Equity Strategy Without Being a Slave to Taxes - Stephanie Riley (PART 1)

Transcript:

Mike Pine: [00:00:00] Welcome to The Hidden Money Podcast. We're super happy to have our guest, Stephanie Riley with us. Stephanie's someone I've been working with for a few years and have learned a tremendous amount about lending. She's not your normal mortgage broker. She truly is an equity strategist. We're super happy to have you here, Stephanie and we want to help our listeners learn how important Lendability is if they're investing in things like real estate and how taxes can impact that?

But first of all, why don't you tell us a little bit about yourself? And as well, you are an equity strategist, not a mortgage broker, though you do that as well. What is an equity strategist? When you're done introducing yourself, please?

Stephanie Riley: Thanks Mike. Thanks for having me. I've learned so much about the tax side of things working with you as well, and I love that collaborative effort and what comes out of that is really, what we've been able to enjoy in helping mutual clients get the most out of what they have to work [00:01:00] with when you can integrate that tax planning with the planning on your borrowing power or your lend ability

My background, I got started in real estate as the assistant to some top real estate brokers in the Silicon Valley. They had a radio show that became very prolific. And in working for them, I found out that they made more money from their portfolio of real estate, they held for investment. Then they did buying and selling real estate for others. And so that really piqued my interest. And so I was behind the curtain there and at 19 years old, they helped me buy my first investment property, a little duplex in Sacramento, California.

And over the years, learned really what your podcast title talks about, just the hidden wealth that there is. In real estate and investing and leveraging the tax code and [00:02:00] how, if you can mix all that together, there's really a superpower to building wealth. And so my background is in real estate investing and then in 2008 and the whole great recession took a big hit then and I learned how important diversification was that Real estate was great, but at the time I had been, I had a transaction coordination company. I had been in real estate, I had been investing in real estate. I had already gotten into the financing side was co-managing a mortgage brokerage. All my eggs were in the basket of real estate when that recession hit.

And so yeah, I learned a lot about, okay, there is strength in diversification, and I'm sure in the tax code too as I've learned it, there's strength there too. And in kind of mixing up those investments and your business types to [00:03:00] get the most tax benefits anyhow, so that's a little bit about my background.

Right now I lead up the equity strategies team at USA Mortgage and our focus is working with investors and we like to get started early to plan ahead because by the time you filed those tax returns, outside of an amendment, it is what it is in terms of what income we can use on a loan application to qualify for financing, and it's important.

You asked about, what, why is it so important? The lend ability and what impact does that have on our wealth? One of the biggest benefits of real estate is as real estate, benefits from inflation and more money chasing the high demand of real estate. The value of that real estate goes up, but the gain in appreciation that you [00:04:00] get.

Is 100% yours. You don't share that appreciation with the lender. So if you are coming in leveraged because of financing and being lendable, let's make the math really simple. You buy a hundred thousand dollars property and you're only putting in $20,000 of down payment, and that property goes up from a hundred thousand dollars to $120,000 over the years.

You just got that $20,000 gain on your $20,000 down payment or got doubled your money. Whereas if you had come in for cash and not gotten that difference, that $80,000 in financing, well now you put a hundred thousand dollars in cash and you got 20,000 on the a hundred thousand. Your return is five times less.

It's just the amount of money, the speed [00:05:00] at which you can grow and compound. Your wealth building is absolutely supercharged by the amount of financing that you can qualify for and apply to the portfolio. So that's what makes this so important for building

Mike Pine: wealth.

Absolutely. So you just pointed out an illustration that's not very uncommon in real investing, but the hidden Money of turning a potential 20% rate of return in a single year into a hundred percent rate of return, that's hidden money right there. That's amazing.

Stephanie Riley: Absolutely. Yeah. And then you compound that over the years. I have a calculator that I use and show to explain the concept, kind of this equity building game plan, and you compound that with optimizing and harvesting the equity and reinvesting it at periodic cycles. If you're coming off a period of 10, 20% a year appreciation,[00:06:00] you may be harvesting equity every two or three years.

But there are cycles where that's much slower and you may have to wait 7, 8, 9 years before the equity buildup is there to harvest and reinvest. But whatever it is, over time, if you're monitoring that and you're harvesting and optimizing and reinvesting that equity as soon as it makes sense, that compounds.

And you'd be shocked at 20 years later the amount of wealth a leveraged portfolio versus a non-leveraged portfolio, the difference that it makes.

Mike Pine: I guess that's equity strategy right there, huh?

Kevin Schneider: That sums it up.

Stephanie Riley: Yeah. And yeah, and you asked what that is and it really, to apply it we like to sit down and look at folks. Both their lendability, like what's [00:07:00] the underwriter gonna see and how can we maximize what the underwriter will say yes to in terms of the amount of financing, but also in real life, in cash flow management and tax strategy and in your actual management of your portfolio.

We like to look at four things. Your cash flow, your equity, and your credit. And look for ways to optimize and get more out of those. And tax is a big place where you are spending money anyway, right? That money is going out the door and if you can simply reallocate it towards finance financing, or that will control real assets now that money is working for you.

Kevin Schneider: Yeah, and from your standpoint, when you're looking at liability, working with the CPAs can be very vital and that's because our [00:08:00] job is to always hammer taxes into the ground. If not below the ground. I want them to go so negative that they're saving on the other active income that they're having. I want the real estate to offset their other income sources, and so we've gone through in several prior podcast of how we do that and some content. But really our job being, let's see how much loss, not cash loss, but how much tax loss we can get on a rental property. Then we have this tax return that shows this huge loss and we go to you as the lender and be like, Hey! My client made zero money last year, look at their tax return. They have no taxable income. So like how do you maneuver that? And how do you walk through the liability process with a tax return that shows zeros? Which means we did our job. But now does that put you in a bind?

Stephanie Riley: It's a great question and it really speaks to the importance of the advanced planning and the collaboration between a, 'your go-to [00:09:00] lender' and 'your go-to tax strategist', getting on the same page about how they're gonna approach structuring your portfolio with you and how that's gonna be reported.

So there's a number of things that I'll just spit off that can help. One of the major things that is a myth in the industry is some borrowers will say, oh, I took the bonus depreciation, I took a ton of depreciation, so I don't show any income. And actually the underwriters understand that is a non-cash expense.

And so if on a tax return you are taking depreciation, the underwriter will not ding you with that as a hit against your income. So they'll actually add that back in to net out what they're going to give you as your net income. Another interesting thing to know about the tax returns is, there's different ways that the [00:10:00] lenders will look at investment real estate and the rental income that comes from it.

So if it's a new property that you're purchasing or a property that hasn't been reported for a full year on a tax return, they'll allow you to use the lease agreement as the income as opposed to the net income that would show up on a tax return averaged over that tax return whatever the tax return reports.

And that's the key point is whatever the tax return reports. So one of the things that happens is a CPA will not know that it really matters how many days that property has been rented out. And so they'll report on a Schedule E that this property was rented out 365 days and generated this much money and had these repairs and expenses and blah, blah, blah, blah.

And here's the net income. The underwriter will take that net income, add back in the depreciation and divide it by [00:11:00] the full 365 days, by the 12 months. If in actuality that property was really only rented, especially if there was write-offs for repairs, and you would turnover if that property was only rented six months or nine months, then only put that as the number of days that property was in service, cuz then the underwriter can take that net income divided by that smaller period of time and you end up with a bigger number that can be used for qualifying income. So those are a couple of things on a Schedule E. You guys, your firm has taught me a lot about tax strategies that can actually shift expenses that would otherwise be reported as this year's cash expenses to non-cash depreciation and making that shift when it's available and when it makes [00:12:00] sense for the client. I mean, that's huge because now you're taking an expense that they actually did have some cash go out the window, but we're putting it on a tax line that's depreciation and from a lendability standpoint, it's not hurting their qualifying income and helping them qualify for more financing. So again, speaking to the collaboration of looking at these things together is important.

Lets

Mike Pine: unpack that for just a second, cuz that was a pretty cool realization that we had a year or two back. Aha! The IRS traditionally has pushed taxpayers, and that's what the tax code does. It pushes taxpayers to say any asset you place in a service that has a useful life of one year or more than one year, you're supposed to not expense it on your profit and loss statement.

You're supposed to put it on your balance sheet as an asset and then depreciate it over time. That applies to things like with our vacation rental people. They spend a lot of money on linens. They spend money on flatware, I mean, all [00:13:00] kinds of stuff that is gonna be used for longer than a year. And in the years of bonus depreciation, by moving it to the balance sheet doesn't mean we don't get a tax deduction for it.

But instead of calling it supplies, follow the IRS rules and the hidden money in the tax code when combined with debt leverage, earning potential, the tax cut says, Put it on the asset and then you can depreciate it because it's eligible for bonus depreciation. So you get to the exact same place tax wise, but suddenly as we found out working with you and your team, you're a heck of a lot more lendable and that was a beautiful 'Aha!' Moment.

Stephanie Riley: Absolutely. Absolutely! And even if you asked Kevin about, if I see tax returns that just show zero income, there are always workarounds. There's always niche lenders that don't go by the conforming Fanny Freddie guidelines. And so if it is a situation where none of these tricks are gonna work. It's [00:14:00] truly to get the tax benefit they're gonna have to show no income from a business or something like that. There are lenders that will do bank statement loans where they recognize for the self-employed borrower that this kind of tax strategy is going on.

And so they'll take maybe the last 12 months bank statements and average the income, apply an expense factor and use that as qualifying income. So there's a lot of different ways we can look at this, but to get to Max lendability at the best pricing available to you, trying to fall into those conforming guides where you can qualify off, of tax return income for your rental properties is a great way to go.

Kevin Schneider: Yeah, and I think that speaks so much to your experience. Cuz in a small testimony here, I had a client who had a very large mortgage lender. Large enough, they're gonna have [00:15:00] probably Super Bowl Ads on this coming week. Like, they're this big. And so I provided tax returns to their lender and everything, and they did not know about that depreciation. I was blue in the face arguing with them saying, they're lendable. I just wanted to take them and squeeze their heads and just be like, they're lendable, I promise. Just, but that's why someone like you who actually uses these tricks and it's not even, it's really just utilizing these hidden tactics to make our taxes go down, but you're more lendable, your cash flow's increasing and to your point when you started here, if you leverage property and you only put 20,000 down on a hundred thousand property, you have 80,000 more to deploy. If you were sitting on a hundred thousand dollars cash, now you could buy multiple properties and start snowballing a portfolio.

So you do need to be lendable and it's so vital and when you add these small tips and tricks throughout the whole process you're gonna be shocked of how much power it has. So it just proves [00:16:00] that, your experience is so needed in the marketplace. I see it from my clients and it's just been great.

Do you have any other..

Yeah

Stephanie Riley: well, and even.

Mike Pine: Oh,

go

Kevin Schneider: ahead. Go ahead.

Stephanie Riley: I was gonna say even, you think about using lendability, using financing to build a portfolio like that. An example of a hundred thousand dollars property where you got 80,000 financing on it that $80,000, that mortgage payment, you're making that interest becomes a write-off for you.

And so once again, you've got money that's going out to taxes that can be redirected because instead of making a bunch of positive cash flow that you may be taxed on if you know we're talking, if you don't have any debt. And this is just a ton of positive cash flow versus if you're just redirecting what you would've paid in taxes to that mortgage interest it's a tax win on top of just being a [00:17:00] portfolio building

Kevin Schneider: And do you recommend debt leveraging to every potential investor out there? Because there are risks associated with this and you don't go bankrupt if you own something a hundred percent. You only go bankrupt if you can't pay your debts and so that risk there is real.

So how do you walk someone through who's wanting to potentially over-leverage? Do you guide them through that? And do you advise them through that process too, to make, keep 'em safe?

Stephanie Riley: Yeah! There's a lot of things to consider and you hit the nail on the head. There's risk involved for going after this big reward and so managing and understanding that risk is huge. In one aspect, I love the fact that underwriters, they've got a lot of funding and experience and facts and statistics to back up why they give you some underwriting guideline.

And so I always think, well, that's a little kind of like big [00:18:00] brother looking out for me. If they're telling me, no, you can't put just 5% down on your investment property, we won't allow you to do it. Well, they know something about what happens when people try to do that. They've learned. They've been burned, right?

And they have cash reserve requirements. You have to have a certain amount of cash reserves and it grows. The bigger the debt, they call it unpaid principle balance. The bigger the unpaid principle balances are on your portfolio, the more cash you have to show that you have in reserves. They have on the non QM or more debt coverage ratio type underwriting. They have debt service coverage ratio requirements that investment property has to meet. They don't want to lend if it's bleeding negative cash flow. On the conforming side, they're gonna lop off a 25% expense factor off the top and only allow 75% of those gross [00:19:00] rents to go towards supporting the expenses on that property.

So all those little things that the underwriting guides are communicating to me are a good sign that those are things I should probably consider too, because they've got a lot of studying behind what kind of setup makes these mortgages get paid or not get paid. At the end of the day, it comes down to the really those two things, your cash reserves and your cash flow.

And so, I think, one approach is to look at each individual property and say, well, I don't want any property to negative cash flow. One of the things that's come up recently is, Investors have built up a lot of equity as we've had this wild ride of inflation and appreciation, but yet we've also locked in 2%, 3% interest rates.

And so to tap that equity means you're gonna let go of a big asset in terms [00:20:00] of a mortgage at a two or 3% rate and walk in today's rates, hovering around 6%. So you're gonna double. That interest expense on the capital you already have borrowed, plus the new capital, the cash out, the equity you wanna harvest.

So one of the calculations I help people do to say, does that make sense? Is not just looking at, cuz a simplistic approach would be, well I don't care if I borrow at 6% cuz I'm gonna make 10, 12, 15%. Well, yes, but managing cash and cash flow, if you're going to jump from these two or 3% rates to now a 6% rate, you've gotta look at the cash flow change and say, what amount of capital after closing costs am I gonna walk away with, and based on this new payment and the extra debt service I'm gonna have going out, what kind of return do [00:21:00] I have to get on this capital?

To at least cover and be ahead on the amount of cash flow that I have going out in that debt service. And today that number is a lot higher than 6% because of where people are coming from. And so I think for some investors be patient and grateful and wait for the opportunity where that makes sense.

And for other investors where they do have quite a bit of equity to work with yeah, it makes sense because you've got so much untapped potential just sitting here in this equity. Another thing you asked about is how do you manage the cash flow and kind of the security of it. You can look at it in individual properties, or I like to look at it as a portfolio, meaning if I decide, well, I'm just gonna cash out each one of my 10 properties at a 50% loan to value so that every single property is [00:22:00] not negatively cash flowing.

I'm going to have 10 sets of closing costs. The amount of expense that's gonna go out to get to that capital becomes more expensive than if I say, you know what, I'm just going to max out what I can get out of two or three or four properties, and I know that, that means I may be a little bit negative on these ones, but I'm not gonna touch the other five or six properties and keep that nice cushy positive cash flow. And if you put it all in a blender, because you don't have all those sets of closing costs, you actually have more cash to work with and your cash flow overall is better. So it really depends. You can look at it on an individual property basis, but I like to consider the portfolio approach, which.

Mike, you and I have met [00:23:00] jointly with clients. Part of considering that portfolio approach is also considering the tax impact of whatever move you're gonna make. So it's not a black and white, but it definitely, Kevin is a great question, is making sure that you are considering your cash and cash flow for the purpose of securing your portfolio while you are chasing those higher returns.

Mike Pine: That, that's really impressive. But it's also complicated for my tax focus brain. So if you do have a portfolio of properties You need some kind of strategist that can help you understand how to mine the equity out of it in the way that makes the most sense for cashflow and for business and for investment.

So I wanna talk a little bit about what I've enjoyed with you and our clients have enjoyed working with your team and our team is, Again, how important it is to have your tax strategist working with your equity strategist. A lot of times [00:24:00] working with your asset protection attorneys, those strategists. If they're not working together, there's so many things again, we can do on tax that's gonna hurt the inability.

Or you can do an asset protection that's gonna hurt the tax or the inability or lability that's gonna hurt tax or asset protection. So, that's also been an incredible experience, I think for us and for clients and your clients all working together especially, and there's times we get a fourth or fifth expert in there, depending on what people needs.

Stephanie Riley: It's true, it's

Mike Pine: powerful.

It is, and so when you have an investor, someone who's running businesses or investing in investments, when you have them working solely and individually with each of their strategists in the different areas of strategy, It's up to them to download all the information from those individual strategists and then propagate it, share it with the other strategists.

And that's not always their cup of tea or their area of specialty. It's usually not. So if you can have all that team working together, they don't have to play the middle man. And I know a lot of our. Clients, they're [00:25:00] like, well, I don't wanna have to pay an attorney and a CPA and maybe a financial advisor and an equity strategist all at the same time.

I'd rather just meet with them time by time. But I think we found, and I'll ask you, when you asked our shared clients that we've worked together, did they find it was actually cheaper or more expensive to have the whole strategy team work together? What do you think?

Stephanie Riley: Oh, it's a million times cheaper. Yes, they love it Because as an investor and kind of the role of the client, sometime you don't know what questions to ask. And so in some ways you're bringing to the table, here's where I'm trying to get to. Here's my problem, here's my concerns, here's my opportunities.

And then you're almost like, sitting as a fly on the wall and watching the tax strategist and the asset protection and the lender all kind of brainstorm and go, well, for taxes they should do this. Yeah. But for lendability they should do this for [00:26:00] asset protection, I'd recommend this. And it's like, okay, well what if we did it like this?

And it's an, it's a collaborative process and being there the client understands why they're making some move in the manner in which they're making it. So it's important for everyone to have that understanding and it's very difficult for any, I won't even say for the client it's difficult for the client, but it's even difficult for me as a equity strategist and a lender, and I'm sure difficult for you as a CPA to advise a client like, well, "I need to talk to your lender", or "I need to talk to your CPA". If I have someone reach out and tell me their story and say, what should I do for lending? It's like, can I talk to your tax strategist because I don't know what they're trying to do here, and if I tell you this, it might mess up what they're trying to

Mike Pine: accomplish. Yeah. And one size doesn't fit all either. It's individualized for each person, [00:27:00] each potential investor or borrower or taxpayer. I've had clients when I said, Hey, we need to go meet with an equity strategist and your financial advisor all at the same time, If you've done this before, can't you just tell me what works for everyone?

I'm like, no, you're different. Everyone's different. Everyone has different risk tolerance. Everyone has different investment intentions and desires and it's just it's funny how each one of those strategy team meetings we do together, we come up with different prescriptions for every single one.

I don't think ones turn out the same.

Stephanie Riley: Yes, exactly.

..And it should be that way. And we discover things too. We discover new strategies because we've got a new, unique

Mike Pine: situation

Right.

Kevin Schneider: It gets a, gives us a chance to be creative too, cuz the tax code, if you're not being creative in our field, if we're not being creative in the tax code and everything's black and white, copy and paste, then we're not optimizing our strategies. So, having these professionals work together is just an absolute value adding and to your point of being, it's so [00:28:00] cheaper to work together in another way that it frustrates professionals is I can work in my silo and get your taxes to zero. But I might be counteracting your asset protection. I might be counteracting liability in a way. And so it's so valuable that I don't sit down, calculate a tax plan or prepare a tax return, send that off, send it to the attorney, or a proposed tax plan to an attorney.

Wait three or four days. They have to wait three or four days to look at it, send it back, and then I gotta wait a day or two to pick it up. It takes weeks, months to get all on the same page when we could just say, Hey. How about an hour and a half, two hour meeting, all of us get in the same room and hash it out and then I have my marching orders when I leave. Everyone has their marching orders and we go about our day, but it's conquered in two hours and then we're all on the same page. So communication is so vital and working in these team environments too.

Mike Pine: It increases efficiency big time. So like you said, two hours for everyone's time versus everyone spending [00:29:00] many hours trying to get it done. So it's key.

Kevin Schneider: Yep.

Mike Pine: So here's a personal story real quick. I grew up, especially early on in my profession, I was a huge Dave Ramsey fan (debt free). I used to get chills down my spine every time I heard someone call into his show and say, "I'm debt free".

And they played that little music thing. I love that.

But I'd say in the last decade, Kevin and I have definitely evolved in recognizing some debt is good. Responsible debt is Great. And it really can in your scenario, which is truly not unheard of, it quintupled someone's return in one year on their investment.

Henry: Learn what the team thinks about having debt and how they manage their debt personally.

Listen to part 2 next week as Mike and Kevin continue the conversation with Stephanie Riley.

Don't forget to subscribe to get notification about our next Podcast. Hidden Money Podcast is available on Spotify, Apple podcast, Google podcast and Youtube

Mike Pine: some debt is good, responsible debt is great.

Stephanie Riley: [00:30:00] Margin calls is one of the things that makes real estate safer, if I can use that word to use debt, is there is no such thing as a margin call.

We live in a financial system that if we don't choose to in debt ourselves, the government will choose to in debt us, on our behalf.

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