1375: Aruba, Jamaica Oh I Wanna Take You To: Success & The Hartman Risk Evaluator - Pt 3

I really need to thank you and Sarah for being there for me. You guys could have easily said, this isn't my problem, this is your problem. Your lack of due diligence is entirely your fault and not done anything at all. But you guys have been there for me every step of the way. You responded on Voxer at 3:42 in the morning. I know it might have been 6:42 depending on where you were, but honestly, who works at that time? So just the fact that you guys were there for me, I appreciate it so much.

Welcome to the Creating wealth show with Jason Hartman. You're about to learn a new slant on investing some exciting techniques and fresh new approaches to the world's most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine, self made multimillionaire who's actually been there and done it. He's, he's a successful investor, lender, developer and entrepreneur who's owned properties in 11 states, had hundreds of tenants, and been involved in thousands of real estate transactions. This program will help you follow in Jason's footsteps on the road to your financial Independence Day. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to episode number 1375. 1375. And greetings from beautiful Aruba. Yes. Does it remind you of that Beach Boys song? I actually went to summer camp with one of the Beach Boy kids of Brian Wilson's daughter. That was kind of cool. You know, growing up in la, you're around all these celebrities. I remember the, the van every morning would pick me up at my crappy little apartment in Mar Vista. And then it would drive through la, up Malibu. We'd stop in, I think it was Bel Air, where, where Brian Wilson lived, pick up his kid at a gorgeous mansion. So quite a contrast really. But you know, I think that was good for me. Even though I felt like I didn't have the good life right, like many of, many of my peers did. But I did see it. And that's one of the things about success. And it's always struck me as an odd thing that unsuccessful people, they see successful people, right? And they might want to be successful, they might want to have money and financial independence. And they see it all around them. They certainly see it on the media. Many see it in their own environment. Live like I did as a kid, you know, I was like the poorest kid of any of my peers. Always, every time. But you definitely see it in the media. You see it in magazines, you see it on tv, et cetera, et cetera. Right? But the funny thing is there's like this disconnect where some unfortunate souls don't think that's possible. It's almost like they think, well, these successful people must be Martians, right? They just have nothing to do with my reality. And in a country like the U.S. especially, and of course, we have listeners in 189 countries. But in a country like the U.S. and I don't just mean the U.S. but a country like the U.S. that's very capitalistic and has good social mobility where people can literally raise themselves by their own bootstraps up the socioeconomic ladder. Right. They can just do it themselves. Right. I did it myself. And it frankly amazes me how far I've come in my life. Many of you listening have exactly that same story. The vast majority of us came from very humble beginnings. But especially if you go back two generations, like, you look at my mother's life, I'm saying mine was humble. Hers was really humble. I mean, she grew up on a farm on a dirt road in upstate New York, the middle of five children. The interesting thing is pretty much all of those five kids, first of all, they left upstate New York the minute they turned 18, pretty much. And they all moved to California. Because back then, California was the land of opportunity. Now it's the land of disaster, which is a cycle that occurs in. In societies, whether they be states, cities, but especially national governments. That cycle always occurs in society. In fact, it's been written about many times that a society moves from. You know, I can't remember these stages, so forgive me, but you've probably read or heard about this over. Over the course of your life. But it moves from poverty and struggle. Well, it moves from the sort of the poverty stage to the struggle stage to the success stage, and then the success breed a kind of apathy, and everything gets really sort of fat and sloppy. Right? And this is what happened to the US government in the 60s and 70s. You know, we started with all these crazy social programs that were pretty much a disaster. And many of them are still with us nowadays in one form or another. And that affluence created an apathy and a laziness not only about how hard an individual has to work, but how disciplined a government needs to be in terms of its fiscal policy. Right. Anyway, we're on a tangent here. I didn't mean to talk about any of this stuff when I turned on the recorder, but here we are Tangent alert me. Okay, back on track here before we get to part three of the Hartman Risk evaluator today. So, looking around, as Tony Robbins says, success leaves clues, right?

Success leaves clues.

And in today's world, all of us, no matter where we are in life, have more access than ever to clues, to examples of success all around us. And people choose how to respond to this, right? They respond to it in one of many ways. Some people see successful people and they scoff at them, and they say, oh, how lucky can they get? They're just lucky, right? They just got lucky, right? Maybe they got lucky with a genetic roll of the dice and their family had money. Maybe they got lucky and had a couple of big breaks in life. You know, they won the lottery or had some big deal that worked out for them. And, hey, I don't deny that there's some element of luck in life. No question about it. Call it luck or probability if you want to be more scientific about it. Call it whatever you want. But listen, some people have more fortunate events than others do. And I do not believe I've had very many fortunate events, but the ones I have had because I was lucky enough lucky, okay, to just happen to be walking through Cerritos Mall in. In California. In Cerritos, California, and I walked into Walden Books and picked up two audio cassettes. And there were hardly any books on audio back then for $9.95 each. And one was the Psychology of Winning by Dennis Waitley, and the other was See youe at the Top by Zig Ziglar. And those two cassettes just changed my life. And I became familiar with Earl Nightingale after listening to them talk about Earl Nightingale or Dennis Wheatley, especially talk about Earl Nightingale, and then Jim Rohn and. And Og Mandino. And these were very, very good mentors. Now, I didn't know them in real life. They were just mentors on audio cassette. By the way, for some of you that don't know what audio cassettes are, you know, they're these things that we used to put into a machine to listen to sound. Okay, Millennials, you don't know what that is, right? It's like an MP3, but a primitive version of it of an MP3 audio file. So they gave a very good example. And one of the things Dennis Waitley and Earl Nightingale taught me is that luck is what happens when preparedness meets opportunity. We all know people that have been lucky in quotes, but their luck, they had, like, their lucky break, and then it just evaporated, right? Maybe they had. If it was a financial lucky break, they had some spending money, but they blew it because they didn't know how to deal with it or manage it. We've all heard these stories of lottery winners that win a big lottery jackpot and a year later they're totally broke, right? Why? Because the context of their thinking did not support that lucky break that came into their life. So as good real estate investors and good successful people in general, right, we want to be prepared for the opportunities that will inevitably drop into our life. Everybody has bad breaks, everybody has lucky breaks. I think we can all agree, looking back on our lives, even if we're upset and we feel ripped off about things that have happened to us, we've all had some lucky breaks, okay? The key is to not let them evaporate, okay? Don't let the luck evaporate because, boy, it will if we are not prepared for that luck when that opportunity drops into our lap, that probability or luck, whatever you want to call it, you know, if you're Irish, it's lucky, okay? You got your four leaf clover. If you're agnostic or atheistic about the concept of luck, fine. It's just probability, okay? You be a scientist. Either way, you know, things happen, right?

Good and bad.

And so when the good things happen, if we're not prepared, we're only going to look foolish, we're going to let it evaporate, we're going to blow it, okay? So we've got to create a good context, a good soil to fertilize that lucky break or that big opportunity that comes our way, right? And similarly, on the flip side of it, when the bad break comes along, and it certainly will, I mean, gosh, we all have bad breaks. I know that some people make those bad breaks the story of their life. They make that the whole context of their life, right? Now, I've talked before on prior episodes about the difference between context and content, right? The content is what happens, the bad break or the lucky break. The context is the environment it happens in. And when I'm talking about it here, that environment is our head. It's our mindset. It's how we take it. Everything in life is what you make it. It's not what is that counts, it's how you take it. Okay, so there's my little motivational message for today. I actually meant to talk to you about some something else, but, you know, I got on a tangent again. And what I do want to talk about in a future episode with you, something I've been thinking a lot about lately. And that's the concept of how rents play out over the course of a decade and how prices of properties play out over the course of a decade. Now this last decade is unusual. It was different, but prior decades, pretty much every single one of them for follows a certain what I'll call 7030 pattern. And I'm going to talk to you about this on a future episode. Maybe we'll make a whole episode about it because it's pretty important thing for good real estate investors or I should say income property investors because that's what we invest in, income property. We'll talk about that in the future because it's a, it's an important concept. Anyway, go to Jason Hartman.com, check out the properties there, reach out to one of our investment counselors or call us at 1-800-HARTMAN or that's 1-800-H A R T M A N. And make sure you are also subscribing to the property cast so you can get the latest properties in I don't want to say printed format, but yes, they are printed. They're PDF files sent right to your computer or mobile device as we get them. And that will really keep you informed of inventory. But at the end of the day, you got to be working with one of our investment counselors to really source good inventory of properties that you might want to buy. Also, if you are new to the show, be sure you check out our Quick Start podcast. Sue and Gary Pinkerton were very instrumental in helping with that and picking out some what we call Quick Start episodes. Of course, you know, if you're new, it's hard to go back and hey, I'm going to listen to 1374 prior episodes and many people do that. Thank you for your loyalty. Many people do it two or three times. Wow, I'm honored. I'm honored, really. Thank you for listening. But if you want to get kind of the more fundamental stuff just on any podcast platform, just type in Jason Hartman Quick Start and that'll give you kind of the hand picked episodes that really cover some of the fundamentals. Okay. And of course we cover them on an ongoing basis, but okay, that's it for that stuff. Without further ado, let's talk about part three, the final part of our deep dive into the Hartman risk evaluator.

We know that now the value is 1.3 million, but the question is, how would you allocate that value between the two primary components, land and improvement?

Did he, he just increased the land value?

Wouldn't he why?

Yeah, that's the puzzling thing. Right? Okay, so I always ask my audience this question when I'm doing this live and I have them vote. Raise your hand if you think it's land value. Raise your hand if you think it's improvement value. And the reality is, George, both people are right. Both things went up in value because construction costs were increasing, okay? And land values were increasing. So both things went up. But what went up the most? Definitely land. Okay? There's no way it costs $485,000 more to build that house just one year later. It was an 1800 square foot house, you know, a nice house, but no big deal, just an 18. It wasn't the best house I ever lived in, for sure. You know, it was a nice 1800 square foot, brand new house, you know, nicely designed with a nice view of the city lights and the ocean in the distance. And it was a good house, right? It was mostly land value. So here's what happened. Another year later, I wanted to refinance because the rates went down. So I call up the same bank, the same lender, and they send the same guy. The same appraiser comes out. Eric, good old Eric comes out. Now, after this, during the Great Recession, they changed all this and probably it's very good thing they did. Now they have to use what they call appraisal management companies. So the likelihood of you ever getting the same guy twice would be extremely rare because they don't want the lender to be in cahoots with the appraiser. Good thing, okay, that's a good thing. But in the old days, that's the way they did it, right? They just had an appraiser on staff or one that they commonly used, and they'd send them out, right? So Eric gives me some bad news the following year. He says, hey, I'm sorry to tell you, your house is now only worth $1,235,000. It went down by $65,000. So now the question is, where did the decline come from? Land or improvement?

Yeah, it's got to be land again, isn't it?

Absolutely. You're absolutely right. Land, you got it. Because look, the improvement value, it doesn't cost $65,000 less to build that house another year later.

Exactly. And plus, even if the. Even if you have asset deflation, typically because wages are so sticky, you're still going to have the CPI go up, right?

Absolutely. And the fact is, construction costs were still rising. It's interesting, as a little aside, I had purchased many New homes over the years before I purchased this one. So always in California, the new home never came with a yard. You always had to hire your own land contractor and do your own landscaping job. So I've done many landscaping jobs. I've hired many crappy contractors. I had to sue one of them and I had to file a complaint against another one who thankfully lost his license. He was so bad. Oh, it was awful. So I'd done many landscaping jobs. Now this particular landscaping job on this house, George, it shocked me how much the cost was. I couldn't believe it. Like I could not get a decent bid. I had so many bids. I had bunch of contractors come out and all of them told me, it's just going to cost a lot, right? It was expensive to landscape this house. I kept asking them, I said, why is it so expensive? I just landscaped another house about a year ago, year and a half ago. And they said, china. And I said, what? And they said, all the concrete has become very expensive because China is using it for all these infrastructure projects. You know, they're building freeways and bridges and skyscrapers, and concrete just became very, very expensive. So that drove the cost up. So you're right. The decline came out of the land value. Okay, what can we learn from this? Well, this is a long winded thing here, right? What can we learn from this? We can learn that the risk when investing.

I can already see where this is going. This is really cool. Really, really cool.

The discovery. After 19 years in the business, Jennifer caused me to discover it. I got to call her up and thank her because I never realized this before. I have followed every real estate guru. I have read a zillion books. I've been to a zillion seminars. Nobody ever taught me this. It came out of my own head this way. Okay? The risk is in high land values. Okay. Right. Now, you know, George, because you listen to my podcast and we talked about on the show that I think there are three types of markets. Linear markets, cyclical markets, and hybrid markets. Right? Guess what? The markets that I don't like to invest in, that I consider to be high risk markets that I shy away from and recommend our investors, our clients avoid are cyclical markets. And guess what? Cyclical markets always have high land values. Okay? And guess what? Linear markets, the markets I like always have, they always have low land values.

Super low. And when he's saying low, guys, I know that my land value. I don't know this for sure, but back when I was investing heavily in Kansas City, when I was buying all these homes, which a lot of them, I still have cheap land. We're talking like $5,000, like $10,000 on a home that's now worth 170.

Yeah.

It just shows you how that equation is so lopsided in the other direction.

It's lopsided in a very good way for the investor. So this on the screen now is a very childish looking, poorly graphically designed. I really need a better graphic designer, clearly. So don't make fun of me. I was going to do this on a whiteboard. It would have been worse than this. Okay. Of the house I moved into, the story I just told you, that's how it looked. Mostly land value, very little improvement value. Okay. The house, the rental property I was buying across the country looked more like this.

Right.

Very low land value and high improvement value. Let's go back to Jennifer, the insurance agent. She calls me up and she says, jason, we're going to give you $135,000 insurance on this house. Well, what I didn't tell you yet is what I paid for that house. The price of that house, I will now tell you, was $159,000. So I knew by deduction that the land value was $24,000 and the improvement value was 135. Here's the thing. Ultimately, that house I moved into, I sold it for a lot less than 1,235,000 because I stayed in Orange County. The Great Recession happened, and guess what? Land values plummeted. I ended up selling that house for, I think I sold it for 917,000. Just a little bit over 100,000 over what I paid for it seven years earlier. Okay.

Yeah. They got to include the property taxes and the maintenance.

Yeah. Oh, hey, my overall bill on that house for hoa, property tax, mortgage, Remember, mortgage rates were much higher back then, was $11,000 a month. That's what I was paying to live there. Okay? So, yeah, California. Outrageous. Right? So here's the thing. If the land value drops by half, let's estimate the land value, though, at the peak of the market on the house I lived in, it was 1.3 million. Remember, the original improvement cost was $155,000. Okay. Or 156, rounding correctly. So let's say that the improvement is now worth the house is now worth 200,000 because it costs more to build it. The construction costs, labor costs have gone up.

Right.

It's worth 200,000. That means the land is worth 1.1 million. Okay. If that land goes down by 50%, I'm going to lose $550,000. Yeah, but on the house, the rental property across the country, where the land value is only $24,000, I'm only going to lose $12,000, and I can live with that. Plus there's another huge thing. When I sold the house I lived in before selling it, I also put it up for rent, and I was asking $4,500 a month in rent, yet my, my payment was $11,000. Not a very good deal at all. Right. But if you think it's going to go up in value again or something like that, you can rationalize it away. But not a good rationalization. So I'm glad I sold it. Okay. But the cheap house, that was 159,000. That's a sustainable property. Okay. I can rent that and afford to keep it. Where the expensive house, I can't rent it and afford to keep it.

There's one cash flow positive, one cash flow negative.

Yeah, absolutely, absolutely. So low land value equals low risk. High land value equals high risk. That's the moral of the story, period. This is true everywhere on planet Earth that you have a cyclical market where you always have high land values. Dubai, Paris, Tokyo, London, Hong Kong, New York, L.A. san Francisco, Seattle, Miami, it doesn't matter. You can name any city on the planet Earth. And I will tell you if it has high land values, it is definitely a cyclical market. And I will also tell you, if it is a cyclical market, it also has high land values. There's no exception. Those are always true together anywhere on Earth. And I will tell you that if it is a cyclical market, your rent to value or RV ratio is going to be terrible. I'll tell you a contemporary story quickly about that. One of my contractors, a guy named Charles, he's a great guy, he's been doing some good work for us. He lives in Seattle. And he tells me just three days ago, he says, hey, we bought a new house, we're moving. And I said, oh, congratulations. We got into the conversation, what are you doing with your current house? And he says, well, we're going to rent it. And I said, how much is it worth?

Yeah, it's in Seattle.

In Seattle? Yeah. Well, Seattle metro area. Not exactly Seattle, but metro area. Metro Seattle. And I said, how much is it worth? He only had to tell me one number. And I've done this many times, George. I only need one number. And I can tell you the other number because the ratio is always the Same. He says, it's worth $400,000. And I said, oh, so you're going to rent it for 2200, huh?

Yeah, I was going to say.

And he says, well, 2300.

I'm pretty close with only knowing one of the numbers. Right? And because that. That ratio holds up all around the world, the only time it ever changes is when there's some funny government intervention with rent control or something. Okay? But otherwise, that RV ratio is always the same in every cyclical market, and it's always the same in every linear market. And in the hybrid markets, it'll be somewhere in the middle of the two.

And not only is his RV ratio horrible, but if he leverage on that, then he's going to be cash flow negative. And to your earlier point, with the land value, if he's got a $400,000 house in Seattle, the land value is going to be, let's say, 75%. So he's got so much more risk than by taking that house, taking out the equity, going into a linear market, and let's say, $200,000 homes, or, you know, maybe not even that.

No, what I do, what I told him is I said, look, Charles, through our network, I mean, look, he works for us. He knows what we do. He's been to our conferences. He listens to the podcast.

You should know better than that. Then what's he doing?

People get a little funny when it's their own. You know, it's. I mean, he's a logical guy. You know, he wants to buy rental properties, too, but he already wants this one. And the view is like a bird in the hand. So I'll tell you the rationalization, okay? I said, look, you can sell that house and you can buy four $100,000 houses, and you can be diversified into, you know, maybe two different markets, two houses in each of them, okay? And you'll get somewhere in the neighborhood of $4,000 a month. Why would you want just $2,300 a month when you can get 4,000amonth? And he says, well, you know, our loan balance is pretty low, so we're actually going to have positive cash flow. And I said, yeah, but then you're going to have a bunch of equity not working for you, and you know, he gets it. But, you know, it's the land value.

And if you did what you said, where you took that 400 and bought four houses with it, the land value would go from being 75% of the cost to cost 10%.

Yeah, maybe 20%. Those Kansas City houses you mentioned those lot values are probably 20 grand now. They're probably not 5,000 anymore.

Yeah, but the bottom line is it'd.

Be far, far lower.

So he'd be getting more cash flow and he'd be reducing his downside. You know why I think how the majority of people rationalize it, at least the people that I talk to, is they won't admit it. They won't admit it, but deep down there, I don't want to sell it because it could double in price over the next three or four years. It's the gambling component. They've seen it go up. It's recency bias, where they're like, oh, man.

Yeah.

But in the back of their mind, they're thinking, you know, four years ago, five years ago, this house was only worth 200 and it doubled in price. And if I sell it and go into those linear markets that Jason's talking about, I'm not going to have the opportunity to double my money. And your mind starts playing tricks on you. You got the devil on this side and the angel on this side, and the devil keeps whispering in your ear that you got to keep that because you could get another home run on this equity, and then you could be rich. And, man, if you get 800,000 out of this house, think about what you could do with that. And then they don't say that, but that's the underlying.

I'm so glad you mentioned recency bias, George, because we should all look up human biases. The other bias that's probably influencing him is what's called sunk cost bias. Right. So he's lived there. He's spent money on that house. He's taken pride in that house, so is his wife. And, you know, they have a sunk cost in it. Right. Then there's this bird in the hand, worth two in the bush certainty bias. Right. So there's all these different things. Right. You know, I don't fault them for it. Millions of people have that same bias. Okay. It's just part of human nature. But. But it's really interesting. The point is, get the equity out of your property. The property will perform. It'll go up in value by the same amount or down in value by the same amount. Regardless of how much equity you have in it, you will get the same amount of income, regardless of how much equity. Have you ever had a tenant come to you and say, hey, what is your loan balance and what is your mortgage payment? I want to make sure I cover that for you. They never say that. Or if it's a low loan balance and a low mortgage payment, they say, hey, give me a better deal. You know, they will say that, okay, but the property will perform the same regardless of the amount of equity in the property. Get the equity out of the property. Okay. It's just not a good place to keep equity. And I've talked a lot about that on the podcast. We won't. That's a whole nother topic, really. The point is, low land value equals low risk. High land value equals high risk. That's the Hartman risk evaluator in a nutshell.

That was really cool. I've kind of come to that conclusion in a roundabout way, but never through that type of analysis. Really, really neat.

Yeah, it took me 19 years to figure that out. It was all because of that call from Jennifer and that aha moment, that epiphany.

Really interesting. Yeah, yeah.

Good stuff, Jason. Well, just to let everyone know that I'm super stoked because this episode of the Rebel Capitalist show is probably airing on Sunday morning. So I want to let everyone know that Jason will actually be joining us tonight on the live stream.

Yes. That's going to be fun.

Yeah, it's going to be awesome. So if you got questions that you want to ask Jason directly, make sure you write those down. Join us on the live stream tonight. It's going to be 7pm and Eastern time, and Jason can answer all those questions for you. It's going to be absolutely awesome. And let everyone know Jason's going to be with us probably once a month or a couple times a month. Once a month on the live stream, at least once a month on the Rebel Capitalist show to continue to educate you on real estate investing and really help you out and help you make wise investments in an economic situation that we're in right now where it's very precarious, to say the least.

Yeah, it is. It is an uncertain time, for sure, George. And I appreciate you having me on, and it's been just great to talk about this with you. So happy investing to you and your listeners. And hey, we'll talk to you tonight on the live stream for sure.

And Jason, let everyone know that if they do have more questions or they want to contact you, how should they go about that?

The best thing is my website is jason hartman.com, just jason hartman.com and then my podcast, the Creating wealth show, you can find on any podcast platform. And I'm happy to say that George Gammon has been a guest on my show and that was an excellent, excellent episode you did with me recently, so check it out. The Creating Wealth Show Type Jason Hartman on any podcast platform, itunes, Stitcher Radio, whatever you use.

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