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You can either be a conformer or you can build wealth. The choice is yours.
“Putting your money to work for you,” despite being a popular piece of advice for generations, does not build wealth. If you were one of Apple or TikTok’s earliest investors with your own money, congratulations. But those stories are exceedingly rare.
People who invest in 401(k)s and IRAs might retire comfortably if they make sacrifices along the way. But this won’t build generational wealth. Wealthy people know that ethically getting other people’s money to work for them is what builds wealth.
The good news is that everyday people can take a page out of a wealthy person’s playbook and use other people’s money for their own financial gain. In fact, when you own cash flowing real estate that you purchased with a loan, you use other people’s money three ways at the same time:
1. The bank’s for leverage.
2. The tenant’s for income.
3. The government’s for tax incentives.
Your Return From Property Equity Is Always Zero
Real estate has made more ordinary people wealthy than anything else. But understand that home equity is unsafe and illiquid, and its rate of return is always zero.
Look, it might “feel right” to scrimp, save and make sacrifices to accelerate principal payments until a property is paid off. Then you’re an equity sitter. But this kills your velocity of money. Even mortgage-free, you’ll still have a housing payment: You’ll owe on property taxes, insurance, maintenance, repairs, utilities, HOA and more.
Property flipping is an active strategy that creates gains in chunks if you know specifically what you’re doing. But you need to stay active to keep getting a paycheck. Also, this active income is taxed at a higher rate than passive income. Flippers have spending money. Buy-and-hold investors build real wealth.
Equity sitters get old, and house flippers get tired.
Owning a few paid-off properties is a slow way to wealth. Having small equity positions in many properties is a fast way to wealth.
Don’t Flip Properties; Flip Equity
Property flippers use a crowbar. Equity flippers use a calculator.
Let’s use an example. Say you own a paid-off $1 million apartment building. At a 5% appreciation rate, this yields an annual capital gain of $50,000. This occurs regardless of the amount of equity you have in the property. Therefore, if you sell this property and use the proceeds to put 25% down payments on four $1 million properties, you have $4 million worth of property.
The following year, a 5% appreciation rate on your $4 million worth of property yields a $200,000 annual gain. You profited from a gain on both your money and the bank’s money (leverage). In this case, no property renovation occurred. You didn’t have to flip a property. Instead, you “flipped” equity. This increases your velocity of money and portfolio size and creates leverage.
You’ve created four levers beneath four properties rather than having zero leverage in one. Recall what Greek mathematician Archimedes said: “Give me a lever long enough … and I shall move the world.”
Personally, the property that I’ve owned the longest in my portfolio was bought seven years ago. If I hold property too long, it becomes equity heavy, and I lose leverage. Because equity flipping incurs transaction costs like agent commissions and make-ready expenses, you’ll need at least 35% to 40% equity in a property before selling it.
Rather Than Paying Your Own Debt, Outsource It
Now, you may be wondering: Isn’t this risky? Don’t 75% loans on $4 million properties mean that you incur $3 million in debt? What if the housing market endures a correction and all of these properties lose value? In fact, this phenomenon crushed investors in the housing crisis and mortgage meltdown of 2007–2010.
Any worthwhile investment has risk. You hedge yourself from losses when you buy property for cash flow (in which monthly rent income exceeds monthly expenses) in multiple markets that have diverse economic sectors. In fact, the market is more important than the property. Owning property for cash flow is what actually made this strategy succeed for me during the housing crisis. When first-time home buyers could not qualify for loans then, it increased the rental demand.
When your rent income exceeds your expenses, you’ve outsourced your debt service to tenants. A portion of their rental income goes to your mortgage’s principal, interest and some extra on top called your cash flow.
Having many small equity positions rather than fewer concentrated ones means you have the ability to own more property and be diversified in several different markets. When you buy right, this “low equity, high debt” positioning actually decreases your risk.
What are your takeaways? Middle-class people get their money to work for them. Wealthy people ethically employ other people’s money — the bank’s, the government’s and their tenants’. You can grow wealth faster by owning small equity positions in many properties.
Why not go out on a limb? That’s where the fruit is.