelwright:

So could you give us, for those who don't know you, could you give us a little of your background? How you just got started in real estate and why?

Dr. Tom Burns:

Yeah, you bet. So strangely enough, I started my life as a doctor, but for one reason or another decided I needed a second stream of income and real estate fit my lifestyle. So I started a long time ago, probably 30 years ago, and I started by jumping in and trying to buy things. So I just started small, telling people everybody starts somewhere and I started really small. And just over time developed a network and partners and the properties grew and the numbers grew. And today I've got one partner, we own some office property. And I've got another partner and we have a private equity real estate firm based in Austin, Texas. So it's been a progression and a learning experience.

Tom Wheelwright:

So I read you're up over $200 million in real estate under management.

Dr. Tom Burns:

It's actually $750 million.

Tom Wheelwright:

Wow. So my data's wailed. That's cool. Congratulations. That's fantastic.

Dr. Tom Burns:

Thank you.

Tom Wheelwright:

So you said that real estate fits your lifestyle. What do you mean by that?

Dr. Tom Burns:

So I was a doctor. I didn't have the background experience or money or anything actually to go start a business. I wasn't going to become a stock trader. Basically I was looking for money outside of medicine. Real estate fit me because it moved slow, low barrier to entry. You could do it with partners or without. I could do it part-time or full-time. And basically real estate's just simple math. You buy something, somebody gives you money to use that, and if that money's enough to cover all your bills, there's a little bit left over for you to use. I thought that was pretty simple and so I kind of took that route.

Tom Wheelwright:

You say it simple and yet we know lots of people have lost money in real estate. So when you think about, okay, over the years, I mean, maybe you've not made mistakes. My guess is you have. When you think of the mistakes you've made, what kind of mistakes have you made and how have you adjusted to those mistakes?

Dr. Tom Burns:

Oh, you bet. I've made plenty. You see, I was just giving a talk yesterday. You give the talk, they look wonderful, they're like Facebook posts. But I stopped at the end and said, “You know what? Always underlying those are the mistakes. That's where we learn everything.” So my number one was not necessarily vetting people that I was either investing in their deals or investing as a partner with them or working with them. Some of the folks that I was associated with are in jail. Some have been raided by the FBI, so that happens. So my character and integrity antenna went up. And also we make deep, deep dives into people and talk to a lot of people, make sure we're connecting up with good folks.

I bought an apartment complex before I knew what I was doing and barely got out of that with my shirt. And so that sort of let me know that if you're going to do something, you probably ought to at least have either somebody with you that knows what they're doing or have a little bit of background before you start. There's a lot to be said for learning as you go, which is kind of how I did. But as it got bigger, it's a lot better to have a little bit of expertise on your team, which helped me move forward to build a team. So yeah, and didn't ever really get caught in short-term lending. But I did sort of, Tom. In right before The Great Recession, we had some deals going where I had some mezzanine debt, sort of personally guaranteed “short-term” private debt. One of them was for a restaurant that we bought, and my suggestion to everybody is don't buy a restaurant.

So things changed. And so that short term became long term and these notes were at 18% personally guaranteed by Tom Burns. So what happened is when The Great Recession happened, most of my stuff did okay. I pretty much, I knew. I always put that in quotes. I kind of knew what stuff was going to probably go flat and not produce income, but I was really confident in some other stuff so I knew I'd be okay.

Well, I found out there that I can't predict the future because I was wrong about that one thing that was going to keep paying me money. So that dried up for various reasons. And when all that dried up, I had money that I owed to people and I had to pay that. So I had to get lines of credit from the bank. I paid that 18%, arbitraged it down to about 4%, and took a few years to pay off those lines of credit. So I missed the first few years of the great sale of real estate right after The Great Recession. So painful lesson, but a good lesson. So that's led me up to where I am now. I'm a little bit more cashed up than I might've been back in 2008.

Tom Wheelwright:

Yeah-

Dr. Tom Burns:

I have a lot more mistakes but…

Tom Wheelwright:

So we'll get eventually to where we are today in today's economy. But you mentioned a couple of things that I thought were interesting. First of all, you said you started small.

Dr. Tom Burns:

Yeah.

Tom Wheelwright:

And then you started talking about the team and the people around you. So if you can start with the, okay, you started small. What do you mean by that? How small did you start and why was that important to you?

Dr. Tom Burns:

You bet. Well, I started small because number one, I kind of had to, didn't know that much of what I was doing, and I did know back then and certainly know now if you start small and you make mistakes, at least your mistakes will be small. And I encourage people to, if they want to learn, start small because your mistakes can be small, but the lessons can be big. And that's kind of how it worked out. I continued to do that. I got very good actually at one particular market and became sort of a little quasi expert in one particular asset class in a very tight little local market. And it made me some nice money.

Tom Wheelwright:

So can I stop you right there? Because I think you hit something that most people don't pay attention to. And that is you became really good at a very niche market, very small market. Why was that? I mean, what was that that got you to really be that specialized and why did that make a difference?

Dr. Tom Burns:

Oh, man. So back in the day when I started, you looked in the newspaper, you couldn't Google stuff. We were still typing DOS commands into computers. So I looked in the newspaper on Sunday nights, there was a real estate section. I had decided it's time for me to go learn. I'm going to be in real estate. I'm going to go buy something. So I looked in the papers, I found stuff and it was a condominium in the west campus at the University of Texas. It had my price range is essentially why I did it. So I'll keep the story short, but I called the number on the thing. I went down there and looked at it and by then I sort of knew the math. I could add up the math and I knew the 1% rule. I had kind of learned about that.

Tom Wheelwright:

If you would, explain the 1% rule.

Dr. Tom Burns:

Yeah. The 1% rule, which is really hard to find right now, is basically whatever something sells for, if the rent's roughly 1% of the selling price, you're probably going to make cash flow on that. So if it sells for a $100,000 and rent's for $1,000, you're probably going to cash flow that thing. So I bought this. I knew nothing, Tom. I had nothing. And the broker and everybody held my hand and walked me through it. And I bought this condominium. I didn't know what a financial statement was, didn't know how to get an inspection, didn't know how to do contract. Everything about buying a property, I didn't know. Which is a great story because that's where I learned it, right?

Well, I ended up making some passive income. Got addicted to that, did it again. I called the guy said, “Hey, I kind of like this. You got another one?” He said, “Sure, I got one down the street.” So I went and looked at that one. The number seemed like they'd worked out. I bought that one. Still learned some more lessons, but it took less time and less anguish to buy than the first one. “Do you have another one?” He said, “Sure.” So I bought another and another and before long, I knew that market like the back of my hand. I could tell you in five minutes if a unit was going to make me money.

I got so good that I bought one site unseen. I bought one for no money down. Didn't plan on doing that, but I knew more about the market than the selling broker and the seller themselves. So that knowledge allowed me to be really good in this little tiny niche market. And I bought quite a few. I didn't stop. I bought quite a few of those until it got discovered and the 1% rule kind of fell out of favor and it was a little harder to make cash.

So that was my first real estate portfolio. And I'll tell you, I still own all those to this day. So I often ask people, “When do you think the last time was that I saw that condo?” Well, it was over 25 years ago when we went to inspect it and ever since then it's been sending me money every month. And you can imagine, Tom, what inflation's done to the value of that property. So they're all off. I could have refinanced them. I have chosen not to for security reasons. I just want to have that. I can tap into it if I want to. But portfolio itself has grown quite large. The cash flow is wonderful. And so that was a nice way to start.

Tom Wheelwright:

So I think you discovered something that a lot of people have a tough time with. There's the old saying that a niche will make you rich.

Dr. Tom Burns:

Right.

Tom Wheelwright:

And I tell people all the time, I'm going, “You really need to get really clear on your criteria and then you just do the same thing over and over again.” And it sounds like that's exactly what you did. You got really good at that basically student housing market and you did over and over again so that you knew it without even looking at the property itself. You knew this was going to be a cash flowing property.

Dr. Tom Burns:

Right, right. And that's really valuable to know your market. And of course it went to where we bought, instead of buying just one at a time, we bought 40 at a time, that sort of thing. And it grew. And if you want to answer your question, you said how'd you get going? After that, I sort of felt like I plateaued. So I went and asked for help. I had a friend who was a real estate developer. I said, “Will you teach me?” So he laughed at me and said, “Well, you're a rich doctor. You don't need to know this stuff.” I said, “No, I'd really like to learn.” So that's kind of where you asked about building the team. So my team for the condominiums was my banker and my property manager, and he's been my team for 25 years. But I increased the numbers of people on my team by getting a mentor and learning another phase of life. We developed medical office property. After that, I started-

Tom Wheelwright:

So on the mentorship, Tom, to stop you right there. On the mentorship side, why'd you go for a mentor? I mean, you've been successful. And I know a lot of people, “Well I'm successful here, so I can just apply that somewhere else.” What made you decide to go to that coach or that mentor instead of just doing it yourself?

Dr. Tom Burns:

Yeah, I wanted more and didn't know how to do it. I felt like I'd kind of hit a bit of a ceiling. I had a nice portfolio, but it wasn't a life changing portfolio for sure. And as we know, real estate kind of moved slow. So I wanted more. I wanted to scale a little bit and I kind of liked what he did. I liked the idea of taking a raw piece of land and turning it into something. And so this was just a really good friend I'd vacationed with and I thought, “Man, I'd like to know what he does.” So that's why. I guess I was greedy, Tom. I wanted more because my plan was to have enough money coming in to where I had choice of whether or not I worked or not. So that's why. And I still do it to this day. In fact, before we started, you and I were talking about mentors teaching us things that we don't necessarily know as much about because everybody knows something that we don't. Every person on the planet knows something that we don't, and we can always learn something from them.

Tom Wheelwright:

So not only do you want to learn, but you've looked at the team that you need to build around you. So talk a little bit about that team, a little bit more about besides the mentor, how'd you go about finding the team? I mean, for example, a lot of people say, “Well I can't find a good property manager. Or it's really hard to find a good banker.” So what did you do to go about actually assembling that team, deciding who you needed on your team, and how to put that team together?

Dr. Tom Burns:

You bet. A little bit of it was blind luck. I stumbled on my property manager for the student housing, so that was good luck. And you stumble on a few people. But I didn't know where to go so I went to people that had good teams. I went to folks that were already successful and I said, “Hey, gee, how do you do that? Who you know that does this?” And they would send me to folks. And sometimes it would work out, sometimes it wouldn't. But I went and asked people that already had good teams, asked them to refer me to folks and you learn over time. And your team changes because your needs change. My CPA was quite adequate for early on, but then I needed somebody who really knew how to do proactive tax planning, which is why you're my CPA. But so you learn as you go, so I plagiarized the team from other people with their consent.

Tom Wheelwright:

Got it, got it. So I started this with how the government incentivizes real estate. So when you look at real estate, I know you look at it as a way to increase, to have passive income, et cetera, and there's a lifestyle aspect to it. Do you look at real estate from the standpoint of having housing for other people and creating housing? In other words, why do you think the government might incentivize real estate as opposed to some other industry?

Dr. Tom Burns:

Yeah, well we need housing and we all know there's an… I mean, I'm in Austin, Texas where prices are going up. There's an affordability crisis, it's everywhere. It's why a lot of people moved out of San Francisco, that sort of thing. There are people that need housing. In the apartment world, we're still woefully under-built, believe it or not, despite the fact that we've gone crazy and built hundreds of thousands of units in the last few years. So the government needs housing because people have a roof over their head, are stable, they can work and produce and pay taxes. It's a pain to build something. And so at least my impression is the government wants to make that less painful, maybe wants to become our partner. So they give us quite a few tax benefits for building or buying real estate.

Tom Wheelwright:

So what kind of impact did… Were you looking at the tax aspects of real estate when you started investing or were you just looking at the passive income aspects?

Dr. Tom Burns:

Honestly, I was looking at the money and we learned as we go along. So I did my own stuff and I would invest in other people's deals and I'd get these documents, whether it be a K-1 or my financial statement. I'd realize I was losing money on paper but paying less taxes. And so I'd run through the house telling my wife, look how much money I lost on this deal. And she didn't understand what I meant, but it meant we were paying less taxes. Because I was a physician, so I was getting ordinary income and you know what the taxes are for that. But that blended tax rate just kind of started lowering and I was keeping more money, so I learned it on the fly.

Tom Wheelwright:

Interesting. So if we can, can we just run through a simple example? It's hard to do this audio to run through numbers, but I'm going to make the numbers really simple. So I'm going to go ahead and start. I'm going to say, if you don't mind sharing, what was the purchase price of that first condo?

Dr. Tom Burns:

Easy. It was $83,000.

Tom Wheelwright:

Okay. And can you still find a property for $100,000 in the U.S.?

Dr. Tom Burns:

Oh, Tom Burns can't. Somebody might, but I'm not sure what you get. But no, no. I don't think so.

Tom Wheelwright:

It's tough. So if you have $20,000 to invest, can you go find a $20,000 property?

Dr. Tom Burns:

I don't think so, no.

Tom Wheelwright:

It's pretty tough. So one of the things that you would have to do is you'd have to have the capital to do that. So you were the advantage, you were a doctor, so you were making some money. So you had the capital, which is why you had the high tax rate at the same time and you did have the excess money. But let's take a simple example. So let's go to $100,000.

Dr. Tom Burns:

Okay.

Tom Wheelwright:

And as I understand in the Midwest, there are few and far between, but there's still some $100,000 property. One of the most important numbers in real estate is cap rate. And can you walk through what that means and why that's important?

Dr. Tom Burns:

Yeah. Cap rates, it can be a confusing number. So essentially if you bought… So you're talking about this $100,000 property. If you bought that $100,000 property for cash and it had a 5% cap rate, essentially that's telling you that you'll make $5,000 a year. If you- [inaudible 00:18:54].

Tom Wheelwright:

And that's after expenses, right?

Dr. Tom Burns:

Exactly, exactly.

Tom Wheelwright:

Got it. So that's your net income basically before you have any debt, right?

Dr. Tom Burns:

Exactly.

Tom Wheelwright:

So that's that cap rate. So what would be in your mind right now where interest rates have gone up and so forth, what would be a cap rate that you think would be acceptable to you?

Dr. Tom Burns:

So we were looking at cap rates that when times were good, we were looking at cap rates below 3%. And for those listening, the lower cap rate, the more expensive the property is to buy because it's an inverse equation. But I've now heard, I just heard recently somebody was going to buy an apartment complex at a 5.5% cap rate. That's significantly expanded from where it was 24 months ago.

Tom Wheelwright:

And if you bought a smaller property, you'd probably get a higher cap rate depending on where it was. Right?

Dr. Tom Burns:

Probably would, yeah. You'd probably be in… I did hear another one. It was a 6.2% going in cap rate, so not bad.

Tom Wheelwright:

Okay. So in using the numbers, I'm going to actually take a little higher cap rate just so that the numbers are easier because I know the math. I can do this math and I think we can do it audio. But let's say I had an 8% cap rate, so if I had an 8% cap rate that would give me on $100,000, that would give me $8,000 a year. Right?

Dr. Tom Burns:

Right.

Tom Wheelwright:

Okay. So interest rates right now are upwards of 6%?

Dr. Tom Burns:

Oh yeah.

Tom Wheelwright:

So one of the things that I always explain to people is that it's not the cap rate that's the most important. It's the difference between the cap rate and the lending rate.

Dr. Tom Burns:

Right.

Tom Wheelwright:

Do you agree with that?

Dr. Tom Burns:

Absolutely.

Tom Wheelwright:

Because that's the spread. That's the leverage you're getting from the debt. So if you have a cap rate of 5%, but you have an interest rate of 6%, probably not a good deal to go out and leverage that property.

Dr. Tom Burns:

Right. So it's making it hard now. You have to put more money down.

Tom Wheelwright:

Exactly. So that means that… Well, or you've got to find a different kind of property. So-

Dr. Tom Burns:

Yeah, more likely.

Tom Wheelwright:

I mean, it's actually bringing prices down, which is the whole goal of the Federal Reserve is to bring prices down, which when you bring prices down, you push cap rates up by definition. Because if the rents aren't coming down and the prices are coming down, then by definition your cap rates are going up. So let's say we had a 6% interest rate. Could we get a 6% interest rate?

Dr. Tom Burns:

Yes, you can. Yeah.

Tom Wheelwright:

Okay. All right. So if we get a 6% interest rate and we put 20% down, so let's say instead of taking that $100,000 and buy $100,000 property, we get $400,000 from the bank and we buy a $500,000 property. So basically our debt to equity ratio, which the accounting term for it would be four. Four times the debt to the equity.

Dr. Tom Burns:

Right.

Tom Wheelwright:

Right? And if my difference between my cap rate and my interest rate is 2% and my debt to equity ratio is four, then that means that the debt is actually making me 8% on that property. Does that make sense?

Dr. Tom Burns:

Yes.

Tom Wheelwright:

So now what we've done is simply by using debt, we've gone from 8% to 16%. But let me ask you the question. So people frequently, there's some very popular influencers out there that say don't use debt.

Dr. Tom Burns:

Right.

Tom Wheelwright:

So you use debt all the time and you use debt from the beginning, right?

Dr. Tom Burns:

Right.

Tom Wheelwright:

So give me the argument for debt versus no debt.

Dr. Tom Burns:

Oh, you bet. So now if you're using debt to buy a couch or maybe your car, then it maybe makes some sense not to use debt. But as one of our good friends, Robert Kiyosaki says, “Debt will make you wealthy.” And the reason for that is, you put in… So in the example you just gave, you put in 20% of the money. The bank puts in 80%. Well, you as the investor are going to get 100% of the benefits of the property. You get all of the income. You get all of the tax benefits, which you're an expert on that. All the depreciation and all the write-offs and things like that. So the bank just wants their money back. So by using other people's money, you can increase the size of your portfolio and there are hardly any large portfolios that weren't built on debt. So…

Tom Wheelwright:

So why do you want to increase the size of your portfolio? Why not just have the smaller portfolio but no debt?

Hey, if you like financial education the way I do, you're going to love Buck Joffrey's podcast. Buck's a friend of mine, he's a client of mine, he's a former board certified surgeon, and he's turned into a real estate professional. So he has this podcast that is geared towards high paid professionals. That's who he is geared towards. So if you're high paid professional, you're going, “Look, I'd like to do something different with my money than what I'm doing. I'd like to get financially educated. I'd like to take control of my money and my life and my taxes.” I would love to recommend Buck Joffrey's podcast, which is called Wealth Formula Podcast with Buck Joffrey. I hope you join Buck on this adventure of a lifetime.

Dr. Tom Burns:

Well, the more doors you own, the more income that comes into you, the more freedom you have to decide what to do in life.

Tom Wheelwright:

Okay, so let's look at the negative side of debt. So I mean, I'm seeing a lot of capital calls right now. And this is because of the debt, because short-term debt was used on a long-term asset. This is kind of the fundamentals to me is that you use long-term debt on a long-term asset. You use short-term debt on a short-term asset.

Dr. Tom Burns:

Right, good point.

Tom Wheelwright:

So the reason they were using short-term debt on real estate is because they were planning on only owning it for two or three years. And if you're only going to own it for two or three years, even if the interest rate goes up, you're still better off with short-term debt. I mean, the numbers work very heavily towards short-term debt. But what happens if you decide, well I need to own the property longer? You've owned your condos, I'm guessing you didn't put short-term debt on those condos?

Dr. Tom Burns:

No, long-term debt on everything.

Tom Wheelwright:

You put long-term debt on everything.

Dr. Tom Burns:

Yeah.

Tom Wheelwright:

And why do you do that? Why the long-term debt?

Dr. Tom Burns:

I don't like to get caught in the squeeze. Long-term debt, that means you can put it away and forget about it. That's why I haven't had to see that place for 25 years. So long-term debt, there's three variables. There's your interest rate, property taxes, and the market forces that affect your real estate property. So if you can fix your debt, you eliminate one of those three. Taxes are typically going to rise, sometimes you can fix that depending on what you do. And then you can't control the market.

So control what you can. The longer the debt, the better. And so it's just real estate is a long-term gain. Now of course there are people that are flippers, and that's more of a business than real estate investing. So I prefer long-term debt and it's your education that helps keep you out of that kind of trouble because maybe some folks haven't had the opportunity to see that time's changed. Things don't always go up. Real estate's not always easy to do. And boy, when you get caught, things go up slowly, they come down quickly. So short-term debt can bite you in the behind.

Tom Wheelwright:

I think that's really good advice. Now, one of the things that I always explain is that I always look at the purpose of an asset, like real estate, is to put money in your pocket. It's to actually increase your income and your cash flow. And the reason you get the debt is to increase the amount of assets you can get. And so my theory is that, and I want your take on this, Tom. My theory is that if you're afraid of debt, it's because you don't trust the asset.

Dr. Tom Burns:

Right, good point. Well put.

Tom Wheelwright:

That make sense?

Dr. Tom Burns:

And you might not have the education to back it up.

Tom Wheelwright:

Well, and I think you make a good point is that you started small, you were able to afford the hard education so you didn't get into something you couldn't afford. Which is, by the way, why we have this whole accreditation process is that the government doesn't want people getting into something that they can't afford, that they can't control. So you have to be an accredited investor to invest with somebody else where you don't have to be an accredited investor if you control it yourself. So the government's saying, “Well look, if you want to take it on yourself, then that's fine. You can do whatever you want. But if you're going to put your money with somebody else, we want to make sure that you can afford to lose that money because you very well might lose that money.”

And so you learned small and then you built that team and you got people around you who knew what they were doing so that you could minimize that risk. But now when you look at, because you've gotten really good at multi-family, that's something you're really good at. You started with condos, single resident, now you've got multi-resident. You've got some very big projects. How confident are you in those assets when, like right now, the real estate market's in turmoil? How confident are you?

Dr. Tom Burns:

I'm always confident long term. I don't want to sound like a homer, that real estate's always awesome. Everything goes up and down. It's challenging right now, but I think over the next 12 to 24 months there'll be challenges. There'll be some folks that are maybe not as well set up and on some short-term debt as you mentioned, that are going to have some trouble. But I think long term, we're still underserved on the amount of units and homes needed to house people. I think real estate is still going to be solid. If you look back over the years, it's always been a growing industry. Very difficult for young people to buy a house now because of these interest rates and the costs of buying a house and inflation. So I think the rental market is going to do very well. And as everybody should know, everything kind of looks good sometimes from the outside. But there are challenges right now. It's difficult to develop properties, it's hard to buy a property that's stable enough to produce good cash flow.

Tom Wheelwright:

Understood. But let's look at your older properties. So you put long-term debt on there and your debt was less than your cap rate, right?

Dr. Tom Burns:

Absolutely.

Tom Wheelwright:

Your interest rate was less than your cap rate, which I still think is the most important thing to learn in real estate is that your debt has to be less. The rate you pay on your debt has to be less than the rate you're making. Do you see that rents are… We've seen rents start to soften a little bit. Do you think rents are going to continue to soften? You think they're pretty solid for the long term?

Dr. Tom Burns:

I think long term they're solid. Historically they'll go up 1.9% to 2.9%, but they do change. I remember Tom in the '80s. Two big banners on apartments that said two months rent-free and a flat screen TV. Or TV, whatever we had back then. So they do change. But those are not long-term trends. Inflation does continue to make rents rise and there is a lot of demand for rental property. So yes, if you've got good long-term debt where your interest rate's less than your cap rate, you're going to be fine. You're going to be fine.

Tom Wheelwright:

I like that. Okay, so let's go back to our example. So basically what you're saying is that we could double, effectively in this example, we double our return on investment. We went from 8% if we just used our money versus 16% if we use the bank's money, right?

Dr. Tom Burns:

Right.

Tom Wheelwright:

So now I always like to know, okay, so how do we do better? And this is where I've done so much of this study and this is what's part of chapter four of The Win-Win Wealth Strategy, my new book that you're very familiar with and been very, very gracious in promoting. But we have what's called bonus depreciation right now. And in your terms as a real estate investor, how do you describe bonus depreciation?

Dr. Tom Burns:

So the government wants to be your partner. And so they know that when you own a property, stuff wears out. Land doesn't wear out, but sticks and bricks and boards and things wear out over time. That's why buildings crumble I guess over time. So they will give you a loss. And so typically over the long term, you can divide your residential property up into 27 and a half years, or a commercial property 39 years. You can get 2%, 3% a year of phantom loss. You can take that off of your taxes. I'll have you explain that later.

But bonus depreciation is wonderful and was wonderful for the last several years. It's still good. It's really great at 80%, but there are things that wear out faster than 30 years. There's sheetrock, there's appliances, there's all kinds of things. And there's a schedule and you can hire an expert who will come in and say, “These things are going to wear out faster.” The government allows you to take all that depreciation upfront on a certain type of formula that I don't really understand. But essentially sometimes you can get a very, very large tax write-off in the first year when you own something. And that helps-

Tom Wheelwright:

Yeah, so… But I'm going to make that calculation really simple for you, Tom. You're going to be able to repeat this over and over again to all of your students and everybody you talk to. You'll be able to give them this calculation. So my experience is that the categories of items that that qualify for bonus depreciation is basically anything that's under 20 years, that'll wear out under 20 years. And the category of that typically is going to add up in a residential type property to somewhere between 20% and 30% of the cost of the building.

So let's take 30% because I can do that math. And if we had 30%, so let's go back to our $500,000 building. So we've got 30% of that $500,000, which $150,000. Now we get 80% of that, we get to write off in the first year. So that means $120,000 we get to write off in the first year. That's 80% of $150,000. So I can do that math because I can subtract 15 twice from 150 and get to 120. So I'm now at $120,000. And now, typical doctor, if you, now not in Texas but in states where they have tax, what would be a typical tax rate?

Dr. Tom Burns:

Boy, if you're in some other states, my colleagues tell they're pushing 50% and over with state taxes because you're looking at 37.5%, 39% plus the Obamacare tax plus state tax. So it's a big hit.

Tom Wheelwright:

So we'll make it even simpler. We'll say it's 42%, so we've got a 37% federal and a 5% state, let's say. So that's a 42% rate. So if I do the math right, then if I take off 42% of that $120,000 and I put down $100,000, 42% of that $120,000 is about $60,000. So I'm sorry it's about $50,000. So if I put down $100,000, but the government gives me back $50,000, so do I need to actually… So that's money that I have that I don't need to give the government, right?

Dr. Tom Burns:

Right, right.

Tom Wheelwright:

So does that mean that I can buy not a $500,000 property, but $1 million property?

Dr. Tom Burns:

Yeah. Yeah, absolutely.

Tom Wheelwright:

Because I really, if I'm only putting half of the down payment down and the government's putting the other half of the down payment down, then I can buy twice as much real estate, right?

Dr. Tom Burns:

Right. That's money in your pocket immediately. Buy $1 million property or two $500,000 properties.

Tom Wheelwright:

Exactly. You don't have to wait because you know that you're going to have that money available from the taxes, right?

Dr. Tom Burns:

Right. Absolutely.

Tom Wheelwright:

So what that means is if I've got that $50,000 that I'm not giving to the government, then that really means that instead of a 16% return on my investment, I now have a 32% return on-

Dr. Tom Burns:

That's right.

Tom Wheelwright:

… my investment. So basically the government with their incentives even this year, and it's not as good as it was last year, but even this year is allowing you to double your return on investment because they're going to partner with you. Does that make sense?

Dr. Tom Burns:

Yeah, absolutely. Yes, sir.

Tom Wheelwright:

I know you like that part of it.

Dr. Tom Burns:

I love it. That's why I love listening to you and having you as my tax strategist because you make it so simple and it's true. Everything you say is true and people think it's very complicated. And even if you think it's complicated, get somebody on your team that understands it and can explain it like that. It's a gift. As I say, depreciation is magic. It's a magical gift from the government. And that sounds pretty flippant, but by golly it really works.

Tom Wheelwright:

Well, that's actually chapter seven of my first book Tax-Free Wealth is the magic of depreciation. It is magic. I mean, you think about it. Nobody buys real estate because it's going down in value. We buy real estate because we expecting may not be where we're planning to make… We want to make cash flow on our real estate. And I want to talk about that just for a minute. But we also expect it to go up in value and yet at the same time we're getting deduction as if it's going down in value.

Dr. Tom Burns:

Correct.

Tom Wheelwright:

Which is pretty cool. Now, some of those things do. We do have to replace things like carpet and we have to repaint. I just repainted my house at an exorbitant price. And so you do have to do those things and those are real expenses that you have to consider. But in the meantime, the government is giving you an advance on that money and increasing your rate of return. So let's talk about, what role… Let's just kind of wrap up here, but what role do you see taxes playing in real estate? You've got a lot of investors now, so you are actually syndicate deals, right?

Dr. Tom Burns:

Right. Yes, sir.

Tom Wheelwright:

So you have a lot of people coming to you and they're giving you money just like you might have given somebody else money in the early years. So what are they expecting? Not just from a rate of return, but how important do you think that tax side of it is to those investors?

Dr. Tom Burns:

People are becoming more educated and they're asking, which is great, which I like. That education's really improving. So often the investors, investors want… It's show me the money is the first thing, as you said. People want money. They either want their money to grow because they don't need the cash flow now or they want cash flow so they can choose to do with their time. But many are asking about the taxes. Will the depreciation be passed through to us as investors or will you be keeping it as the sponsor?

And so most of the time, and many times if you invest in, if you're just one piece, one person, one investor in a large deal, they will often pass through a good portion of that depreciation pro rata based on your percentage ownership of the project. So you can just without having to have all the knowledge, you can as a individual investor, put $100,000 into a deal and get quite a significant bit of depreciation with the sponsors doing all the work to hire the cost segregation engineer and all that stuff. Everything gets done. You get a K-1 at the end of the year that says, “Hey look, you lost a whole bunch of money.” And that works well for your taxes.

Tom Wheelwright:

Even though you didn't because that's just a paper loss, right? That's not a real loss.

Dr. Tom Burns:

Exactly. Exactly. Paper loss.

Tom Wheelwright:

Exactly. And actually I would take it one step further. You are actually as the sponsor required to pass that on to the investor. Now a lot of sponsors do not know that. And so that's actually something to really pay attention to is does your sponsor… Remember, Tom, you were talking about the team, right?

Dr. Tom Burns:

Yeah.

Tom Wheelwright:

And nowhere is the team more important when you're relying on somebody else's team. It's not your team, it's somebody else's team. And part of that team is does the sponsor, does this syndicator actually understand how the tax law works and are they actually passing on that depreciation? Which by the way, under the law, they're required to. I want to be really clear. This is not an option for most real estate deals. As a general rule, if you've got non-recourse debt, which means that the sponsor is not personally liable for it. If you've got non-recourse debt, you have to pass the depreciation on to those who put the money in. So I actually think that's a very important note for people who are thinking about investing with somebody else.

Dr. Tom Burns:

So that's interesting. As long as I've been in this, we have always passed on the depreciation of course. I don't know if I knew that we had to. So again, you can always learn something.

Tom Wheelwright:

So you mentioned something, there's always this kind of competition between are we looking for cash flow or are we looking for appreciation?

Dr. Tom Burns:

Right.

Tom Wheelwright:

And can you talk about just for a minute here about the importance of cash flow?

Dr. Tom Burns:

Yeah, absolutely. And that was my one goal. I just wanted cash flow. But cash flow that comes in, whether you work, vacation, play with your kids, or sleep is another little bit of magic. Just like depreciation. Once you have cash flow, I ask my people to figure out what it costs them to live. And once your cash flow that comes in without your effort equals what it costs you to live, you can decide what you want to do. And so that could be continue to work, work harder, or grow that cash flow. That gives you choice, choice of what to do with your time, control of your life.

So cash flow, it gives you freedom. So cash flow is king, right? So that will give you the ability to make a lot of choices with some comfort that you don't have to worry where your next meal's coming from. The flip side is the capital appreciation, which is where you put your money in and it sits for all. It's essentially buy low, sell high, right? Buy a stock low, sell it high. Buy a property for $83,000, sell it for $200,000 20 years later. That sort of thing. So I personally, whether it's right or wrong, I favor cash flow because that gives you the ability to choose and decide what you wish to do with your next investment.

Tom Wheelwright:

And when you do it. I mean, here's one so let's get to what's going on in the market right now with the time we have remaining. So like I said, I'm seeing a lot of capital calls right now. I'm sure you are too.

Dr. Tom Burns:

Yes.

Tom Wheelwright:

And this is because they actually had to pay the bank to cap the interest rate on those short-term loans. And now the bank's coming back saying, “Well interest rate's gone up so much, we need you to buy another loan cap, but this is a lot more expensive.” So a loan cap that might have been $40,000 last year is $3 million this year. It's literally gone up that much because of the uncertainty in the interest rates. So when you're looking at the economy right now, I mean, what do you… First of all, what do you think's going to happen? Where do you think real estate is going in the short run? Let's not talk about the long run. We know where you think it'll go in the long run. But the short run, what do you think's going to happen?

Dr. Tom Burns:

I think there's going to be trouble. I don't think it's going to be the bloodbath of 2008, but there's going to be trouble. And there are a lot of opportunistic funds out there who believe the same thing and we're seeing it. I mean Tom, we're seeing it right now. I mean I'm at a real estate conference right now and there are a couple things that happened. One, there are people that had short-term bridge debt for doing value add on multi-family. They're running out of that and they're either going to have to do a capital call or sell for a loss because interest rates have gone up so high that they're a bit underwater. That's a problem. Development projects, they're taking longer. And so loans are starting to amortize now when typically expected to be leased up and stabilized by then. So there's some trouble out there.

I think they will all get rescued by either capital calls, pref equity infusions, or purchased by opportunistic funds. I think everything will be okay. We're not going to see empty neighborhoods like we did in 2008, but there will be people that make money and there will be people that unfortunately on the other end of that equation. I think in the long run we're going to be fine. And we look at our portfolio, nothing's perfect. We have issues with supply chain and COVID has stretched out our timelines, has made us work a little harder as sponsors. But we know long-term that things are going to be fine. So I think yeah, the 12 to 24 months, Lord knows what's going to happen. But it's going to require some lightness on your feet and a good team and access to capital and some creativity. But I think we're going to come out of it.

Tom Wheelwright:

So what are you recommending investors do over the next 12 to 24 months?

Dr. Tom Burns:

So I personally have some cash so that you can take advantage of opportunity if you see it. If you are not in that all the time and you're relying on other sponsors, this will sound funny, but I would suggest you seek out some sponsors with a little silver in their hair. Somebody that's been through the recession of 2008, 2009, maybe back to 2001 because again, we don't know what we don't know. And if you've never been through a recession, you just don't know how fast things happen. So I always think people should always be looking for investments, staying in the market, investing if they find something that makes sense for their investment thesis. But stay in the game because things are going to change, but just be conservative. We are looking currently now for the best of the best. We actually cut down what we were going to do. I think everybody should not be too greedy and look for the best and interview previous investors, interview your sponsors. Be kind of picky about that if you're investing with somebody else's expertise in somebody else's team.

Tom Wheelwright:

Well, and obviously there are some things that you can do that are just like you say, it comes back to the math. And I love that that's where you started is it comes back to the math is that look, if your cap rate and you're confident in your cap rate and your cap rate's higher than your interest rate and your interest rate's a long-term interest rate. Because they're talking now about another 0.5% raise and they're talking about accelerating where the… The market all thought that this was going to level out, but then inflation raised its ugly head again last month. So if you're looking at those numbers, are you comfortable that if you find a property where the cap rate is, there's some good spread between the cap rate and the interest rate that you're going to be okay?

Dr. Tom Burns:

Yeah, absolutely. I mean, example is, I've been around for a while. I bought my first house at a 10% interest rate and I was happy to get it and it worked out fine. And even before that, it went higher. So the math tends to follow. Sellers tend to, they're a little slow at with their pricing, but the market pretty much forces that hand. And so we do see cap rates rising and it all levels out. It's just sometimes they're a little bit disjointed in their timing. So I'm ultimately confident real estate's been good. Real estate goes back thousands of years. It's going to be okay and it's very local. So the government will say, “Hey, real estate's down right now. It's not the favored asset class.” Well real estate is hyper-local. There's always a good deal whether it's good times or bad times.

Tom Wheelwright:

I like that. So if you were to say two or three things that an investor could do right now when it comes to real estate investing, what would you tell them?

Dr. Tom Burns:

I would tell them, try to understand the numbers that Tom talked about. Those really are important and that gives you some confidence and comfort. I would continue to get educated. Listen to podcasts, get feeds sent into your email so that you can just stay up on what's going on. It helps to understand some macroeconomics to see what people are saying. They're going to say different things for sure and get to know some. If you are a passive investor, not an active investor, get to know some sponsors. Talk to people that are really happy with who they've worked with. Get some references, talk to folks, and be ready. And if you do your homework, you can do pretty well and nobody's ever going to guarantee that you're going to make money. But what you want is if you happen to lose money or not make as much as you thought you were going to make, you want it to be because of market forces that were unforeseen, not because of somebody that was not capable or had a lack of integrity. That's very important when you're investing with somebody else.

Tom Wheelwright:

I love that. Thank you, Tom Burns. Tom Burns' book is Rich Doctor, and you can find him at richdoctor.com. I love what you've done. I love your experience and I love you sharing your experience, Tom, and I know you're really putting a lot of effort into sharing your experience in educating people. Really appreciate that. I might add one more thing is I have to make sure that if you are looking at your sponsor, make sure that the sponsor understands taxes and that they're doing that cost segregation. They're giving you that bonus depreciation because remember the taxes can double your rate of return. So who doesn't… Do you really want to get the lower rate of return? Did you want to double your rate of return and get those big tax benefits? And I think when you do this and you really follow the numbers, you start small, you get the team around you, all this great education that Tom recommends, what's always going to happen is you're always going to make more money and pay less tax. We'll see you next time. Thanks, Tom.

Dr. Tom Burns:

Thank you.

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