Many investors fall prey to adversarial behaviors where they adopt a pro-risk attitude with their investments, but when it comes to the strategies we are going to discuss, they adopt more of a scarcity mindset.
It is well known that entrepreneurs and real estate investors create the most wealth in the world. I’m going to explain how you too can benefit from the same strategies the rich use to build 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:
- They take advantage of other people’s money to increase their wealth.
- They continue to benefit when the assets they own appreciate over time.
- They benefit from exponentially greater cash flows through leverage and exploitation of their assets.
#1: They exploit other people’s money
Most often, when a real estate investor buys a property or constructs a building, they take out a loan from a bank to finance the project. They rarely pay for properties in cash. The more resources they tie up in one property, the less cash they have to acquire other properties. By using bank 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 guarantees the property in exchange for the capital to acquire the property. Suppose an investor buys a property valued at $100,000. The bank finances 75% of the purchase price and the investor 25%. By doing this, the investor now has a property valued at $100,000 that he paid $25,000 out of pocket to acquire.
From a retail perspective, you can highlight that there is a loan and the equity position is only 25%. That’s true, but there’s more to why it’s a huge plus for the investor. Which brings me to the next point.
#2: With their asset growth comes an intrinsic advantage
What many people don’t understand about real estate is that property is worth the same whether it has a mortgage or not. In our example, even though the investor has a $75,000 loan, the property is still worth $100,000.
This is important because the investor – not the bank – benefits when the property appreciates. The investor benefits from a $100,000 property that appreciates with only $25,000 invested. In other words, if the property appreciates 5%, or $5,000 on the $100,000 property, that’s actually a 20% return on the $25,000 investment of the investor. This is called an internal return.
#3: Their cash flow grows exponentially due to leverage and trading
Of course, no investment property is acquired without the potential to generate cash flow from operations. Whether it’s a business operating in the property or a lease, the investor has a plan to create cash flow from the use of the property.
Now this is where the multiplication happens, 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. Suppose the rent collected is $1,200 per month or $14,400 per year. Using the same calculations as before, $14,400 would equal 14% of the property value and 57% of the investor’s $25,000 investment. This is an external return.
After canceling the mortgage payment on the $75,000 by about $6,000 a year, or 6%, the investor’s returns are still over 30%. And when you combine that cash flow with building appreciation, you get an annual return of over 50%, all things considered.
This is why an investor often favors the use of money from the bank. Yields are higher. And if you multiply that 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 just one property.
Of course, this involves risk, as with any investment, and the actual returns from a real estate investment will vary from transaction to transaction.
The advantages of this concept if you are not an entrepreneur or a real estate investor
This concept of internal and external returns can apply to anyone with real estate, but it can also 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’s worth taking a moment to dispel some common myths.
The Mortgage Myth
The challenge that many people face with a home mortgage is the misconception of what constitutes sound financial advice. On the one hand, an investor believes they can invest in the stock market and earn 8-10% over time, while simultaneously supporting a contradictory view that having a 3-4% mortgage is a bad idea. . If that’s you, I’m sorry to say, but that mindset doesn’t support its own logic.
If you think it is possible to get a higher return than what is otherwise paid to a bank for the mortgage, then there is no mathematical evidence to support accelerating mortgage repayment.
Of course, there are those who simply don’t want to have a mortgage – and that’s a personal preference, not an economic decision.
The myth of life insurance
There are few topics more misunderstood than life insurance. With all the uses and applications and the multiple types of policies, it’s easy to see why the opinions and views of life insurance are all tangled in a web of confusion.
But let’s be clear: when a dividend-paying whole life policy is designed and funded properly, its benefits mirror those of most real estate. Both are similar in that they create equity, increase deferred tax, allow tax-free access to money, and can be held freely and clearly.
With the overlapping characteristics of life insurance and real estate, I see the two being used as a conduit to receive both an internal and external rate of return.
So here’s what we know to be true:
- Real estate will appreciate the same whether it is mortgaged or not – Internal return.
- Accessing cash through real estate refinancing is a tax-free operation.
- Holding on to cash while raising capital can improve cash flow – External return.
The same can be said about a specially designed life insurance policy:
- Cash values will appreciate in the same way whether or not there is an internal yield loan.
- Accessing cash through a loan is a non-taxable transaction.
- Holding on to cash while raising capital can improve cash flow – External return.
One of the advantages of a life insurance policy loan over a bank loan is that there is no obligation to repay the loan. This is a cash flow advantage because you have the ability to set the terms.
Here are some quick examples
Let’s say you have some investments and need to make improvements to your home. Consider using the equity in your home to make these improvements rather than using your investments. There are three advantages to this:
- You keep your money invested and growing.
- You use the equity in your home that is not earning anything to increase the value of the house.
- You could potentially increase your cash flow depending on the performance of the investment and the current mortgage balance.
Another example would be to use specially designed life insurance:
- The insurance company lends you money while your money stays in the growing policy.
- You receive an internal rate of return on your policy money while using the money taken out as a loan to create a new asset that appreciates, giving you both an internal and external return.
- You could potentially increase your cash flow based on new assets and ongoing bank payments. In other words, the policy works like your bank.
Proper use of these strategies can be a catalyst for building wealth and increasing cash flow efficiency within your personal economy. To learn more about how to build this system for yourself, visit BUILDBanking.com.
Benefits and guarantees are based on the insurance company’s claims-paying capacity. Results may vary. Any descriptions involving life insurance policies and their use as an alternative form of financing or risk management techniques are for illustrative purposes only, will not apply in all situations, may not be fully indicative of present or future investments and may be modified at any time. at the discretion of the insurance company, the general partner and/or the manager and are not intended to reflect guarantees on the performance of the securities. The terms BUILD Banking™, Private Banking Alternatives, or Specially Designed Life Insurance Contracts (SDLICs) are not intended to imply that the issuer is creating a real bank for its customers or to communicate that life insurance companies are the same as traditional banking institutions. This material is educational in nature and should not be considered a solicitation of any specific product or service. BUILD Banking™ is offered by Skrobonja Insurance Services, LLC only and is not offered by Kalos Capital, Inc. or Kalos Management. Skrobonja Insurance Services, LLC does not provide tax or legal advice. The opinions and views expressed herein are for informational purposes only. Please consult your tax and/or legal advisor for such advice.
Founder and Chairman, Skrobonja Financial Group LLC
Brian Skrobonja is an author, blogger, podcaster and speaker. He is the founder of the St. Louis Mo-based wealth management firm Skrobonja Financial Group LLC. His goal is to help his audience uncover 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 received the Best Wealth Manager award, in 2021 received the Best in business award and the Future 50 in 2018 from St. Louis Small Business.