How to Reduce Investment Risk, Part 1

How to Reduce Investment Risk, Part 1

George Gammon and Jason Hartman talk about The Jason Harman Risk Evaluator. In Part I of a three-part series, Jason discusses his ‘eureka’ after 19 years of experience in Real Estate. He starts the story with a call from an insurance agent named Jennifer, which leads him to an understanding of a key metric, land to improvement ratio.

Jason Hartman 0:00
I love your podcast. I think you educate you entertaining, and I always learned something even if it’s not real estate related. 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 multi millionaire who’s actually been there and done it. 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 13 73 1373 and greetings from somewhere in the Caribbean Sea outside of Turks and Caicos. I’ve got some homework for you some homework. Yes. Today, let me give you the homework assignment. It’s kind of interesting. I think you’ll learn something from it, then we will get to the core message of today’s show, go to Wikipedia. The other one that’s interesting is the CIA World Factbook, or something like that. The CIA keeps information on every country on Earth, of course, and there’s some fascinating stuff there. But here’s what I want you to find. You can DuckDuckGo this, certainly you don’t want to Google it.

Jason Hartman 1:40
DuckDuckGo or Bing it and type in something along the lines of List of GDP, by country, okay, or GDP by country list. Type that in, you’ll find, and this is one of the things I always do when I’m visiting all these countries, Turks and Caicos so that we can Just left last night was the 85th country I visited. So in visiting these countries, I always look up the GDP of the country, the gross domestic product. And why is this important for real estate investors? Well, I’m talking about it on a nationwide basis. By the way, do you hear the crashing waves? I don’t know if you can hear that. But I certainly hear it as the door to the balcony and my stateroom here is open, just thought I’d give you a little flavor of how it is here at sea. Unfortunately, I can’t share the wonderful fresh air with you, at least you get some of the sounds hopefully. So in looking up the GDP. This is on a national basis of domestic basis and comparing country by country. Now, just the GDP is not enough information. And I want you to think of this as you’re investing in different places around the United States, because every state has in essence, a GDP in sodas every metro area Have a version of a GDP. Now, obviously, it’s not gross domestic product because, hey, it’s not a country, right? But the same concept applies the same concept applies. So the first homework is to look up the country list by GDP and how many countries are there on earth? Well, that’s debatable. Why is it debatable? Because not all places that call themselves countries are recognized by other countries as countries, right? So it depends. But there’s somewhere between about 195 and maybe 206 countries, I believe. And of course, we have listeners in 189 of those countries. So almost every country on earth is covered. And we have listeners on this podcast, so thank you so much for listening. And unfortunately, we have not been able to get Raphael Castro in Cuba, any of the Cuban delegation or The North Korean delegation you know, as soon as Kim Jong Hoon starts listening to the show, we’ll have more countries listening. So hey, that would be great. Maybe it will, will change their ways, right? they’ll change their ways because of listening to to the podcast and understanding the glories and benefits of capitalism. Either way, I, I don’t hold out any hope for that, by the way, either way. So now you’ve looked up the GDP list of all the countries in the world, and you’ll see that some don’t even have a number like Venezuela, and I mean, North Korea, nobody really knows exactly. But no matter what, it is absolutely pathetic. It’s It’s awful. North Korean GDP is. I mean, it’s terrible. I can’t remember the number but it’s extremely low. It’s so sad for people that live in these oppressive regimes. So the GDP is not enough information. Why? Why is it well What we want is actually not the GDP. Let’s take one more step. Now let’s look up per capita GDP. So in other words, that really is a good indicator of wealth, because it shows you on a per person basis, how rich or poor The country is, right? So per capita GDP would be the next slice, but that’s not enough information, you need to take one more slice. So, there are three searches you have to do for your homework today. The next slice is to look up per capita GDP and then type these letters ready P P P,

Jason Hartman 5:41
yes, P P P, so per capita GDP by country P P P, okay, what does PPP mean? You ask well, this is very important. PPP is purchasing power parity. Now why is that and why? It’s vitally important. Think of it as nationwide real estate investors. You might be listening to this and you might live where I used to live, you might live in Los Angeles, California, where I grew up, where you might live in Orange County, California, where I spent most of my adult life in Newport Beach and Irvine, California. Now, if you just looked up and understood the typical income of people in those areas, or if you could look at the GDP, if they were countries, right. And by the way, some of these economies are so large that they couldn’t be riding with countries, but they’re not because the GDP stats for any of these metro areas or any of these states, as a matter of fact, wouldn’t really be that accurate like they are for a nation, right. But here’s the problem. If your GDP in Newport Beach, California is $100,000 a year per capita GDP, right? If we could get an accurate measurement on that, that is not the same as a GDP of $60,000. In Atlanta, Georgia, one of our markets By the way, you can find properties at Jason Click on the properties section. You can check out properties we have in Atlanta or Memphis or little rock or Indianapolis, or even Chicagoland area. Yes. My investment counselors informed me after a podcast we did last week that they had a new team they liked in the Chicagoland area. So hey, you can check that out. Whatever, right? You can look at all these areas. And of course you intuitively understand that $60,000 in Atlanta, probably goes further than $100,000 in Newport Beach. Right? And then of course, you’d have to ask what area of Atlanta? Is it? Stone Mountain, or is it Buckhead? Huge difference? Buckhead being a very expensive upscale area. In Atlanta, and the Atlanta metro area. So all of this stuff matters, right? It all matters. But what we want as real estate investors to think about is we want to think about having a very favorable per capita, purchasing power parity GDP. Why? Why is that important? Because the likelihood is, and it’s not perfect. Of course, there are many other factors. But it is a good indicator. It’s a strong indicator. It’s not the only thing but it’s something for sure. It’s a strong indicator of how much pricing power we will have as investors as landlords, how much pricing power as sellers and the future someday will we have in being able to increase our rents okay, because if we have very favorable per capita Purchasing power parity GDP, if you will, I know I’m misusing GDP, I get it. And hopefully you get it to my point is the same. If we have very good per capita, purchasing power parity GDP in a given metro area where we own rental properties, then the likelihood of us seeing upward rents in the future is very good. And the likelihood of us being able to sell our properties someday in the future, maybe 27.5 years from now, why 27.5 you ask? Well, because that’s when your depreciation schedule run out. And that’s what we recommend, buy and hold investing. Of course, there may be times that you want to sell and I’ve profiled many times over the last 15 years on this podcast times that I’ve sold properties because I could turn them into turn one property into two properties and increase my cash flow substantially and get a Rifai till you die benefit at the same time, so many times, you know, be in touch with our investment counselors, have them do a free portfolio makeover for you, and have them help you with us. But that’s the homework. Okay, so you got the assignment. So first off, you’re going to look up, you’re going to use DuckDuckGo. And you’re going to look up. And by the way, we had the founder of DuckDuckGo. on the show before, you might remember Gabriel Weinberg, you’re going to look up GDP list by countries, then you’re going to change that search a little bit and you’re going to look up per capita GDP list by country. And then you will understand not only what the country produces in gross domestic product, but what each person based on you know, divide by the population essentially gets in GDP for themselves on average. And then, third and final search you’re going to do is this homework is you’re going to look up per capita GDP by country Free, PPP, purchasing power parity. Now you might have to spell that out. But I don’t think you will because PPP is the abbreviation or the acronym, if you will, that many economists use in describing this. And then you’re going to get an idea of how rich or poor a nation is. And then you’re going to use this new education to think about the properties that you see at Jason slash properties. And you’re going to think about that purchasing power parity per capita GDP, as it applies to these metro areas. Now, you’re not going to get perfect stats on this, you’re not going to get perfect statistics. But you are going to see that investing in these good solid linear markets that we like and maybe a hybrid market now and then, but definitely not a cyclical market, where it’s way out of whack, where people are essentially poor in these cyclical markets. You’re going to see how good this Is as an investment strategy and how much it has paid off for the people that have done thousands and thousands of transactions with us over the last many years. So, there’s your homework now, today, let’s get to a deep dive into another important, important principle that I’ve taught you over the years. But here we’re going to take the deepest dive ever into the Hartman risk evaluator. And this is an interview I did with George gammon where he interviewed me on his YouTube channel. George is a fantastic educator. He really takes a deep dive into lots of economic news and principles on his YouTube channel and just does a great job with that. And he interviewed me on his channel and we did a very long over an hour deep dive, but don’t worry, it’s not going to be an hour today. We’re going to cut this up for you. Make it bite size and digestible because inch by inch anything’s a cinch. And how do you eat an hour One bite at a time. Right? So we’re going to take a deep dive into this over the next three days. And I think you’ll really enjoy this. And, of course, many of you listeners that have been listening to me for the last 15 years or the last 10 years, George started listening to my podcast in 2012. So eight years, you know about the Hartman risk evaluator or something, it took me 19 years I was 19 years into my career before I even discovered this. And it was an amazing discovery, really, its original thought you haven’t heard it anywhere else before it came out of my head. It is a very useful guide when investing in income property as to how to dramatically lower your risk to mitigate risk to be a better investor. So we’re going to do part one of that today. Remember your homework three searches you’ve got to do. I think you’ll find that to be very enlightening and educational and apply that as you think about nationwide investing across the United States. Okay, here we go. With the first part of the deep dive into the Hartman risk evaluator.

George Gammon 14:05
Today we’ve got Jason Hartman, the real estate expert, and we are going to talk about something that’s extremely important to your investment portfolio. And that is how to properly measure risk. Let’s dive right into the episode. Alright guys, welcome to the rebel capitalist show. We’ve got my good buddy Jason Hartman here. If you haven’t listened to any of our videos in the past, I don’t know what you’re doing because if you’re interested in making money at all, this is the guy to go to. He’s got the most popular podcast for real estate investing in the United States. The creating wealth show, my buddy Jason Hartman, thanks for being here. Hey, George. It’s great to be back on your show and you just do such a good job educating ever since our client clay Slocum, who loves your channel, told me that you mentioned my name on your show a couple times. I tuned in and I’ve been Learning a ton with your awesome whiteboard videos. So it’s really an honor to be back. So thanks. All right. So we’ve discussed a few things in the past that are extremely important to people who want to get involved with real estate investing. But we haven’t gone over everything. And one of the main things that you discuss that is so incredibly valuable is how to assess risk. So today, I really want to focus on that. And I think you’ve got a PowerPoint presentation for us. Is that correct? Yes, I do. And one of the most important things to do is manage risk. There’s a great idea of getting a return on your money, but the most important thing is getting a return of your money, right? Get a return of your money first, and then get a return on your money after you get a return of your money. So, so that’s what we’re going to talk about today. And you know, George, it is amazing that you can really, really dramatically limit Your downside risk, nothing is risk free. There is no such thing as a passive investment. Income property certainly is not a passive investment. Anybody that promises that is a complete liar. They should be drawn and quartered because they’re lying. Okay? They’re just totally lying. All right? Maybe not drawn and quartered, but put in jail. How’s that sound? No such thing as a passive investment. In fact, I of course, it s&p index fund is not a passive investment. a mutual fund is not a passive investment. If you’re investing in stocks, bonds, mutual funds, you better get educated, you better pay attention. Because the market is dynamic. It’s always changing. There’s always stuff going on, and you cannot afford if you want to get a return of your principal, and certainly return on your principal. You better pay attention and be educated. Interestingly, and I’m sure your viewers and listeners would agree with this, but By and large, most people in the general public would not even I would assert that even a bank account is not a passive investment. Of course, you’ll get eaten alive by taxes and inflation, because the tiny little bit of interest, you’re going to get on that money, you’re going to be taxed on that. And then of course, it’s the hidden taxes, inflation, and your principal value of your investment in that bank account. Even a savings account is going to be destroyed by inflation, right? negative real rates. Everyone thinks that Japan and Europe have negative rates. So we’ve got them too. It’s just, they’re just not nominal. They’re real, right?

Jason Hartman 17:38
Absolutely. Absolutely. So there’s no such thing as passive investment. We want to get a return on our principal and then a return of our principal to of course, and after 19 years in the real estate business, I discovered a secret on how people can almost eliminate their downside risk on a real estate deal. And I just want to share that with your audience today. So let’s dive in and take a look at that. I call this the Hartman risk evaluator. And basically what it consists of George is most people have heard of the LTV ratio, LTV, loan to value ratio. And that just says that, you know, if you’re putting 20% down, and you’re getting an 80% loan, then your loan to value ratio is 80%. Right of the value, right, that’s LTV. Now I invented another ratio. And I call that ratio, the LTI ratio. And that is the land to improvement ratio. Remember, whenever we buy a property, we’re really buying two things. There are two major components. One is land and the other is the improvement or the house or the apartment building or the retail buildings. Or the office building or the industrial building sitting on that land? That’s the improvement. Okay, right. And we certainly don’t recommend raw land as an investment because that’s highly speculative. It produces no income. That would be just like a non dividend paying stock, or precious metals, single level strategy, a one dimensional strategy, which is just buy low, sell high. That’s it. That’s the whole strategy. Of course, a multi dimensional strategy is better income properties, beautifully multi dimensional, it’s great like that. Then you go to two dimensions. So then paying stock, you know, buy low, sell high plus get some dividends on the way Go ahead. Oh, no, that’s what I was going to ask you what makes income property multi dimensional, a whole bunch of things that income as the name would imply that it produces, right the rental income, there’s the appreciation, the leverage, the tax benefits, and the depreciation depreciation. Meaning that all Some tax benefit you get, that’s the holy grail of tax benefits is called depreciation. And we can talk about that as well. beyond those commonly known things. There’s a thing we talked about in that that three part video series we did for your viewers, and that is inflation induced debt destruction. I DD. I know it’s a mouthful, inflation induced debt destruction. Okay. So let me just tell you this story of how this came about. And this was, this is not an invention. It’s a discovery. And I discovered this after 19 years in the real estate business and 18 years as a real estate investor, right? 19 years as a broker, 18 years as an investor, and here’s what it was. Here’s what happened. I bought my first out of state property. I lived in Southern California at the time. I thought it’s a big world. The world is my oyster. I was looking at investing internationally. I was looking at investing nationwide. I had been through a couple of recessions in Southern California. I was getting older, I was getting more conservative. I didn’t want to do that again. So I thought, well, you know, the old saying in real estate is that all real estate is local. All real estate is local. So I wanted to take the best asset class income property, but diversified geographically. Okay. The amazing thing I discovered is I got this call from my insurance agent. Her name is Jennifer. She worked at an Insurance Brokerage in Irvine that I had used Irvine, California. So I was buying two properties right around the same time. One was a home in which to live. Okay. And that was in Orange County, California was, you know, fairly expensive home compared to the rental properties we look at. And another was a rental property across the country. Okay, in the southeastern United States, and

Jason Hartman 21:59
Jennifer calls me up. And she says, Jason, we’re going to give you insurance on your rental property for $135,000. And, you know, George, it struck me at that point. That was the discovery. That was the aha moment. That was when the light bulb went on. Here’s why. The insurance company only ensures the improvement, not the land, because the land doesn’t burn down. The land doesn’t get vandalized, the land is not insured. Okay. If a lot that the house is sitting on, but the house itself, the improvement, the structure is insured. And so what Jennifer was telling me then, is that the insurance company believed that if that house burned to the ground, the replacement cost of that house would be $135,000. Right. Got it. This was the aha moment. Why? Because of the price I had paid for that happen. House. So I’ll show you, we’re going to get back to this in just a moment. Okay? So if you’re looking at the screen now, you’ll see these two component parts when you buy a property, land value improvement value, okay? The improvement value consists of the cost to build the house, or the apartment or the office building or whatever, I’m just using a house as the example. Right? Plus the builders profit, when the builder can’t make a profit, George, they’re not going to build the house anymore, right? They’re gonna, they’re going to finish out their their inventory, if they can afford to, this is what happens when you go into a cycle and go into recession. And then they’re going to just stop building because the machine doesn’t work anymore, right? So they’ve got to make that work. Now, let’s look at some of the factors that increase improvement value, right what influences improvement value, what drives the value of that house sitting on the lamp? Okay, environmentalism Building restrictions that increases improvement value. Why is that? Well, it’s because if the government makes it very hard to construct new homes, then homes they’re already built increase in value. We’ve certainly seen this in my former home state where I lived most of my life, the Socialist Republic of California. And in California is quite a disaster. Actually, last year, they did three things that are just going to kill them. I mean, economically, they are chasing people out of the state. They did rent control. They did this new sort of draconian data privacy law, which was and I’ll be the first to agree that, you know, we need to keep some of these tech companies in check. Right. But the reality is that’s hard to comply with, it’s expensive. It’s going to chase a lot of businesses haven’t state I think, and then they did a B five, which was the gig economy. bill that basically it sort of arose out of the lift and Uber debate, right, that ride sharing companies, where all of the democrats in their misguided ideas, decided that, you know, all these drivers for Uber and Lyft. You know, it’s not fair to make them independent contractors, they should be employees and have all kinds of employee benefits. So guess what that’s going to do? It’s going to make supply go down. And it’s going to increase cost, right? Obviously, that’s what happens every time. And now all of these workers that the liberals said they were going to help are now picketing, and they’re very upset because they don’t have enough work. And all the people that work on the sites like Upwork, and these different sites, contractors in the gig economy, you know, nobody wants to hire them anymore. They’re all getting their contracts cancelled, and if they’re in California, so it’s great. And you gotta you gotta have a side hustle in California just to get by. Yeah. Especially in LA. And also I think what’s amazing to me, I don’t want to go on too much of a tangent. But it’s amazing to me that these politicians think that, Oh, well, it’s a big company. It’s Uber. So they’ve got to just be printing money hand over fist. I mean, they ever made right, losing money in the last quarter, they lost $4.5 billion in one quarter in one quarter. How did you incinerate that much money. And so now they’ve got this on top of these billion dollar losses that they have quarter after quarter after quarter. I mean, they’re in deep trouble at anyway I don’t want to give on this stuff is just epically stupid, right? It’s a mess. But there’s an old riddle. What do you call a developer? And the answer to that is somebody who wants to build a house, at the beach or in the woods. What do you call an environmentalist? Somebody who already owns a house at the beach.

Jason Hartman 27:02
Exactly right. I had the, the great thinker, Thomas soul. Man, he’s my he’s he’s my personal hero rather than my father. Yeah, he is just amazing. Thomas soul was on my show. And of course, he’s a Harvard professor, I guess, former one and an author of many great books. And he’s right for fountain magazine times. He’s He’s a real intellectual. He’s a real thinker. And we were talking about this environmental building restriction thing. And I coined a new term during that podcast. Basically, the concept is as soon as someone owns their house there, they don’t want anybody else to be able to build a house there, right? They want to keep them out. Right? That’s always the way it works. And they do it under the guise of protecting the environment. But really, I created a new phrase. during that interview with Thomas soul. I called it environmental racism, the concept the way you keep the people of other races out is you create a bunch of restrictive environmental zoning policies so nobody can build a house so the house prices skyrocket. Nobody can afford to live there. Right. Right. Not this other races just just anyone, period. Anyone? Yeah, yeah. Yeah. You can’t have any neighbors at all right. So environmentalism in building restrictions definitely increases the value of improved properties. Okay. That’s a big driver. Okay. Next one. industrialization of developing countries, namely, China and India, of course, are the biggies, but there’s many others. And why is that? Because as these countries industrialized, they are just sucking up materials. They are sucking up concrete, lumber, petroleum products, there it is just, you know, they they’re just the demand for these commodities for copper. That, by the way, is copper wire in your house right. The demand for these commodities becomes very scarce, as we have the rising what they coined the term the rising billion, but it’s really the rising 3 billion people on earth that are moving up, they’re going to move up into the middle class. You know, hopefully that works out. And this rising tide around the world through globalization is really impacting this. But it’s also making materials and commodities more valuable in putting, putting upward pressure on the prices of them. And I think you just hit on a really amazing point right there that very few people think about. I know I’ve thought about this, but that’s just because I’ve listened to your podcast for so long. And that people see a house is just a structure. It’s It’s where we go to eat or we go to sleep. It’s just it’s a house. But it’s not. It’s just a combination of a bunch of commodities, right? Absolutely. And therefore when you start to look at it as a group of commodities, whether it’s copper Glass, concrete, metal wood, then you look at that from a valuation standpoint, and you start to see things much, much differently. Yeah, you do you do, because what you really see and you know, just to demonstrate it right, I bought this house last year. And you know, if I go back there and knock on the wall, right? It’s what I call packaged commodities invested as real estate investors were really commodities investors, you know, but the difference between buying our commodities packaged in the form of a house versus buying them on the exchange is that we can get leverage, we can get very favorable tax treatment, we get all of these benefits when their package, we own them, right. We get paid on them because our tenants pay for them. And it creates what I call self liquidating debt. Right? The mortgage debt gets paid off by somebody else. It’s really a form of in the corporate world, what they call an L Bo, a leveraged buyout. You know, when you buy a piece of property, you’re essentially making a leveraged buyout, at least for maybe 80% of it, right? You have a cash flowing company. And to be clear, when I’m doing my live streams or on my channel, the way I kind of compartmentalize things, is I always tell people that at least my definition of an investment is something that you have to get paid to own it, and you’re not getting paid on it. Right. In my opinion, it’s not an investment. It’s a speculation. If people compartmentalize things that way, they do a lot better with their overall portfolio, not just with with real estate, but

Jason Hartman 31:38
yeah, I think you’re absolutely right, you’re getting paid to own it. And that is a beautiful thing. When you package the commodities, you take advantage of very special characteristics that are not available in the individual commodities. If you just buy copper on the exchange or you buy lumber. or pork bellies or coffee or whatever, right? It’s not a packaged commodity. It’s an individual commodity. Adam Smith, in the Wealth of Nations, he talked about specialization, right? We’ve all studied this book as a hack economists that we are right. Or at least I’ll speak for myself. I’m a hacker con. You, you’re, you’re a professional. We look at the specialization of labor, right? And we know that when you make something that’s a specialized item, it’s way more valuable than it is as an unspecialized item. And I think, actually, if I remember correctly, in that book, he uses the example, a big piece of iron or something. And then he talks about well, you could make it into this, make it into that, but if you make it into little needles, little pins, it’s worth a fortune, right? That same piece of iron, right? Because it has in that sense of sort of like the unpackaging but it says it becomes a specialized thing right? So the same is true of a house, or or anything like that, or a rental property. And I would take it a step further say, like commercial space or anything. If you can compartmentalize a commercial space, you can rent it out for a lot more per square foot, just like Adam Smith’s example of breaking things down into a needle. Right? Yeah, yeah, breaking it down, you know, becomes more valuable that way. So, so getting the commodities package is a much better way to be a commodities investor. Okay, I think we’ve established that okay. This will be continued on the next episode. Thank you for listening and happy investing. 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 Hartman 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.