In my last real estate post, I mentioned how I was considering setting up a holding company.
I thought about it for a while, read up some more basic information on it, and ran some analysis numbers. In the end, it definitely made sense to do so.
The setup costs ended up being a lot less than I had thought. I thought it would be close to $15,000, but my accountant corrected me saying that that would only have been if I decided to set up a family trust as well. I decided to delay the setting up of a family trust until sometime in the not-too-distant future, since I think it’s a bit premature for that yet. I definitely went ahead with the holding company though.
I am now the sole shareholder of 2 corporations.
The incorporation costs for the holding company should only be around $1,200 or so (my corporate lawyer hasn’t billed me yet, but that was the quote). However, I will now have added ongoing legal (paperwork) and accounting costs. Legal will be around $500-600 a year, and accounting approximately $5,000 a year.
That’s a little scary, because that’s now money I have to pay regardless how well my business does. Whether I make $100,000 a year or $0 a year, I have to have $5,600 ready at the end of the year to pay my lawyer and accountant.
But the money I’ll save in the long run by setting up this holding company will more than make up for any costs associated with its setup and ongoing costs.
I decided to go with a Named Corporation as opposed to a Numbered Corporation, the latter of which is slightly cheaper and quicker to setup. I spent a while thinking of what name to use, and after asking some contacts on Skype, was satisfied with my ultimate decision.
The setup of the corporation is still underway. The name is all set up, but I have an appointment to come in on Monday to sign all the paperwork.
I haven’t decided if I should bother getting a logo, stationery, etc. setup for the new corporation or not. Seeing that it is a holding company and not an operating company, I think I’ll pass.
I’ll also have to set up a new bank account for the corporation. Man, I’ll have so many bank cards soon… it will be, let’s see… 6 different bank accounts now!
Anyhow, again, the corporation will be "live" by Monday.
I won’t bother discussing the added legal or corporate structure benefits, but will share the numbers as to why I ultimately decided to go ahead with setting up the holding company.
Night and Day Real Estate Numbers
Okay, so the main reason I ultimately decided to set up a holding company is regarding real estate.
As it turns out, if I purchase income property through my corporation, regardless of whether the property is an actual commercial property or not (4+ units or business), mortgage lenders here will require that I use a commercial loan.
A commercial loan, as compared to a residential loan, basically only has downsides:
- 25-year-amortization (versus a 30-year-amortization with residential)
- 1% higher mortgage rate (killer on the larger properties!)
- 1% mortgage broker fee (residential lenders pay the broker, commercial lenders do not)
As you can see, the above really killed my numbers, especially cashflow, and my heart sank a bit after I found out I would have to use commercial lending and these handicaps.
But there was a way out. Apparently, even though a holding corporation and an operating corporation are more or less the same thing on paper, my broker says the lenders here will allow a holding company to use a residential mortgage! And so, on Monday, I should be all set up with a holding company.
Here are how the numbers look on one of the properties I’m interested in with residential and commercial lending (last night I actually added functionality into my spreadsheet to toggle between the two for easy reference):
I mean, that’s a 65% improvement on cashflow! That’s huge!
Here’s the comparison on another of the properties I’m interested in:
…and boom, from negative cashflow to positive, not to mention a 4%+ jump in 5-year ROI!
What’s even better, is that the more properties the holding company amasses, the better the payoff. That’s because I only have to setup the holding corporation once while still have it purchasing properties under residential loans.
There will be a limit eventually though, perhaps after 4 properties or so, before I’ll be "maxed out" on residential mortgages and will then have to get a commercial loan. But by then, I should have enough passive cashflow to offset the added commercial loan expenses.
I will be looking at a few more properties either tomorrow or on Monday. They don’t look all promising though, to be honest. I have a few on my existing list that I do like, but I have to wait for the holding company and bank to be all finished up before I can make an offer.
I may also need to complete my operating corporation fiscal year end as well… which would take about a month if required.
Surprisingly, I am a very late adopter when it comes to technology. I stayed with my Blackberry until just around 2-2.5 years ago, I didn’t sign up to Twitter until several years after it was already out, and I didn’t even have an Instagram account until just a few days ago.
The reason for this is because with new technologies and social networking sites constantly coming out, I don’t want to waste my time trying to gain a presence on each one if I don’t know if they’re going to last.
I decided to finally sign up to Instagram for a couple of main reasons:
1. Some websites and platforms have social media prerequisites, and I found myself not being able to take advantage of a good opportunity a little while back because I didn’t have an Instagram account.
2. I am not a big social networking "follower" kind of guy, but there has been the odd occasion when I wanted to view somebody’s photo they linked on Twitter or elsewhere, but was unable to because I didn’t have an Instagram account.
And so, I am now on Instagram!
My username there is tylercruzdotcom.
So far, I only have 1 friend/follower (LukePeerfly), and I want more
I have 10 photos and 1 video in my account so far, and have my account set to private, so you will need to follow me before you can see my photos.
I’m still brand new to Instagram obviously, but from what I can make out of it, it’s basically like Twitter but with photos. But… you can add photos (and more recently, video) with Twitter too…
So, what I decided to do is to use my Instagram account to share my photos as taken with my phone, and will only post my PC desktop images (screenshots) via Twitter. As a result, my Instagram account will inevitably be a bit more personal oriented.
My username is tylercruzdotcom though, so the account is made for the business side of me and so I’ll try to include business-related photos… but being that I work from home it may be a bit difficult. Especially since I don’t go to conferences. Perhaps I’ll include photos when I purchase a new toy or something, or maybe some shots from when I go real estate hunting.
A lady named Jackie contacted me from PersonalCapital a few hours ago with the following question:
"Your 20s are typically the perfect time to start planning for retirement, but
sometimes life gets in the way. What did you do successfully in your 20s, or if
you could go back in time, is there anything you would have done differently to
ensure a better financial future sooner in life? In a post on TylerCruz, I would
love to hear your thoughts on how you could’ve built your financial safety net
in your 20s better–and how you can start it now if you haven’t already. What
would be your ideal retire at 65 plan?"
To change things up a bit, I thought I’d go ahead and dedicate an entire blog post to answer her question.
First off, I do no think there is much I would change if I was back in my early 20’s. I mean, I’m assuming that I couldn’t do anything obvious such as invest in Apple stock or "invent" YouTube. I’m also assuming that I couldn’t start affiliate marketing sooner. So no – there isn’t really anything I would do differently.
I have always been pretty good with managing my money. I don’t suffer from shiny object syndrome, needing to have the latest car or smartphone. In fact, I still drive the same 2004 Corolla CE that I bought when my blog was just starting out a decade ago. At the same time, I’m not penny pinching either – just yesterday I bought a new patio set for the back yard. The year before that, I bought a nice new house with my girlfriend.
Instead of saving money, I prefer to make money.
Time > Money
The most valuable commodity in the world is time. Not money.
I could write a whole other post about how I don’t agree with how some people (especially in my industry) are working 16 hours a day every day, just so they can buy a 3rd Lamborghini instead of working maybe 4 hours a day so that they can enjoy 1 Lamborghini, but I’ll save that for another day.
Instead, I think I’ll focus on the other end of the spectrum first – the penny pinchers.
I know a lot of people who are always trying to get the best bargain, the best deal, the lowest rate. Personally, I automatically equate money to time. For example, yes I could bake my own bread and maybe save a few cents on the loaf (although I wouldn’t be surprised if it ended up costing more due to the economy of scale!), but at the expense of time. At least an hour. More likely a few hours if you include clean-up, looking for a recipe, watching the oven, and the actual preparing of the dough (and letting rise and all that crap!). So in the end, I’d basically be trading the saving of 50 cents or so (remember, you still have to pay for the ingredients!) in exchange for 1 hour of time (absolute minimum!). I’m worth far more than $0.50 an hour.
You might think that that’s an extreme example, but I mention it to prove a point; there are countless things people do all the time just to save miniscule amounts of money, but at the expense of their time.
Here are a couple of other random examples just off the top of my head:
- Repairing relatively cheap things ($<100) and spending the time and resources to do so instead of simply buying a new one, which will almost always be a better use of your time and money.
- Driving to a store twice as far away just to take advantage of the 10% discount.
- Cutting out and using coupons – it’s not even worth the time to do all that crap in most cases!
- Fixing a car
Okay, I don’t want to continue too far on this point, but you can see how I look at this type of thing. I simply determine how long it would take me to do something, add in all the costs it would take as well, and compare that to how much I could make by simply working at my job instead.
True: the less a person makes, the more it might make sense to do things on your own, but the fact remains clear – they are still trading their time for money. The only difference is that it may make more economical sense for them to fix their own car rather than make the minimum wage.
Which leads me to my main point…
I Like to Make Money, Not Save What I Have
When you’re saving money, you’re just hanging onto what you already have. You’re not even really saving money, really, you’re just spending less.
There’s only so much you can actually save, and that is always dependant on how much you’re making. And for most people – maybe 99% – there is a very small scale of earnability (there’s no such word), meaning that there’s only so much that they can ever save.
You can save all you want and put that money into basic guaranteed investments that will at most keep up with inflation, but that will almost never even get close to comparing with how much you can end up with if you focus on making money instead.
By making money, I mean doing anything outside of your normal non-self employed job that actually brings in money, as opposed to simply saving money. This could be anything from getting a 2nd part-time job, to buying old stuff on Craigslist, fixing them up and selling them at a profit, to teaching English to non-native speakers over the Internet.
Yes, this all takes time of course, but that’s my point! You’d be making a lot more money on an hourly basis teaching English online for $15/hour than you would saving $0.50 hour baking your own bread. Or $10 an hour to drive twice the distance to pick up those cheaper headphones.
I’m sure you guys could think of some scenarios and examples where my point does not reign true, but in general I think most of you will agree that it does.
My Advice to Young 20-Year-Olds
So to circle back to Jackie’s question, here’s my advice to the youth of today who are interested in long-term wealth:
Don’t be stupid with your money by spending more than what you have. You don’t need a new car every 2 years, or a new smartphone every 2 years. I was reading a post on BiggerPockets (a community for real estate investors), when I learned of one investor there who drives a basic older non-flashy car that has a bumper sticker that says "My other car is an apartment building". Haha, love it!
Don’t buy things just to impress other people. Impress them by not being in debt. Buy a fancy car once you’ve hit a specific money-related goal for yourself and deserve it.
Focus less on penny pinching to save $1 here and $0.50 there, and more on how you can increase your cashflow (Related book recommendation: Rich Dad, Poor Dad by Robert Kiyosaki), whether that be on working to get a promotion, getting a 2nd job, or creating your own job and becoming an entrepreneur!
Think big (realistically), not small. Focus on increasing your hourly earnings from $10 to $20 instead on how you can save $15 here or $20 there.
Hope that wasn’t too didactic, and I hope that answered your question Jackie!
I’ve been continuing to focus 100% on real estate lately, completely ignoring everything else.
Mainly, I’ve been studying by reading countless articles and forum threads on BiggerPockets – an online community for real estate investors. Think of it like StackThatMoney but for real estate investors.
I’ve also been rehashing my numbers over and over again and constantly improving my analysis spreadsheet and learning the numbers. Just when I think I have a good foundation on the numbers, new things constantly pop up.
I’ve also been in constant contact with my realtor and my mortgage broker, and soon will need to meet with my accountant again and possibly a lawyer. Real estate, real estate, real estate.
Here’s a breakdown of what I’ve been up to the past week:
Upon talking to my mortgage broker to keep her up to date with my recent escapades, I was reminded/informed that I would likely need to end up obtaining a commercial loan as opposed to a residential loan.
The reason for this being that I will be purchasing the income property through my corporation, which apparently must be done via a commercial loan.
So what are the differences between a commercial loan and a residential loan? Well, there are a few… basically a commercial loan is kind of the "next step up" and is usually required for anyone (whether it be a corporation or an individual) who has "maxed out" the number of mortgages they already have, or is purchasing a property that comprises of typically over 4-5 units such as a small apartment.
Commercial loans are also generally used for any large purchase, or non-residential purchase such as for retail mortgages for example.
For the loan applicant, they are basically worse than a typical residential loan in every regard:
- The interest rate is higher (from 0.5 to 1.5% higher) which is the #1 downside by far
- There is often a balloon payment required
- There is usually more analysis and due diligence done by the loaners
A balloon payment is basically a requirement that the FULL amount of the loan must be paid back in a set time, typically in around 5 years. Even though the amortization might be for 30 years, a balloon payment might be required to be paid off in 5. If it can’t, then a refinancing is done with the current rates at that time.
However, my broker says that I can get around commercial lending in two ways:
- By purchasing through my personal self instead of through my corporation (which I will definitely not due for legal and tax reasons).
- By purchasing through a holding company
My accountant sat me down and explained to me the pros and cons (mainly pros) of setting up a holding company a year ago, and I also briefly read up on it the other day, but while the idea of it may be somewhat simple, it can get really confusing quickly.
I won’t bother explaining about it here as you can read up on it yourself if you’re interested, but basically it would cost me like $8,000-$15,000 to set up a holding company and I’d have to go through the process of lawyers and accountants again.
I’d also have added fees down the road for accounting and legal "preparation", but they would probably only be around $500 a year extra I’m guessing.
The thing is, apart from other legal and tax benefits of owning a holding company in addition to my corporation, that I’d be able to use a residential loan instead of a commercial loan, which over the long term would actually make up for the set-up cost of creating a holding company.
I probably have to talk to my accountant again about this to see what I should do.
Debt Service Coverage Ratio
One of the new numbers I learned about recently is the Debt Service Coverage Ratio, or DSCR.
This article on BiggerPockets explains what it is very well.
Basically, it is a metric used by the banks (especially in commercial lending) that is a big determining factor in deciding whether or not to grant you the loan. Typically, they want to see a ratio of 1.2 or higher, although depending on the strength of the deal, they may accept a lower rate.
A ratio of 1.0 means that the deal breaks even in terms of cashflow (basic expenses are used only). 1.2 means that it will cashflow at 20%, so they know you have money to cover repairs and other issues that come up. It’s a simple metric helped to quickly assess and compare deals that they use.
I’ve added this into my spreadsheet, and all my deals would hit the 1.2 mark (in fact, some go as high as 6.5!). However, this means that on most of them I would need to make the highest down payment I can, which removes a lot of the creativity I can do numbers-wise.
Redid CoCR Formulas; Added ROI
I decided to redo my Cash on Cash Return formulas because before I was factoring in equity into it, and by definition the CoCR should be net income for the year only, so I decided it would be better to only factor in pure net rental income and not gained equity.
I also added a simple ROI column into the After Selling Closing Costs table, which gives me an ROI factoring in everything including both buying and selling closing costs per given year.
I’m now using that (in particular, year 5) as my primary base metric on which to compare deals, with net cashflow being the other.
Here is the latest Main page of my analysis spreadsheet, this time showing one of the cheapest properties on my shortlist. Sorry, you’re going to have to squint… it’s hard to cram all that info here:
I increased my given mortgage rate from 3% to 4% in my spreadsheets to account for the commercial lending difference. As a result, it absolutely kills my cashflow and ROI. Ugh.
For example, on the property above, I’m only achieving a 6.45% ROI after 5 years…
The only thing I don’t account for in my spreadsheet is property appreciation and rent appreciation.
Now, rent appreciation may sound like I’m reaching for every extra income here, but it’s actually nothing to sneeze at. My realtor sent me this link of rental changes over time, and in a nearby city, rents increased by 9.4% in the past 5 years.
On the property scenario above, it’s currently bringing in $1,700 a month in rent. In 5 years, that could rise to $1,859.80 using the 9.4% number again (although it’s likely to be even higher due to population density only increasing here). That’s $159.80 more a month which works out to $1,917.60 more a year. And that’s on the cheapest property I’m looking at.
So, these things do add up.
Market is Still Dead
Right smack into spring and nearing summer, the market here is deader than ever. It’s still such a seller’s market.
Nothing new meeting my criteria is hitting the market, and there is maybe 1 price drop every 2 weeks.
I have a shortlist of 5 properties that I’m interested in, but the numbers are really not too desirable on any of them now due to the increase in mortgage rate I’m looking at with commercial lending.
Nearly Bought a Duplex
If you remember from my Affiliate Landlord: Hitting the Streets – Tour #4 post from a couple of weeks ago, I was fanatical about a property I called the The Dark Horse Duplex.
I was so serious about it, in fact, that I scheduled to take another look at it a week later with my realtor. We went into the first side first again, and walking through it, it wasn’t quite as high end as I had remembered it to be. It was still good overall, but it didn’t have the same "wow" factor it did the first time.
Taking a look at the roof again, it is pretty apparent that it indeed very likely that it needs to be replaced. That’s a $12,000~ expense right there.
But the biggest surprise was the 2nd side. If you remember, we couldn’t see it on our first visit because the listing realtor had given us the wrong code to enter. I knew beforehand that it wouldn’t be as nice as the first side, but sadly I was extremely disappointed with what I saw.
You could tell that all the renovations that were done were very amateur. I am not very handy myself, yet I could spot a lot of shoddy craftsmanship – namely in the floors. It’s just a shame, because there were so many renovations done, and with just a bit more care, they could have been done really nicely.
I mean, the place is decent, but I just noticed all the imperfections in the renovations.
In addition, the 2nd unit is a little bit smaller, but not by too much.
Prior to entering the building for the 2nd time, I was ready to make an offer. The 2nd viewing was more of a mere formality than anything else really. But afterwards, I walked away very disappointed.
I am still open to purchasing this place, but it must make a pretty recognizable drop. The roof needs to be replaced, and the renovations on the 2nd side weren’t done professionally.
Back to Affiliate Marketing Very Soon
I mentioned in the past that one of the main reasons I wanted to invest in real estate income properties was so that I could put some of the money I made from affiliate marketing into more passive means of earning money. After all, affiliate marketing is extremely volatile, and also requires active participation in order to keep making money.
That is all true, but there is another reason as well.
After a while, making money month after month with affiliate marketing can get a bit… boring. I mean, it takes a lot of work and all that, but what’s the point? What do I need the money for? Apart from breaking new personal bests, there is not a whole lot of incentive for me to work because I already live a comfortable life.
Would I love a new car or a bigger house? Of course! But that is more of an excuse on how I should spend my money, rather than a desire to make more of it.
With real estate, I discovered that I am actually pretty interested in it! But where I live, real estate is pretty expensive, and the corresponding rents are comparatively low. As such, I need a lot more capital in order to make any noticeable growths on the real estate side.
I think that if I can generate around $4,000 a month in net cash flow with real estate, that I would then be at the tipping point to where things start to skyrocket.
I stopped affiliate marketing partly due to all the health issues that came up, but also partly due to boredom. I now have a new reason to try to strive and get money rolling in again – every $1,000 I make is another $1,000 I can put towards my next down payment.
*Haha, first time in over 1,000 blog posts I ever ended a blog post with the end (although this one comes close: http://www.tylercruz.com/the-3-little-web-entrepreneurs/)