How to Reduce Investment Risk and The Hartman Risk Evaluator, Part 3

How to Reduce Investment Risk and The Hartman Risk Evaluator, Part 3

Jason Hartman talks about preparing for opportunities that inevitably present themselves. He continues his three part story with George Gammon and ends with how it became the Jason Hartman Risk Evaluator.

Jason Hartman 1:21
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. And that was kind of cool. You know, growing up in LA or around all these celebrities. I remember the van every morning would pick me up at my crappy little apartment in marvista.

Jason Hartman 1:50
Then it would drive through la up to Malibu, we’d stop in I think it was Bellaire where were Brian Wilson lift pick up his kid or to go 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, 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, etc, etc, right? But the funny thing is, there’s like this disconnect where some unfortunate souls I 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 US, especially, of course, we have listeners in 189 countries, but in a country like the US and I don’t just mean the US but a country like the US that’s very capitalistic and has good social mobility, where people can literally raise themselves by their own bootstraps up the socio economic ladder, right? They can, they can, they can just do it themselves. Right. I did it myself. And it, frankly amazes me how far I’ve come in my life. You know, many of you listening have exactly that same story. The vast majority of us came from very humble beginnings, especially if you go back to generations like you look at my mother’s life. I’m saying mine was humble. hers was really humbled. I mean, she grew up on a farm on a dirt road in upstate New York, the middle of five children. The 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 move to California because back then California was a land of opportunity. Now it’s the land of disaster, which is a cycle that occurs and in societies whether they be state cities, but especially a 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 breeds 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, Tamsin or Amy. 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 in in today’s world, all of us, no matter where we are in life, have more access than ever to clues to examples. Success all around us. And people choose how to respond to this. Right? They, they respond to it in, you know, 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 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 Serato small in in California to redoes, 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 and 95 cents each, and one was the psychology of winning by Denis waitley. And the other was See you 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 Denis waitley. Especially talk about Earl Nightingale and then Jim Rohn and augmon Dino 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.

Jason Hartman 7:51
Okay, millennials.

Jason Hartman 7:53
You don’t know what that is right? MP it’s like an mp3 but a primitive version of it. An mp3 audio file. So they gave a very good example. And one of the things Denis 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 and Everybody has bad breaks. Everybody has lucky breaks. I think we can all agree. Looking back on our lives, even if we’re upset, 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 lack of operate because boy, it will, if we are not prepared for that luck, when that opportunity drops into our lap that probability or lack whatever you want to call it, you know, if you’re Irish, it’s luck. Okay, you got your four leaf clover. If you’re agnostic or atheistic about that 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, good soil to fertilize that lucky break or that business. 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 everything in life is what you make it, it’s not what is the 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 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 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 an important concept. Anyway, go to Jason Hartman comm check out the properties there, reach out to one of our investment counselors or call us at one 800 Hartman that’s one 800 h AR t ma 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 before format, but yes, they are printed their 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 quickstart podcast, Sue and Gary Pinkerton were very instrumental in helping with that and picking out some what we call quickstart episodes. Of course, you know, if you’re new, it’s hard to go back and hey, I’m gonna listen to 1300 and 74 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 more fundamental stuff, just on any podcast platform, just type in Jason Hartman quickstart and that’ll give you a kind of that the hand picked episodes. 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?

George Gammon 13:29
duty, you just increase the land value in the

Jason Hartman 13:33
Y. 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, got 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 in the ocean and the distance and it was 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 sent the same guy the same rates. What 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 last 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 appraisement. 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.

George Gammon 15:45
It’s gotta be land again, isn’t?

Jason Hartman 15:46
Absolutely you’re absolutely right. Land you got because look, the improvement value, it doesn’t cost $65,000 less to build that house another year later, exactly.

George Gammon 15:57
imposing inflation. Even if the You if you have asset deflation, typically, because wages are so sticky, you’re still going to have the CPI go up.

Jason Hartman 16:08
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. Okay, before I purchase this one. So always in California, the new home never came with the yard, you always had to hire your own landscape 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 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. 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 costs up. So you’re right, the decline came out of the land value. Okay. What can we learn from this with this is a long winded thing here, right? What can we learn from this? We can learn that the risk Yeah, this is investing

George Gammon 17:50
that I can already see where this is going. This is really cool. Really, really cool.

Jason Hartman 17:55
So the discovery after 19 years in the business, just For caused me to discover it. I gotta call her up and thank her because I never realized this before. I have followed every real estate guru. I’ve read a zillion books. I’ve been to a zillion seminars. Nobody ever taught me that it came out of my own head. This one, 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 high land values, okay. And guess what linear markets the markets I like always have, they always have low land values,

George Gammon 18:58
super low in 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 cheat sheet 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

Jason Hartman 19:21
direction. It’s lopsided in a very good way for the investor. So this on the screen now is a very childish locating poorly graphically design. I really need a better graphic designer. made fun of me. I was gonna do this on a whiteboard, it would have been worse than this. Okay. Was the value 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 value. Let’s go back to Jennifer. The end. 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.

George Gammon 20:54
Okay. Yeah. You got to include the property taxes and the maintenance.

Jason Hartman 20:58
Yeah. Oh hey, my over 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. 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 gonna lose $12,000 and I can live with that. Plus there’s another huge thing. When I sold the house I lived in the for selling it. I also put it up for rent. And I was asking 40 $500 a month in rent, get 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.

George Gammon 22:54
cash flow positive one cash flow negative.

Jason Hartman 22:56
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, LA, San Francisco, Seattle, Miami, it doesn’t matter. You can mean 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. tell you a contemporary story quickly about that. One of my contractors 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, I Seattle, in Seattle? Yeah. Well, Seattle metro area, not exactly Seattle, but metro area, Metro Seattle. And I said, How much does it work? 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, cuz 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?

George Gammon 24:43
Yeah, I was gonna say he says, Well, 2300

Jason Hartman 24:49
I’m pretty close with only knowing one of the numbers, right? Because that that ratio holds up all around the world. The only time that 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 then the hybrid markets that will be somewhere in the middle of the two. And not

George Gammon 25:15
only is his RV ratio, horrible, but if you do that, and he’s going to be cash flow negative, yeah. 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, let’s say $200,000 homes or you know, may not even

Jason Hartman 25:44
know what I do what I told him, as 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 once 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 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 for $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 20 $300 a month when you can get 4000 a month? 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

George Gammon 26:44
land value. And if you if you did what you said where you took that, that 400 and bought four houses with it, the land value would go from being 75% of the cost to call it 10%,

Jason Hartman 26:56
man, maybe 20%. You know, those Kansas houses you mentioned You know, those live values are probably 20 grand now they’re probably not 5000 anymore.

George Gammon 27:04
Yeah, yeah. But yeah, but it’d be far, far lower. So he’d be getting more cash flow. Right. And he be reducing his downside. You know why I think how the majority of people rationalize it, at least the people that I’ve talked 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. Yeah, it’s the gambling component. Yea seen it 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 gonna have the opportunity to double my money and your mind starts playing tricks on you got the devil on this side and the angel on this son, 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. Yeah, but but that’s the underlying.

Jason Hartman 28:09
I’m so glad you’ve 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 spent money on that house, he’s taken pride in that house. So his his wife, and you know, they have a sunk cost in it right? Then there’s this burden, 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 millions of people ever. Same bias, okay. It’s just part of human nature. 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 and 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 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, 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,

George Gammon 29:42
that was really cool. I have never, I’ve kind of come to that conclusion, in a roundabout way, but never through that type of analysis.

Jason Hartman 29:55
Really, really neat. Yeah, it took me 19 years to figure that out. It was all about Because of that call from Jennifer that aha moment, that epiphany. Really interesting. Yeah.

George Gammon 30:07
Yeah. All right, Jason. Well, just to let everyone know that I’m super stoked because this episode of the rebel capitalist shows 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 gonna be fun. Yeah, it’s gonna 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. Eastern time. And Jason can answer all those questions for 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 why investments in an economic situation that we’re in right now where it’s very precarious. Yep. To say the least.

Jason Hartman 31:09
Yeah, it is. It is an uncertain time for 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,

George Gammon 31:23
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

Jason Hartman 31:29
thing is My website is Jason Hartman. com, just Jason Hartman, calm 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. Thank you so much for listening. Please be sure to subscribe so that you don’t miss any episodes. Be sure to check out the show’s specific website and our general website heart and Mediacom for appropriate disclaimers and Terms of Service. Remember that guest opinions are their own. And if you require specific legal or tax advice, or advice and any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to iTunes or Stitcher Radio or whatever platform you’re using and write a review for the show we would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.