01:08 Quick recap of episode 5, Real Estate Part 1
Patrick Donohoe: Hi, everybody. This is Patrick Donohoe, joined by my good pal and colleague, dear friend Gary Pinkerton. We’re here for episode two of a three-part series on real estate, and this episode is called “Home Sweet Home: The Ins and Outs of Where You Lay Your Head.” So, Gary, what do you think about our previous episode?
Let’s recap that quickly for those who are just tuning in. I think it was essential to discuss the philosophy behind property and real estate, and how people can use it to express their creativity, insights, and intuitions to improve it and derive multiple uses from it.
Gary Pinkerton: Yeah, my biggest takeaway from that podcast, and our conversations leading up to it, was that everything happens on property or at a property. That was a significant realization for me. As the “real estate guy” here at Paradigm Life, my passion for this topic goes beyond the typical concerns like tenants, toilets, and cash flow. It’s not just about growing long-term wealth or protecting yourself from inflation, although we will discuss these aspects. It’s about continuing and propagating the experiment rooted in the philosophy of John Locke, which emphasized that for freedom, one must have property and the ability to control, grow, and improve their own life through acquiring and making the best use of real estate.
03:02 How real estate and identity are interlinked
Patrick Donohoe: This topic is intriguing because where a person resides is of significant importance. There are numerous opinions about whether to rent or own a home, whether to opt for a 15-year or 30-year mortgage, and whether to make a substantial or minimal down payment. Determining how much home one can afford is a complex task, and it can be bewildering. People often find themselves leaning toward a particular choice, influenced by someone else’s philosophy, without delving into the reasoning behind that viewpoint. I’m eager to delve into this conversation because it’s a decision everyone makes or will make in the future.
Gary Pinkerton: Absolutely. It reveals a lot about an individual’s personality and thought process. A person’s home can tell you a great deal about them. For instance, Warren Buffett’s modest home may not align with his massive wealth, but it offers insight into his character.
Some people associate their identity with their home; it becomes a significant part of their identity. This connection often relates to ego and what is showcased on social media. In contrast, I align more with the Warren Buffett mindset. I don’t attach too much of my identity to where I live. If circumstances changed, and I had to move elsewhere, I’d simply find a new place to live. However, for most people, their home is a major part of their identity, and this is a crucial decision.
Patrick Donohoe: Your point reminds me of an interesting story I heard while preparing for this podcast. I’m a Utah Jazz fan, and attending games can be frustrating at times. It makes the excitement of their victories all the more fulfilling. But let’s talk about Prince and his unique perspective on homes. It’s fascinating how he once rented a mansion from NBA player Carlos Boozer.
So, Carlos Boozer, who played for the Jazz, secured a massive contract with the Lakers, but he kept his Bel Air mansion because Prince wanted to rent it. The amount of money Prince offered was substantial. However, when Boozer, who got injured, returned to his house, he was stunned. Prince had transformed the place, infusing it with his unique style and identity.
Prince had essentially made Boozer’s house his own through property alterations. Boozer was in shock, but Prince was true to his word. He wired half a million dollars and signed a contract to restore the property to its original state when the lease ended. The story illustrates the homeowner-renter dynamic and the extent to which someone might be willing to invest in making a property their own.
Homeownership and renting each have their distinctions, and the story of Prince and Boozer serves as an example of the line between renting and owning, highlighting the significance of a balanced exchange between the two parties. Boozer signed the lease assuming Prince would pay to live there, not pay to make the house his own.
07:55 Should you rent or own?
Patrick Donohoe: Indeed, there has to be an equal exchange for renting and owning. In the case of Carlos Boozer, he entered into a contract, assuming Prince would simply pay to live in the house without making it his own.
Whether it’s to rent or own, this decision is not just a practical or mathematical choice. There are emotional and psychological factors to consider. It’s a delicate balance. Let’s discuss some primary considerations regarding renting, transitioning, or owning a home.
Gary Pinkerton: Prince’s mindset is intriguing. He likely wasn’t a mathematician and probably hired accountants who told him renting was not a wise financial decision. Why spend so much money that could have bought a decent house? The answer might be the baggage that comes with homeownership. Owning a house means losing mobility, and this can be a significant concern, especially during times of economic change or uncertainty.
Your ability to adapt and be geographically agnostic can be crucial. When you put down roots with a house, it may not be suitable for various uses like Airbnb or renting, and it may limit job opportunities or other possibilities. Mobility is a vital factor when deciding between buying and renting.
Patrick Donohoe: Family considerations are also essential when deciding where to live. While some people prioritize their profession, the events of COVID forced many to work remotely. This shift put the location of one’s residence at the forefront, with the profession taking a back seat.
Gary Pinkerton: Family also includes factors like your kids’ education. Renting a place in a good school district can add value, and people are often willing to pay more to enroll their children in such schools. Geographic bachelorhood can be a result of prioritizing family over purely financial considerations.
11:23 What are the benefits of renting?
Patrick Donohoe: Let’s discuss the advantages of renting before delving into the topic of homeownership. Apart from the flexibility and mobility it offers, what else makes renting appealing?
Gary Pinkerton: Well, aside from the emotional benefits we just covered, renting can serve practical purposes. It can help you access the desired school district or get closer to your workplace. Renting allows you the flexibility to decide where to establish your roots. Many people, when relocating for a new job or moving to a new area, opt to rent initially.
This approach is beneficial when you need to get settled quickly to start work in the coming weeks or even days. Rushing into homeownership can lead to hasty, potentially regrettable decisions. You might find that you dislike your neighbors or discover that your initial market assumptions were short-term, and the market is declining. This can result in significant long-term financial mistakes, making short-term renting a valuable consideration.
Patrick Donohoe: Absolutely.
Gary Pinkerton: Renting offers mobility while also carrying financial advantages. Consider the hidden costs of homeownership, not necessarily hidden, but rather the fine print details within a homeownership contract. It involves a significant time investment. For instance, I have taken on the role of the pool caretaker in my house, even if I don’t look like your typical pool guy. We used to employ someone for pool maintenance.
Furthermore, my wife now takes care of the yard because we were part of a homeowners association. This reduced the financial burden, but the time commitment increased significantly.
Patrick Donohoe: When you’re renting, these issues are typically handled for you. Whether it’s a broken toilet or the lawn needing maintenance, these services are typically included in your rent, although there are exceptions. Many maintenance tasks and property upkeep responsibilities are part of the rental package.
Gary Pinkerton: Exactly. However, renting also comes with its own set of considerations. For example, what is the cost associated with not having the wall colors you prefer? Sometimes you may not have the freedom to paint your rented space as you like. It’s a trade-off, and you might need to accept certain compromises.
Patrick Donohoe: You might recall the idea of opportunity cost. If you really want that purple wall, you could make it happen. The cost might not be a direct financial expense, but rather a trade-off in some form.
Gary Pinkerton: That’s right. In summary, renting is often more convenient and a simpler solution. It’s comparable to choosing between cooking your own meal, finding all the ingredients, and mastering the recipe or simply swiping your credit card. Renting is like the latter option, where you can conveniently address your needs with your resources. In contrast, buying a home entails a more substantial commitment, both in terms of time and money, with ongoing responsibilities and potential expenses. It’s a more intricate process.
13:51 Is your home an asset?
Patrick Donohoe: Let’s discuss our friend, Jason Hartman. He’s an incredible individual with real estate properties across the country. Jason’s principle is to own locally but rent everywhere. He chooses to rent because the cost difference between renting and owning in certain areas can be substantial. Renting is often significantly cheaper than the full cost of ownership.
This concept ties into the financial aspect of homeownership. Robert Kiyosaki, the author of “Rich Dad, Poor Dad,” challenges the notion that your home is an asset. He asserts that a home is not an asset, a perspective we agree with. However, there are missing pieces in this calculation.
Gary Pinkerton: The phrase “your home is not an asset” is easy to understand and has improved the financial knowledge of many people. It simplifies the idea that if something puts money in your pocket, it’s an asset; taking money out of your pocket is a liability. Kiyosaki categorizes a house as a liability rather than an asset, a concept that’s straightforward to grasp.
Nevertheless, considering the broader picture of life in America, you’ll find it’s not entirely true. Factors like inflation, property value appreciation, tax deductions, and improvements can impact the financial aspect of homeownership. However, there are also non-monetary benefits, such as a better quality of life and increased family happiness. Wealthy individuals in America have often accumulated wealth through homeownership over time.
Patrick Donohoe: Let’s establish a fundamental point: you will exchange money to live somewhere. Whether it’s through renting or owning, you will spend money to have a place to live. It’s a critical line to draw, with exceptions, as the primary rule is that you will spend money to have a place to live.
17:06 What are the benefits of owning?
Patrick Donohoe: When it comes to home ownership, you now have to exchange more. You typically have a down payment, taxes, insurance, and other costs. But let’s assume you have to make a down payment, which is not always the case with renting. So, you’re putting money into a home’s down payment, but you’re also saving money by not having to pay someone else for rent.
Kiyosaki’s definition of an asset is something that puts money into your pocket. So, one could argue that putting money into a home’s down payment does put money in your pocket, considering you would have had to pay rent otherwise. That makes sense, right? You have monthly payments, taxes, and insurance, but you also get some tax benefits associated with homeownership. You can deduct mortgage interest against your earned income.
In addition, there’s inflation. We operate in a monetary system we can’t control or influence, which is debt-based. For the economy to grow, money has to be printed. There’s also asset appreciation, especially in residential real estate. It’s a substantial part of the U.S. economy, and houses appreciate over time, offsetting the devaluation of the currency.
Gary Pinkerton: Absolutely, and like any other hard asset, you have to consider that the timeline matters. If you look at it over 100 or 200 years, most things that haven’t gone extinct have increased at a similar rate. Residential real estate appreciates consistently over time. It’s a storehouse of value that helps counter the rate of currency devaluation. It’s more convenient than living inside gold, and it offers various non-monetary benefits.
Patrick Donohoe: We’re living in an environment where we have a long-term fixed-rate locked-in loan, which is typically below the rate of inflation. This loan is often subsidized by taxpayers, providing you the ability to buy real estate. With a long-term fixed-rate loan, you can lock in the cost, and this is a significant benefit.
Gary Pinkerton: Buying hard assets like gold versus property is a crucial comparison. With property, you can put down 20% and essentially borrow the rest. When you buy gold, you have to pay the entire amount upfront, making real estate a much more accessible investment.
Patrick Donohoe: We’ve got a tutorial coming up that will show the math of renting versus owning. It will demonstrate whether you’re better off renting or owning based on certain assumptions. The tutorial will also highlight a game-changing element, where renting is considered as an alternative.
We’ll also address the perspectives and philosophies that exist regarding homeownership. For an explanation to be good, it must be comprehensive and include the math behind it. We’ll demonstrate the difference between a 50-year mortgage and a 30-year mortgage to provide a more accurate picture of how the interest is distributed.
23:31 What is equity, and why is it valuable?
Patrick Donohoe: Let’s begin by using math to illustrate our point rather than discussing the calculations in a podcast blitz. Before we dive into our next episode on real estate investment, I’d like to address the concept of equity because a substantial down payment generates equity. In theory, a 30-year mortgage results in less equity compared to a 15-year mortgage, particularly when it comes to payment allocation between principal and interest.
So, what exactly is equity? Why is it valuable? What are its benefits, and what limitations does it have?
Gary Pinkerton: Equity is essentially stored value, like potential energy in physics. It’s the cash you could theoretically access. However, equity comes with its own set of challenges and associated risks. One key question is how to obtain this equity. There are various ways, such as using it as collateral to secure a loan or selling it. But if it’s your primary residence, the decision becomes more complex. Equity isn’t always readily available; it’s illiquid, meaning you can’t instantly access it, even if you have a line of credit.
Furthermore, equity can be fleeting. If your property’s value decreases due to factors like the local job market or hidden issues like an old gas station site, your equity may not match your initial expectations. So, it’s essential to act before these changes in value occur.
Patrick Donohoe: So, to clarify, equity is essentially the difference between an asset’s value and any outstanding loans or obligations against it. Realizing this difference is only possible by securing a loan, which brings its own contingencies. The value of a home is also somewhat unpredictable, as it isn’t solely dictated by platforms like Zillow; it’s the amount someone is willing to pay for it. This can fluctuate over time. In addition, your property can be subject to claims from both tax authorities and mortgage lenders in case of default, allowing them to access your equity to recover their losses.
So, while equity is valuable and has economic worth, when we delve into the Perpetual Wealth Strategy and its applications, particularly regarding home ownership, we’ll discover methods to have equity in multiple locations, often with fewer contingencies. This could lead to a reevaluation of your financial strategy to maximize your wealth while maintaining a higher level of certainty.
27:54 What is the Hierarchy Of Wealth, and how can you use it to guide your real estate decisions?
Gary Pinkerton: We’ve previously discussed the Perpetual Wealth Strategy that Patrick introduced in the podcast. One key element in my discussions about wealth with clients is the Hierarchy of Wealth. It serves as a framework for building your financial foundation. Think of it like constructing an Egyptian pyramid; you start at the bottom with a solid foundation and then build upwards. The bottom layers are where you have the most control, resources, and guaranteed liquidity.
For instance, your primary residence, though technically in tier two, is close to the bottom because you have a significant degree of control over it. While you can’t control external factors like factory closures affecting property value, you can manage maintenance, payments, and property upkeep. The Perpetual Wealth Strategy, with its strong foundation in cash reserves, provides essential protection. This is especially crucial when you’re dealing with something illiquid and making a long-term commitment like buying a home. Relying entirely on your cash for a down payment can be risky, potentially leading to financial instability if unexpected expenses arise.
Patrick Donohoe: I’d like to add a few points to that. The Perpetual Wealth Strategy, as outlined in the series, is based on three core tenets: cash flow, protection, and wealth. Depending on your stage of life, the objective might be wealth accumulation or wealth distribution through estate planning. Let’s focus on cash flow protection and wealth for now, and understand that these tenets follow a specific sequence. Cash flow is the most critical aspect because it involves the money coming in and going out.
I first encountered personal finance back in 2007 while working at a nonprofit call center that helped people negotiate credit card balances to avoid bankruptcy. It was eye-opening to see the debt burdens people faced, not by choice but due to a lack of a proper cash flow strategy. Knowing how much money is coming in, how much is going out, and what it should be spent on is crucial. Even as a financial advisor, I’ve noticed that many individuals, even those with substantial means, often struggle due to the absence of a cash flow strategy.
Understanding your cash flow is essential for determining how much house you can afford. As Gary mentioned, life can be unpredictable, and unexpected expenses can arise. That’s why part of a solid cash flow strategy should include having two to three months’ worth of expenses in liquidity as a buffer for unforeseen financial needs.
Protection is equally important. While wealth accumulation may be the primary focus of investment, it assumes that everything goes as planned. Real life, however, is full of uncertainties like disability, lawsuits, and divorces. These can disrupt your wealth accumulation, and if you haven’t adequately protected yourself, you may have to start over or deal with a significant setback in your financial journey.
33:18 Why is cash flow important?
Gary Pinkerton: Cash flow is like the lifeblood of our financial well-being. It’s what keeps everything running smoothly. But many people tend to dismiss cash as “trash” because it doesn’t earn much while sitting in a bank, given inflation. They might opt to invest it in illiquid assets, taking on more risk. However, having cash on hand is essential. Recently, I spoke with a client who was experiencing a -$2,000 monthly cash flow issue. He had money in the bank but chose to pay off the loan, solving one problem but leaving him with no emergency fund. In an emergency, he’s stuck. Having readily available cash is critical to handle unforeseen challenges, especially ones as significant as housing emergencies.
Patrick Donohoe: As we segue into our next episode, it’s crucial to consider personal finance within the context of the Perpetual Wealth Strategy. Our goal, repeatedly emphasized, is to maximize wealth while increasing certainty. We aim to help you achieve your financial goals, leading to the lifestyle you desire with the highest level of certainty possible. Real estate investment and primary residence ownership fit into this framework. It’s vital to make informed decisions. Sometimes, people buy too much or too little house, affecting their lives and financial stability. We specialize in providing a calculated approach to maximize wealth while taking on less risk rather than more.
Gary Pinkerton: Lastly, it’s essential to remember that significant decisions like these can’t be made in isolation. It’s about considering your entire financial picture and how this choice impacts everything else. Take retirement, for example. Does buying this house put your retirement at risk? Maybe, but there are options like a reverse mortgage that can provide cash flow in retirement. Legacy plans also come into play. If you don’t want to burden your kids with an old house, there are ways to use the equity and maintain the legacy while providing for your own retirement. It’s all about making a well-rounded decision.
Patrick Donohoe: So, there’s no perfect decision, and making choices in a vacuum doesn’t always work out. It’s essential to prepare for the complexities that come with significant financial decisions. Thank you for joining us in this episode as we discuss a topic many people will face multiple times in their lives. As Gary mentioned, there isn’t a perfect decision, but making informed decisions is the key.
39:09 Coming up in the next episode.
Patrick Donohoe: In reality, life doesn’t unfold in a vacuum. Tomorrow will differ from today, and the future is full of uncertainties. The key is to make the best possible decisions as you navigate this journey. So stay with us as we move on to the next segment. We’ll continue building upon the principles of real estate and apply them to the context of owning property that you lease to others. This adds another layer to our discussion beyond primary residence ownership. Join us in Episode Seven.