384: Profit First for Real Estate Investors with David Richter

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It's my pleasure to welcome David Richter. He is the founder of Simple CFO Solutions and and he is maybe the world's biggest fan of the Profit first methodology. So we're going to talk about that today and let's go ahead and take a dive in. David, how are you?

Yeah, I'm good Jason, thanks for having.

Me on and welcome. You're coming to us from Maryland, right?

Yep, coming to you from Maryland.

Excellent. And if you want to go ahead and share your screen and some may be listening to this on audio, so if you are, we will go ahead and try and explain the visuals to what extent we can and you can also see the video on our YouTube channel. Okay, so let's go ahead. So I guess I'll start with sort of the fundamental question, and I know I asked you this before off air, but what is profit first and what's the big deal?

Awesome. So I'll definitely go into that and that'll cut down on the slide time. But the, the big thing behind profit first is a shift in mentality for a lot of real estate investors. They think I'm going to go to work, I'm going to get all the, I'm going to sell the properties and once I sell the properties, I'll pay everyone and if any, if I have anything left over, great. If I don't, you know, it's just I'm reinvesting back into the business. But profit first says it is the sales minus profit equals expenses. So like you have your sales, you take your profit first, you actually pay yourself first. Like Robert Kiyosaki and all the other books tell us what to do. And profit first really is the practical, the practicality, the steps behind that. And like to say this is what you do and in order to know that you can pay yourself first and to be a healthy company. So that in a nutshell is what it is. And honestly it's like the envelope system for a business. That's what if I had to just sum it up, that's what it would be. And then I think it's very practical for real estate investors because it's that shift in mentality.

Okay, so I don't want to make any assumptions though. What is the envelope system?

So the envelope system in like the personal finance world, that's where you take different envelopes for certain expenses where it might be, you know, like for your car, for your house or whatever, and you're divvying them up into certain envelopes and putting money in there for, you know, like for those specific times. So that's what, that's basically what Profit first is. You're creating different bank accounts to hold specific general business like expenses or accounts for you in order to know where your money's going. And that's where it's like, it's more geared towards the owner than it is an accountant or bookkeeper. It's more for the owner to understand their finances. When like 97% of investors I work with, you know, come to us and just have no idea what the numbers are, have no idea where they stand financially.

And when you talk about investors, I think you're mostly referring to like the active type real estate investors who are doing fix and flips, wholesaling, et cetera, versus, you know, many of our clients are the buy and hold type investors. You're not really addressing them, are you?

I work with a lot of buy and hold too. I actually work with a lot of those. And there's, there's a little nuances to the different types of, of the exit strategies. But yeah, I mean, it doesn't matter if you're wholesaling a fix and flipper or a landlord buy and hold person. This methodology works for all of that. The practical steps to it just change a little bit.

Okay, great. So take us through some of your visuals, if you would.

Sure. So first of all, I'm not a cpa, so here's the legal disclaimer here. If you don't like what I say, good, then you don't have to listen. So why this mission? Why do I want to do this? Because I started out in the real estate investing world with this group with Wayne Schaefer, Tom Olson and Gary Harper. And my story is I read Rich Dad, Poor dad and wanted to do my first deal, did my first deal, then hooked up with a real estate investing company and we scaled that company from five deals a month to 30 deals a month. So I've seen a ton of deals. But then even in that business, I saw number of deals done. Doesn't matter if you don't have the net profit. So that was like my first eye opening to that because I got to sit in every seat and one of those was the finance seat. But from there made a life change, moved to the Richmond, Virginia area, helped another investor kind of get his books in order. I sold all the properties I had from northwest Indiana when I moved from there, helped him get his books and he looked at me and said, you've changed my life. And I said, this is it. I need to get this message out of Profit first and I need this to be in the real estate investing world because I was, I'm a real estate investor, been a part of over 800 deals. But it seemed like it's not the number of deals done, it's the net profitability and the health of the company. So that's when I dove into and started helping real estate investors on the financial side of their business really understand that. And that's when I read Profit First. That's. I read Profit first and it opened my eyes. Gary Harper said, once I started this business, you should read this book. I think it goes in line with what you're doing. I read it that night, took 10 pages of notes and said, this is a great framework for a real estate investor to understand how to manage the cash flow. So then once I read it and started implementing it with real estate investors and saw the life changing things that it had done for them, I knew there were nuances from the original book that don't apply to a real estate investor or there's a different way to set it up. So I went to Mike Michalowicz and I asked him, I said, hey, could I write the book for real estate investors because of the success we're having and the actual framework changes a little bit from what the original book is. And he was like, yeah, let's do this. So that's when I, I'm right now in the middle of Profit first for real estate investing because I'm on that mission. I want to change a million investors, lives on the financial side.

Let's dig into the system. So sales minus expenses equals profit.

So that's where that's the normal, that's the normal formula. And that's where everyone gets it wrong. They think, let me, let me sell all the properties, let me then pay all my expenses and then what's left over I get to keep. But profit first flips out on its head. Sales minus profit equals expenses. So thinking of the mindset, that shift in saying I'M going to pay myself first, make sure that I'm profitable first. So how do you actually do that? Like what are the practical steps? Because once you get that from a lot of other books. So what do you actually do? The four steps. Number one, set up accounts. So set up bank accounts. So what bank accounts would you set up? So let me show you. It is the modernized envelope system. We already touched on that. So I'm going to give you the suggested accounts right here. So if you have a real estate investing business, I have an income account which is like a holding bucket. I'd have a profit account specifically designated to your profitability and owner's compensation, owner's tax to save for your taxes, operating expenses. Those are the foundational accounts. The other accounts, OPM Giving and charity are my spin on the profit first system. I'll go into those in a second. But those four, those five top accounts are the foundational accounts, meaning that profit, owner's compensation and owner's tax is all for you, the owner. They are the golden tree or they are the heroes of your business. Meaning once you start getting money into that income account from sales or rentals, you're allocating the first percentages of the money into those accounts. So that's the practical step behind it is set those accounts up first. The OPM is for other people's money. I like to do that with real estate investors because they don't usually separate out like those short term loans from their operating money. And that's where I like to separate out. If you've got a rehab project going on, put it in a separate account with more lenders money. So that way you're not commingling that and then getting into a bind. So that's where I set that up. Giving and charity. I just always, I see the investors who do that who have the giving and charity accounts grow their business faster. For rentals specifically, I would set up a PITI account for your principal interest, your property taxes and property insurance. And then also the holding account for security deposits. Like just making sure you have those set up for the system and then others that I've seen is debt pay down and marketing. Like you can separate these out more to like really get a grasp on your finances. But all everyone says objection like that's way too many accounts. But can you set up one account designated for profit specifically and transfer 1% if you into that from every deal, can you learn to live on a little less than what you're bringing in right now? So that's the key behind it.

I'm curious, was Mike inspired by the old book the Richest man in Babylon by chance?

Oh, I'm sure, because that's where I've read that book. I love the Richest man in Babylon, so I'm sure he was inspired by that. I'm sure there was a lot of other books too, because this theme is throughout this. But I love the system, the clear, simple system from profit first. But, yeah, I'm sure he was.

You know, let's talk for a moment about the most famous real estate investor on planet Earth. I think we know who that is, and that's, of course, Donald Trump. Does he use the system?

As far as I know, I'm not sure if he uses this system conceptually.

Does he think that way, do you think?

I think he would at this point. It's probably where he's got that set up with the systems, with the people that run this portion of of his business, where it is like, okay, I need to make sure everything's separated out. That's why he could take so much in tax. You know, like, how he could know to pay so little in tax, which it wasn't $700, but it was. He took so much because he was able to separate this out. Probably do a lot of cost segregation or whatever he did, you know, to get his taxes down to where they were as minimal as possible because he was able to separate out his finances. Sure. So I think this system works for if you're a newbie investor or if you have done a thousand deals, this will at least give you a framework to have a handle on it. So I think out of all investors, probably Donald Trump has a handle on his finances. So he's probably running some type of system like this. It just might be a much modified version of it, or like he's got a super team of accountants around him to run it at that level.

Okay, good stuff. Keep going.

Okay, so number two, making sure you pay yourself. So if you just do the first step and you just set up one bank account, make sure the second step is you're actually paying yourself. This is where I see a lot of real estate investors don't pay themselves or pay themselves inconsistently. That's 51% don't pay themselves. I mean, Inc. Magazine, this is entrepreneurs across the board. And I'd say just from my collection of real estate investors I've worked with that it's more like 80% that someone isn't paying themselves consistently or just paying themselves, like, as they can randomly or there's no real set system for them to pay themselves. They're just trying from every deal to take what they can. And that's where if you have that, what can you do to start paying yourself consistently? Can you get either set yourself a salary and then take profit out, you know, like to either to celebrate your wins. But getting a system to pay yourself like this to set up that second account that's specifically for your owner's compensation. Because a lot of fix and flippers, wholesalers, landlords too, you know, like, what are you paying yourself from your rentals? Because I know depending on the goals of people and where they are financially, that's where a lot of people in the real estate investing world just don't even think about this. They think every single dollar has to go back into my business. If I pay myself, they'll feel guilty, they'll feel like, you know, like I'm hurting my business. But if you're not healthy, the business is not going to be healthy and you're going to eventually have to go belly up, you know, like if you're not, if you're not getting a system around paying yourself. So that's where the step two is setting up that second account, the owner's compensation, making sure you're actually paying yourself from your business. Step three, there's a transfer rhythm. So this is the actual. When you get property profit in or rental, rental income in. This is where in the original book Mike talks about the 10th and 25th. But for a real estate investor, that is going to be wildly different. So you might, when you get income in is when, when are you going to be able to consistently do something? I have investors that I work with where they sell one property a quarter. So we do a quarterly allocation and it's literally covering like their whole quarter. Or we have people that are selling several properties a week that we work with. So that allocation or their transfer of that income to the different accounts happens on like a weekly basis. But it's getting them into a rhythm to say, this is when I manage the finances, this is when I'm looking at them. This is when I'm actually being able to cover what I need to cover. So that's where a system just like this, to get in that type of rhythm, it needs to work for you, but there needs to be something where you can do it consistently. So that way you're always on top of it too, because that's where the power in the system comes from, being able to do it on a consistent basis. And know where you stand.

Does it involve setting a profit goal? I mean, I know that sounds incredibly basic, right? But because of the way you do the formula, income, profit, and then expenses, do you set a profit goal at the start of it?

Yes, there's actually, let me pull up. I have got several other things here too. I want to make sure that I can get to everything. So in the original book, he talks about target allocation percentages. Like, these are the goals you should be shooting for. So like as a healthy business, depending on the size of your business, because you can see from $0 all the way up to $50 million.

Just blow that up a little bit. Zoom in a little. Okay, not that much, but okay, that's fine.

Is that better? There you go. So that way you can see, depending on the size of your business, these are the goals you can be shooting for as a fix and flip for wholesaler. Even landlords. Landlords, There's a couple different accounts, you know, like with the PITI or the Vacancy. But this is like a basic goal to be shooting for. So, like with the investors we work with, there's one whole thing that we go through. We assess their business, like, what percentage are they at currently? And then we say, what target do we want to shoot for profitability? Like, what can we start with right now? Is that 1% or is that 5, 10, 15? Like, where are they right now in order to get there? So, yes, that's a part of this system. We do that right away with investors. Like, what size business are you right now? What should we be shooting towards? And where are you currently? So that's where this comes into play.

Yeah. It's interesting that he's got awfully low tax rates and profit, it goes up, then it declines based on revenue, and then owner's pay is really big at the beginning, and then it declines as revenue increases. I sort of wonder about that. I'm sure a lot of people ask that question, right?

And that's because in the original book, it's more like as you get more profitable or you get more revenue coming in, you might be just taking draws as the owner and from the profit account and not paying yourself, you know, you're more in that owner's box and you might have other businesses going on or whatnot. Once you get that level, as far as taxes go to, this is 15% of the real revenue. So it's not like it's like. It's almost like 30% of the total of what you bring in. Because this is the 15% of that real revenue number. It's like if you took out the operational expenses, it's like if you did, 35% of that number is the same as 15% of the real revenue number. So that's where he's just like, make it real easy. That real revenue number is like in selling or wholesaling business is like the property profit. So that's where 15% of the property profit that's like taking into right from that top, that gross property profit. And then all the operational expenses or whatnot still have to come out. So it ends up being about the same as if you saved 30% or whatnot after you paid your operational expenses. So that's where that comes in too. And then as far as profitability goes, this is just after researching literally thousands of business. And, like, what he saw was the most profitable or the most. The healthy percentage points to shoot for. And I've seen this be very accurate for. Because what we work with, I work with the investors from like, basically 250 to about 5 million. And I've seen these percentages be very reasonable. I've had people where they've literally hit those targets. And this is. They're like, this is where I want to be. So it is. I've seen it now pretty consistently in the people that I've worked with, too. Okay, so then what rhythm works for you? And then the last step, build and keep reserves. This is like the true key to the whole system is then being able, like you said, shoot for that profitability target and then not touching it, not rating those accounts, not going into profit all the time and yanking money out, but showing that you have a profit in there. The rhythm for the profit account is, he suggests once a quarter, you take out a certain percentage of that profit account and actually reward yourself, because that's true profitability. And that's where you can see, okay, this is more of a system. This is more of the reward that I get for actually following the system and not just going crazy with my finances and having it all over the place. And then with the taxes, that's whenever you're paying your business or your personal taxes, too. So that's a quarterly or once a year or whatnot, but having those accounts set up specifically for you because it gives your people safety, making sure that if you have employees, that they know that you have reserves, so that way that they're there, they don't have to worry about their job. And then protecting yourself from the IRS and for emergencies, whatever comes up, who knew There was going to be a global pandemic in 2020. So that's why you need those reserves and then growing your business. This is one of those things where it sounds backwards to a lot of investors, like, why would I keep money to grow my business? Don't I need to throw it at every deal that comes across my plate? Well, no, if you have reserves, that's going to help your fundability with banks and with the institutional type of that. But you're also going to be able to, as you grow your business and as you get that institutional money or if you're refinancing your portfolio, that's where you're going to be able to use the other people's money to grow and not yours all the time. Because lenders like to see that doesn't matter if it's private lending or institutional lending. They want to see that your business almost doesn't need the money in order to grow. And it puts yourself in a better position to grow. And if you do need the money there for the deal, reserves are there to help you for what you need. So that's where a lot of people just don't realize that they think I get the money in all of it has to go out the door and just marketing or whatnot. And then they end up wasting a ton of it without just being thinking about that step. So that was, that was basically it. I got a lot of, A lot of this stuff that I give away or that I actually show over here. I give. If people email this last email address on this last slide. So I'm not sure how you want to handle that, but it gives this.

You can give it out or give out your website. I mean, I recommend website, but it's up to you.

Sure. So you can either email this email address. That's where you can get a bunch of the free stuff. It goes into the. All those little, you know, those diagrams that I had on the other page, the taps gives you a chart of accounts, gives you the first two chapters of the Profit first book too. But then also if you just go to simple CFO solutions.com that's our service and that's where we provide that. And we also have a Facebook group free one there that gives information I get in there a lot to answer questions on Profit first as it relates to real estate investing. That's Profit first for real estate investors. And we have a podcast due for the Profit first for rei. So that we're just trying to get. I'm trying to give away as much of the information as possible. Like in the book, these are the steps that I say in the book. You know, I'm trying to just get the message out there because I've seen it now over and over, Right. Change investors lives because it's such a topic where a lot of investors, real estate investors just don't want to talk about. And this just puts it on the bottom shelf to where they're like, oh, now the light clicks on and like, okay, I can handle this. So I'm just trying to get the message out there because it's such a simple one. Like you said at the very beginning, like offline, like I get profit first. But like what in the world? Like it just seems like why is it such a big deal? And I think it's because it's how simple it is. Like taking the richest man in Babylon and saying here's the practical steps to do that for you. The owner instead of like the accounting or bookkeeper.

Sure, yeah. No, it is deceptively simple. So David, thank you so much for sharing this with us today. I don't know if you actually gave out the website, so I just want to make sure you do that as well.

Okay, so the two side, profit first, rei.net and then we've got simple CFO solutions.com both of them have information on them. Profit first rei.net is where we host the podcast and then the Simple CFO solutions is also available. That's where I've been helping the investors too. So those are the two websites that you can go to.

David, thanks for joining us.

Thank you, Jason.

So George Gammon, Jason Hartman and I have, we've created a high level mastermind group called the Collective. The goal of the Collective is for you to learn from the three of us as well as of course the other members on how to build and more importantly, how to maintain your wealth. In this video we're going to go into detail about what the Collective is and what it can do for you. Enjoy. So I'm Ken McElroy, I've been in real estate for over 30 years. Started with a two bedroom, two bath using my own money. And now I own over $1 billion worth of real estate that I bought over the years. Built a big company, we have a construction company, a development company, a property management company, and of course an investment company. And typically now we syndicate and work with large, both private and public institutions for the equity and the debt. And so what I bring to the Collective is how to scale, how to grow, starting with One really small property with no experience at all and growing it into an organization which I've been able to do that basically runs almost without me. So that's what I'm going to bring to the collective. We decided to start the Collective because one I met George Gammon and George brings a very interesting perspective about the economy and the Fed and the way money works and Bitcoin and alternative types of investments, which quite honestly, I was super focused on real estate almost the entire time. And even I want to be a little bit more diverse. So when I talk to George and to Jason, they're always doing very, very different things. On the investment side, Jason specifically is more focused on the single family housing and what's going on in that market so that we could collaborate and have different viewpoints on different things. And so that's why I thought the collective would be good because I think everybody's kind of searching for the same kinds of answers. So the collective means to me basically the collective group, the whole. And I've always been a big believer of team and collaboration. So for me it really means collaboration, collaboration of everyone kind of coming into a room and learning from each other based on their individual highs and their individual lows and to be very, very respectful of all their independent views on things and to be more open minded, transparent and authentic. So I cannot wait for the group to get together each and every quarter because we all have very different walks of life that we're going through. And so it's very, very cool to get into one room with like minded people. I think the right person for the collective is somebody who's into personal development, somebody who's trying to be a better individual, somebody who's trying to have that work life balance, trying to figure out good decision making on the investment side specifically, good decision making on the personal side perhaps, certainly on their health and on their wealth. The members that have already signed up are people typically that have businesses that they're growing, businesses that they've started or businesses that they've sold. So typically they're higher net worth and they're trying to figure out what to do with their money. They're probably a little bit afraid of inflation, they're probably a little bit concerned about where to invest. And they're obviously looking at real estate as one component. Somebody that's trying to do the right things both on the personal side and on the financial side. So some of the experiences that members can expect to get out of the collective are certainly the network. And I think that's always super powerful. I've been involved in groups like this before like EO and ypo, the Entrepreneurs Organization, and ypo, which is Young Presidents Organization, which is kind of a peer to peer network. And I that's what I envisioned and I think people are going to certainly get that out of there. They're going to have lifelong friends for sure from this, and they're going to meet people at every single event. But also we're going to have fun. So as an example, things like race car driving and doing all kinds of really cool things and meeting celebrities and things like that and fashion shows are going to be part of it. So it's kind of a how do we have fun and learn together? And we're going to have that at each and every event. So thanks for watching. If you guys are interested, there's a link below you can click on. It'll take you right to the website, which has a load of information on exactly what the collective is, where the next events are, and what exactly you'll be getting if you become a member. Thanks for watching.

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