It’s a well known assertion, at least in real estate circles, that more people have become wealthy in the USA through real estate than any other pursuit.
There are many UNIQUE aspects of real estate that build or contribute to wealth accumulation.
Real Estate Wealth Building Strategies Using Life Insurance
So, what are the unique benefits of a real estate wealth building strategy? We provide the following 6 for you to consider.
One way that real estate creates wealth is appreciation. This aspect of real estate is demonstrated by the real estate market itself and rising property values across the spectrum over time.
After all, you only need to talk with someone who bought a home many years ago to see how real estate has appreciated considerably over the last century.
As a product in demand, real estate appreciation may be a result of inflation or other economic changes affecting the cost of living.
In this single way, real estate is a bit like stock market investing. However, the similarities with stock investing may end here.
Whereas real estate is a primary asset that people need, and therefore is accompanied by some level of consumer demand, stocks are intangible or, as Robert Kiyosaki states in his book Second Chance, a tertiary asset rather than a primary or secondary asset.
The tertiary nature of stocks and the fact that no wealth is actually created (with the possible exception of dividends) is one of the reasons that stock market investing is a zero sum game for the participants. Zero sum means there must be a winner and loser in every stock trade.
Real estate is often a positive sum wealth builder in a number of other ways. Not only do you have a product creating cash flow and potential appreciation, but you also provide a service (housing) to others.
As populations grow and markets expand, real estate that was once of nominal value can become highly sought after and command high compensation. This phenomenon is also described as being in the path of progress.
While one property may sit for decades with only nominal change, real property in a growing area may double or triple in value. So, those with unique foresight and vision are often rewarded with higher profits.
Land Development and Assembly
When real estate is situated in an opportune location, such as the center of a sought after retail development, the owner of the last track needed of land can have substantial negotiating power.
When these tracts are acquired by developers, the process of improvement continues as zoning matters are contended with by teams of experts. Nowadays, environmental clean up and mitigation issues like storm water retention and green space are often addressed and the public at large benefits.
Real Estate Improvement
Some real estate investors acquire real property that is either distressed legally or is in bad need of repair OR both.
Either situation is often deemed a fire sale, and requires some special skills such as legal knowledge and/or construction or project management.
Improving real property in these ways is a win-win situation, because in seeking a profit, the investor is motivated to resolve legal title, debt or tax issues AND/OR rehabilitating the property by making it attractive and useful once again.
Everybody wins when real estate deals are done right.
Another way that real estate contributes to compounding wealth building is through tax advantages.
On the residential side, the benevolent souls over at the IRS allow the mortgage interest deduction.
So, even on your home, which Kiyosaki defines as NOT an asset because it doesn’t produce cash flow, you get a tax reduction that contributes to wealth creation because those tax savings may be invested elsewhere.
For investment real estate, the tax advantages get much better, because depreciation is allowed ever year over a period of time depending upon whether the real property is residential or commercial.
Further, cost segregation can provide additional tax benefits through accelerated depreciation of tangible personal property.
Also, other expenses such as improvement labor and materials and other business expenses can be deducted from taxes.
Finally, investment property can be rented to a third party resulting in, you guessed it, cash flow.
Another important advantage to real estate investment is the ability to use state homestead exemption laws OR build wealth in asset protected structures. This is a way to help make sure that wealth continues to grow. Asset protection laws can vary depending upon the state.
And the asset protection increases substantially when you use life insurance as your real estate wealth building account. Cash value life insurance has creditor protections in most states, providing another layer of asset protection.
Real Estate as a Positive Sum Game
For all of the above reasons, real estate investing is a positive sum game.
The landowner who initially acquired the real property paid the taxes and cared for the real property until such time as the need and demand matured.
Land assembly and development is a win-win situation because the new owner or developer has acquired a valuable property that may be joined with neighboring tracts and improved further to the benefit of all parties AND society by fulfilling a need for residential or commercial facilities.
The fire sale buyer or flipper has resolved legal or structural issues and created a property that is again useful to the consumer.
Tax advantages add to the overall equation by contributing to the positive sum obtained by the investor.
Finally, using proper asset protection strategies can provide additional security for your wealth building strategy.
Real Estate Wealth Using Financial Leverage
We’ve now built the framework to help you understand how real estate creates wealth by offering a win-win, positive sum opportunity for wealth building. We haven’t yet talked about the impact of financial leverage.
Financial leverage is actually one of the key aspects of building wealth through real estate. It is also a key in how real estate can be used to exponentially grow and perpetuate wealth building.
Leverage is important to real estate in a couple of different ways.
First, and most obvious, is the fact that you can finance buying real estate because banks and other lenders are willing to collateralize its value.
Essentially, real estate is so stable and marketable that lenders are willing to provide you with a portion of the funds to purchase.
Of course, if conventional banks are involved, then credit requirements must be met and costs and fees will follow. The property’s loan to value ratio will also be a critical factor.
Second, as real property appreciates and primary mortgage loans are paid, thereby reducing the loan balance, additional equity may become available for an additional source of financing future opportunities.
Taking out a home’s equity to fund additional cash flowing properties can allow investors financial liquidity and the opportunity to capitalize on the velocity of money.
Because equity lines of credit can currently be acquired at lower rates than many other type of loans, this can also allow the investor to get an arbitrage on the loaned money.
For example, Jim’s investment property recently appraised for $100,000 and he owes $50,000 on an equity line of credit. Jim’s bank is willing to provide him with another $30,000 because his credit is good and the equity is there to allow the loan and still reserve 20% equity in the property which mitigates the risk of a real estate downturn. Jim plans to purchase another investment property for $50,000 with a $10,000 down payment and using the other $20,000 to fund improvements to the property.
In the above example, Jim used his real estate investment to create leverage to pursue another investment opportunity. Although a bit simplified, this approach describes a real estate wealth building model that has been successfully pursued by many real estate investors.
Conventional Financing Benefits for Real Estate Investors
Jim’s advantages in this conventional financing approach are that he obtained additional capital for his new investment at a reasonable interest rate AND his equity appreciation on both investment properties will continue with the markets.
He will also reap passive tax advantages rental income and ongoing tax advantage.
If and when he desires to sell a property, his gain will be taxed at capital gain rates in most states at rates that will likely be lower than regular income taxes.
Real estate investment using conventional financing; however, is not without its challenges and disadvantages. It wasn’t too long ago, that the interference of the major banks in the normal functioning of the real estate markets was revealed in living color. You might argue that the easy availability of bank financing taints the market by inflating values.
For small real estate investors, is there a more advantageous way to obtain leverage and secure all the benefits and then some without the disadvantages.
Conventional Financing Disadvantages for Real Estate Investors
Referring back to our example above with Jim, the disadvantages to his approach of using conventional bank financing are as follows
- Encumbering his investment property up to the max LTV ratio
- Cumbersome approval process with any bank loan accompanied by appraisals and costs
- Credit reporting ramifications for future loans thereby decreasing leverage
- Inflexible repayment terms concerning minimum payments and consequences for nonpayment
- The bank can “call the loan” due and payable at any time
Encumbering real property as leverage with additional bank debt in order to secure a new opportunity is not ideal for a few reasons.
The equity in the property a hedge against a downturn in the market. After the new loan, Jim only has a 20% buffer and may lose money if the market tanks and he needs to sell.
The approval process on conventional and even home equity loans is detailed and cumbersome.
Appraisals are required which might not be available if the real property isn’t finished.
Timing for obtaining approval is another issues and the luxury of extra time isn’t always available when pursuing real estate deals.
Finally, conventional banks charge administrative costs and other charges such as points.
Your credit will also have an impact on financing costs and credit reporting results in a catch 22 when it comes to bank financing.
If you’re starting out in real estate investing, you’re likely to to be applying for loans individually as opposed to through an investment entity such as a LLC. This means that the amount of debt you have related to your income and assets may effect your ability to get future loans.
Your ratio of debt obligations as a percentage of total available credit will also impact your credit report, thereby making bank financing more expensive as debt accrues. One, way to accommodate this is to stay disciplined and pay down debt.
Inflexible repayment terms as well as the potential for the bank to “call the loan” should be additional concerns for every real estate investor. Yes, you may find it hard to believe that your friendly neighborhood banker could wake up one day and decide to call your loans.
Talk Show Host Dave Ramsey has talked openly about how early in his real estate career, he was heavily leveraged in this exact way through conventional bank financing, when for no reason, his bank called his loans and decapitated his financial empire in one foul swoop.
If you think that banks wouldn’t call your loans in today’s world, slap yourself now before reading on. They absolutely can do so and will if there is a strong financial reason.
Banks are in this game, not to help you, but to make it rain…money money money plain and simple. They can cut you off on a sunny day without even a crisis. Their reasoning could be something as simple as tightening their belt and cutting off the fat.
Financing Alternatives for Real Estate Investors
Sourcing private lenders and taking loans from other non-real estate assets are two viable alternatives for financing and leveraging real estate investments.
Self funding should be mentioned because of our societal emphasis on saving. However, whenever you save to spend on investments, the net effect is mostly the same as borrowing, because the entire time you were saving, you gave up the opportunity cost of that money applied to other investments.
Private lenders can be a valuable resource, especially where the desired loan is for a fairly short turnaround time, perhaps 12 to 24 months.
The advantages to private lenders are often speed to close and no credit reporting.
Disadvantages may be the shorter loan term and higher interest rates of perhaps 10 – 12%, so it is much harder to obtain a long term arbitrage on the money.
IRA and 401K
Self directed IRA financing AND borrowing from a 401 (k) are common ways to finance real estate without a bank’s involvement. These approaches offer some advantages and disadvantages as follows:
The most notable disadvantages to using a self directed IRA is that the transaction is highly regulated by the IRS due to the qualified tax treatment of the IRA.
Investments funded by self directed IRAs will lack some flexibility because IRA monies cannot be commingled with other funds without legal complications and risks. Self directed IRA proceeds also are only appropriate for certain assets such as real estate, and are not allowed for investments such as private lending.
Disadvantages to funding through a 401(k) include a loss of opportunity to benefit from the growth of the account. The 401(k) owner generally is not allocated the gains for the portion of the account that is loaned out.
The 401(k) treatment of loans prohibiting sharing in gains is in direct contrast to the advantage of borrowing from a mutual company offering a participating whole life insurance policy which will continue to pay dividends at normal rates regardless of outstanding loans.
Using Cash Value Life Insurance for Real Estate Investing
Given the many disadvantages of the alternative sources of real estate financing, discussed above, an alternative to consider is leveraging a cash value life insurance policy for your real estate investments while applying the infinite banking concept® as a strategy for wealth building.
I can’t take credit for this idea. Many others have come before and used this real estate wealth building strategy to create a financial empire.
Walt Disney borrowed from his whole life insurance policies to acquire tracts of land in Orlando Florida to become modern day Disney World.
Ray Kroc borrowed from his whole life policy to finance his budding McDonald’s franchise. Contrary to popular belief, McDonald’s has always been a real estate company and not just a burger franchise.
How to Cash Value Life Insurance For Real Estate Investing
A life insurance policy must be the right type of policy, with the right life insurance company, and must be properly designed as a personal banking system. This simple premise accounts for much of the confusion, even among life insurance professionals, concerning how soon a policy can be utilized for self banking purposes.
Most professionals have the ingrained mindset of a policy that is primarily focused on purchasing a death benefit. However, a policy designed in this way will accumulate cash value very slowly and thus will take a long time to gain the traction needed to become useful for self banking transactions.
Proper design for this strategy would entail the use of some options to allow faster accumulation of cash value. This is typically orchestrated through a paid up additions rider OR another formula that maximizes cash value accumulation and minimizes the required base premium for the death benefit.
It is important to remember that special policy design expertise is required because the IRS has created rules to limit the amount of premiums that can be paid all at once into a policy. The IRS has determined that if too much cash is paid into a policy at once, a Modified Endowment Contract (MEC) is created and the tax advantages of the permanent life insurance policy can be lost.
In addition to policy design, choosing the right life insurance company for building cash value is an important decision. There are many top companies that offer permanent life insurance policies; however, we offer a top ten list of the best dividend paying whole life insurance companies for real estate investing.
Cash Value Advantages
Once your policy is designed and funded and enough time has passed to allow for the accumulation of adequate cash values (and this will vary somewhat from policy to policy), you can begin borrowing from it as a source of private funding.
Unlike the other financing sources discussed above, using your policy offers an immediate source of funds without any complications.
The benefits of Cash Value Life Insurace are as follows:
- Fast and easy loan approval
- Does not impact your credit
- Does not add risk by encumbering real property
- Low fees and interest rates
- Gains and growth continue in policy regardless of loans
- Peace of mind in controlling your own loans
In addition, A Dividend Paying Whole Life Insurance Policy provides:
- Guaranteed cash value growth
- Guaranteed leveraged death benefit
- Guaranteed fixed premiums payments
- Potential dividends
- Tax favored
- Creditor protection
When you borrow from a policy, you’re borrowing from your own insurance policy, so your approval and funding can be issued in hours and NOT days. There is no qualification, appraisals or other hassles.
Your credit is NOT impacted by your policy loans, as they are secured by the cash value in your policy.
Your LTV (or debt to equity) ratio on the property stays in tact because the equity from your real property is NOT being used to fund the loan, thereby preserving flexibility if the downturn in the market occurs and the property would need to be sold.
The right insurance companies charge low variable rates (in today’s market around 5-6%) (some companies offer fixed options) for loans.
So, it is feasible to get an financial arbitrage when proceeds are borrowed and re-loaned to third parties. Fees for taking loans are nominal as opposed to the considerable closing costs that can accrue from obtaining mortgages and equity lines of credit or other bank funded loans.
The right mutual life insurance company will allow payment of dividends on the full cash value amount regardless of loans, and this is a huge advantage over loans secured by other financial products such as 401(k) accounts.
Additionally, because this is your policy and you control it, there is no concern about having loans called or otherwise altered.
The ease of borrowing and repaying your policy will at a minimum enhance the real estate investor’s ability to quickly capitalize on opportunities, adding the velocity of money to the equation, and opening up a new way to an entirely new level of freedom and success.
A common objection is that using permanent life insurance in this way isn’t an efficient approach for real estate investors because the policy costs money upfront and is therefore too expensive.
However, this belief is especially illogical in the context of talking about real estate. A whole life insurance policy is weighted up front, with a down payment of sorts, in the same way as real estate.
In this way, real estate and permanent life insurance are symbiotic. Although both real estate and life insurance assets may lack equity in the beginning, once fully funded, they provide lifelong enormous freedom and benefits to the owner.
Using cash value life insurance as part of a real estate wealth building strategy is an excellent way to protect your hard earned money. It also provides an excellent tax advantaged vehicle and true compound growth with guarantees that typical savings accounts lack.
So what are you waiting for? Give us a call today to learn more about how to get started building your personal banking system for real estate investing and wealth building.