Jason Hartman starts with a discussion about the recent Facebook IPO scandal. Morgan Stanley and the other IPO underwriters gave the bad news to their big clients about Facebook having a bad quarter but didn’t bother to tell their financial advisors and individual clients about this – more bad behavior on Wall Street? Short Bloomberg News clip. What would Eliot Spitzer think of Morgan Stanley CEO James Gorman?
Jason reviews a SWOT Analysis for Investment Property including the following points:
Fragmented Markets & Providers
Physical, Real Asset
Inflation-Induced Debt Destruction(TM)
Regression to Replacement Cost(TM)
Acquisition Price Below Replacement Cost
Low FICO Scores = More Renters
New Inventory Suppressing Rents
Join Jason and his team for their very first LIVE east coast event! Atlanta Income Property Investment Tour + Education http://jasonhartman.webimpakt-green.com/atlanta-investment-property-tour/. Finally, Jason talks with one of his clients who finances farmland about his growing income property portfolio and outlook on the residential rental property market.
Welcome to Creating Wealth with Jason Hartman! During this program Jason is going to tell you some really exciting things that you probably haven’t thought of before, and a new slant on investing: fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self-made multi-millionaire who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it! And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
JASON HARTMAN: Welcome to the Creating Wealth Show! This is your host, Jason Hartman, and you are listening to the swankiest show on real estate and on investing and economics out there! So, thank you for joining me today for episode two sixty-nine, and today we’ve got a few things to cover. We’ve got another client case study, we’ve got a lot of good feedback that you guys like those, so I’m glad to keep interviewing clients and so forth, as well as our expert guest authors and such, as we have done on so many episodes in the past. But before we get into that, I’m always talking to you about being a direct investor and maintaining control over your investments.
Now, there are a couple of ginormous, if you will, companies out there. And you know of course Google, and Facebook, and these huge, huge companies—they really control so much of our lives and our information in so many ways. And with the Facebook IPO just about—what was that, about a month and a half, two months ago now—it’s interesting to watch what’s happened with that. And many people are—there’s much litigation that has come out of that, and many people are crying foul, and saying it’s really criminal activity. But of course on Wall Street, I mean, is criminal activity ever really punished? Well, not too often. In fact, with the mortgage meltdown, and all of the scams that happened on Wall Street starting about three and a half, four years ago—or at least that’s when they came out and became visible to most of us—nobody has gone to jail yet! Isn’t that amazing to you by now? That after all this time, there has not been a criminal prosecution. At least not that I know of. Nobody has gone to jail.
Well actually, in the Enron case, there were criminal prosecutions. So, maybe I need to say, nobody has gone to jail out of this last round of Wall Street malfeasance. And when you look at the Facebook IPO—and by the way, thank you to Mario, one of our listeners and clients, and a couple of our other clients that I can’t remember off the top of my head—that sent me articles on the Facebook IPO and so forth. And to Aaron, who actually sent this interesting video. And I want to just play a little bit of the audio track of that, and then I want to come back, talk to you about a SWOT analysis, and then go to our case study today, and maybe talk about a couple of other things. So, I’m just going to play that for you now, and I will be right back afterwards.
FEMALE VOICE: Now you mentioned Zynga, which went public. There are quite a few tech companies that have gone public, which aren’t—you just mentioned the stock price, I mean, which have underperformed pretty much everyone’s expectations. Facebook, I’d be lying if we didn’t bring that up. How has that IPO changed the tech ecosystem?
MALE VOICE (ROGER): Well, you know, I think in two fundamental ways. The first thing is that it has ended the possibility of anybody else getting public for probably the rest of the year. And I think they may be doing us a favor. The second thing it did is it exposed, in my mind, the extreme corruption in the capital formation process, and really in Wall Street itself. NASDAQ’s behavior on this in my mind borders on criminal. I think Morgan Stanley’s behavior borders on criminal. It appears they made a profit—
FEMALE VOICE: Criminal versus incompetent?
ROGER: Oh, no. This was clearly done on purpose. And you watch what all these people have been doing in secondary offerings. Do you think it’s a coincidence that every secondary offering trades down five—every company trades down five or six days before the offering, then they price it down 15%, and then it pops—it sure looks to me like the underwriters are shorting the stocks. What I’m saying is, I look at all of this, and as a thirty year investor, I think people on Wall Street have just so totally lost track of honesty that—
FEMALE VOICE: You don’t even want to participate—
ROGER: I’m just saying, look at the LIBOR effect! I mean—it’s staggering, the level—and first we had 2008. I mean, if you’re an individual investor, you’re getting picked off 17 ways to Sunday. And these poor tech companies, where there is a lot of news, and a lot of uncertainty—they’re doing a baton death march, because you can create rumors out of nothing. I mean, the issue at Yelp is some college kid recycled a rumor from a year and a half ago, and it knocked the stock down three bucks, even though it was literally ancient history!
FEMALE VOICE: I obviously don’t work for the NASDAQ, so I’m not going to become an apologist for the NASDAQ or for Morgan Stanley—
ROGER: Nor should you!
FEMALE VOICE: Nor should I.
ROGER: These are not good people!
FEMALE VOICE: But what about the presence of high frequency trading? And I’m not saying that they’re not doing business with by choice, but there are different elements perhaps that factor in.
ROGER: High frequency trading is part of the problem. NASDAQ is a member organization. High frequency trading advantages the NASDAQ traders over all other market participants. It allows them to pick off all price arbitrage before it ever hits the market! I mean, that is so fundamentally corrupt. They basically—look at the profits of these firms! I mean, their “clients” are more like marks, now! I mean, I’ve been doing this thirty years, and I can tell you, people say, hasn’t it always been like this? No! It was never like this!
FEMALE VOICE: Even—I know you were back at [unintelligible]—I mean, you ran a fund—
ROGER: Especially not back in those days, okay? I’m saying for all the corruption that took place in the LBO community and all in the 80s and around Drexel Burnham and all that, you never had people manipulating whole markets for—the deregulation has allowed people to overwhelm any individual market for brief periods of time, and move it. So most of these things aren’t actually trading; they’re arbitrages set up by overwhelming amounts of capital. And experienced market observers see this, and none of us know what to do about it, because the regulators are asleep! They’re—basically what it is, is there’s a set of really clear regulations left over from the Depression that affect consumer products, like mutual funds. But there’s nothing for hedge funds, and nothing for market makers! So they’re just running amok.
FEMALE VOICE: So if you think the IPO process then is dead, broken, corrupt, as you say, what’s the choice? Strategic purchases for the companies that you’re working with?
ROGER: That’s clearly—that’s the primary one. But what happened with the negotiated, the private secondary market for Facebook and Yelp and Zynga and Groupon worked very very well. There were more than a thousand transactions. I’m not talking about [unintelligible] or any of the consumer stuff. But the negotiated transactions looked like NASDAQ looked in the old days, in the 70s, and there wasn’t one accusation of fraud. There was one IPO on Facebook, and thousands of accusations of fraud. Right? Think about that for a minute. The unregulated, person-to-person market, is clean. The so-called “public market” is not! And I personally—I just think it’s tragic. And like I said, part of what’s tragic is that the people doing it don’t seem to realize that most of what they’re doing is wrong! And that it’s destroying our economy!
FEMALE VOICE: Roger, before the break you were saying look, you have 30 years in the business between Wall Street and being a tech investor, and you see Wall Street as being corrupt, as being broken, the IPO process as being broken. What should have been done differently with Facebook? Let’s say if we were back 10 years ago or back 15 years ago, when you say there was actually more honesty in the system—how would that have played out?
ROGER: Well, the difference today is that because of high-velocity trading, and because of the lack of regulation of the primary investing of banks, they make so much money from trading that investment banking, which used to be a super high profit margin business, is now an afterthought. So, the fees on IPO is 7%. It used to be so big that people would kill to get a great IPO. Now it’s a rounding error, compared to the damage they can do in other parts of the market.
FEMALE VOICE: So what was the worst thing that went wrong in the Facebook—
ROGER: Well, I would say if there’s a—let’s just say for example that there are 25 things you have to get right in an IPO. They blew at least 24 of them. I mean, let’s think about it this way. They allowed people apparently to cancel orders during the quiet period of the three days before the deal. I’ve never heard of that happening at an IPO before. It was clear NASDAQ systems didn’t work in the morning; they should have cancelled the offering first thing in the morning when they couldn’t get it to work right. When it didn’t match up, they should have cancelled it. So NASDAQ clearly is at fault for not cancelling and postponing the offering. And Morgan Stanley’s at fault for increasing the size of the deal, and the price, with a complete absence of demand!
FEMALE VOICE: I want to get back to that idea of the price and the valuation, but as far as Facebook, why did they do it, then? Did they just think it would be okay?
ROGER: Well, of course! I thought it was going to be okay! I was naïve. I was looking at this thinking, how could they possibly dare to screw up the largest tech IPO in history? I mean, this is Facebook! They have 900 million members! You blow this thing, and it’s out there in the public, and eventually the SEC’s gonna have to look, and when they look, all of these people are gonna have to explain 24 horrible decisions in a row.
FEMALE VOICE: You mentioned the price. Why is the price, the valuation—obviously now we see with the public market, it was too rich. Does this bring up a cautionary tale for other investors and entrepreneurs coming up? You can’t take too much money from VC, because eventually VC has to get it back out. Investors are gonna—
ROGER: Facebook didn’t take that much money from venture capitalists, okay? Let’s remember, they didn’t need much money. I think the real—and let’s put it this way. I think the venture capitalists have a lot of explaining to do, because they influenced increasing the size of the deal and increasing the price, and then increased their sales in the transaction without sharing that information with everybody else. So, clearly, everybody has some problems here. But no—why on earth would—I mean, how could you possibly expect NASDAQ and Morgan Stanley to do so many things wrong on such a high profile transaction? And then to hear Morgan Stanley actually made a profit the first day? If that’s really true, I mean, that—how are they going to explain that?
JASON HARTMAN: Isn’t that amazing, though? Literally, the criminal, or legalized criminality that goes on on Wall Street. It’s just beyond ridiculous. And that is why we need to be direct investors, and maintain control of our financial future—so we don’t leave ourselves susceptible to the three major problems: you might be investing with a crook, you might be investing with an idiot, and assuming they’re honest and assuming they’re competent, they take huge management fees off the top for managing the deal. So, we’ve talked about this on many prior episodes, so I won’t dive into it today so much. But on the good side, one way to maintain control is to learn more about how to maintain control!
Join us for our Atlanta Property Tour, and that’s September 28th through the 30th at the gorgeous, stunning, and swanky Grand Hyatt Hotel in Atlanta, Georgia. We will have the Creating Wealth in Today’s Economy Boot Camp all day that Saturday. We’ll have the tour on Sunday, and by the way, just rewind, we’ll have a nice reception for you on Friday evening before we start everything; a little social and networking reception before that. So, you can register now, at www.jasonhartman.com, in the events section, and we’ve got early bird pricing, only $197. And the beautiful Grand Hyatt has offered a discounted room block. It does have limited supply, I have to tell you that, and that is just $129 per night for your room, and I think you’ll really enjoy this event! So, be sure to join us for the Atlanta Property Tour. And by the way, I only mentioned it one time, and several of you have signed up already! So, thank you for signing up, and I look forward to seeing you at the end of September.
It’s going to be just a fantastic time of learning, laughing, enjoying each other’s company, networking, and touring as well, so that’ll be great. At our last Meet the Masters event in Irvine, California, I did a SWOT analysis. And I might actually share the audio clip of that in the future. But I recently posted the SWOT diagram that we created on my Facebook page, and we got a lot of interaction on it, so thank you for checking that out. And it really just shows you—the SWOT analysis, by the way, is something commonly used in business. I learned it originally maybe 10 years ago in Young Entrepreneurs Organization, now called Entrepreneurs Organization, because as all the entrepreneurs got old, they wanted to keep their membership, so they changed the name to EO rather than YEO, and this is affiliated with the Young Presidents Organization.
So, this SWOT analysis—S-W-O-T—stands for strengths, weaknesses, opportunities, and threats. And it’s commonly used in business; it’s probably used in the military as well. But here, let’s use it as it applies to income property, and the types of investments we have. So the strengths: of course there are many. They say that income property is IDEAL, and that is an acronym for all of the benefits of it, but I’ll just share a few that are here under strengths in my SWOT analysis. #1, cash flow. Be a cash flow investor, because as a cash flow investor, you’re investing in much more of a “sure thing.” Now, there’s no sure thing, of course. But it’s a much more reliable thing that appreciation. If appreciation happens, hey. It’s icing on the cake. But cash flow’s pretty darn reliable, actually, and you can exert a lot of control over cash flow. So I love being a cash flow investor for that reason.
The other thing is that it’s a fragmented industry, and it has fragmented markets. And this fragmentation—you know I’m always fond of saying, embrace the fragmentation. Most people think this is frustrating. I think it’s a benefit. The reason it’s such a benefit is because it keeps the Wall Street institutional-type investors largely out of our business, and it leaves these high return opportunities for us. Many times on prior episodes I’ve shared institutional investments. I’ve talked about them. And I’ve shared the types of cap rates, or capitalization rates, and returns, that these institutional investors are clamoring for. And frankly, they’re lousy! And so, these are the assets institutional large Wall Street investors are buying. They’re not that great! They’re buying the triple net lease on the Walgreens, or the CVS. They’re buying the big storage facility.
The institutional office building asset class. These types of things. Big shopping malls, and so forth. And as you can see, the head of Simon Properties—they do shopping malls. They’re a shopping mall manager and developer, and I think he was—well, he was the highest-paid CEO in America, and I think I shared it with you on a prior episode—his income was like $137 million last year. So, that business is obviously good for the insiders, but it’s not that good for us. Again, another example of taking huge management fees off the top. And these lower your returns. So if you invest in any institutional asset class—like a REIT—a real estate investment trust—a fund of any source, a TIC—a tenant in-common deal, TIC—you are again, going into markets that aren’t very fragmented, and that’s why the institutional investors are there: because they can manage them.
And it’s again, not a very good deal for you. But with us, we get to embrace this fragmentation that the institutional investors don’t have the ability to take advantage of. Remember what Warren Buffet said just maybe two months ago? He said hey, if I could buy a couple million single family homes and figure out how to manage them, I would. I think it’s the greatest investment opportunity right now. But the point is, he can’t really figure out how to manage them. Good for us. Huge thing in the strength category. Push appreciation. Now, what do I mean by push appreciation? Well, push appreciation just means that you can add value to the asset.
You have the opportunity through your creativity to add value by fixing it up, by doing certain things to the property that can actually push the appreciation. Now, of course another opportunity you have is actual appreciation, just based on the market. But push appreciation is the sort of creative appreciation that you create for a property. Certainly this is done all the time in apartment buildings, for example, where you can look at multiple different income streams, where you might add a laundry facility and make money off the laundry facility, or something like that. You might charge for parking when the current owner that you buy the property from hasn’t been charging for parking.
So there again is another example of push appreciation. You could re-tenant the building. You could kick your tenants out, remodel the units, and raise the rent. Push appreciation, another example of it. But again, all things considered—and it’s interesting, I was talking with one of our vendors actually in Phoenix the other day, and I quote him. He said to me, Jason, if I could just do single family homes all day long, that would be my favorite. Bar none, it is the favorite asset class. Single family homes, they’re the hardest to institutionalize, and that means the fragmentation opportunity creates the high returns for us, and they are just the best asset class! They’re the most historically proven asset class of all.
The other strength is that it’s a physical, tangible asset. So again, it’s not an airy-fairy thing, it’s not susceptible to Wall Street’s games and criminal activity; it’s not a house of cards—it’s a physical, tangible asset. So, huge benefits there. Now, let’s look at some of the weaknesses, going to the next letter, the W in SWOT. Repairs! So, maintenance costs and repair costs. Those things can become a weakness if you don’t manage them properly. If you don’t buy the property properly to begin with. And again, all of these weaknesses—well, all except one—are things that we help you with. That’s what my company does, is we help you manage these weaknesses through education, and through exerting leverage over the service providers, or vendors, that are selling you the property and managing the property for you. And then teaching you how to manage them as well, through education.
Another weakness is vacancy. You have the potential for vacancy. Now, this isn’t a very big problem anymore. A few years ago, it was. It was much more of a problem. But nowadays, the rental market is phenomenal. One of our investment counselors, Ari, just sent me an article two days ago, and this is from my former town, my old hometown, Orange County, California. Glad to have left, by the way. But this article said that Orange County apartment rents are the highest they’ve ever been in history. Now, isn’t that interesting? California is a state that is just plagued with economic problems. The Socialist Republic of California is the poster child for fiscal and economic disaster. Yet at the same time, all of this is happening. Orange County apartment rents are the highest on record. The highest they’ve ever been in history.
Why is this happening? Well, so many people have been foreclosed on, or damaged their credit in the last few years, that they’re forced to be in the renter pool. They can’t buy, even though interest rates are historically low, housing affordability is the highest it’s ever been in history—it is the best time ever to buy, okay? Since it’s been recorded, and I shared with you the details about that on a recent episode. But a lot of people still can’t take advantage of it! Those people will rent from you, and that is a huge opportunity for us as investors. So vacancy—it is a weakness to know about, but again, it’s not much of a weakness right now at all. The rental market, virtually everywhere in the country, certainly in every market we are recommending, is phenomenal right now.
Management. Well, you could have management problems, and again, this is one of the problems that we try to help you solve. Property managers can be difficult; they can be flaky, they can be flightly, sometimes they don’t do their job, or they don’t do it quickly, or they don’t do it well. Certainly a legitimate concern. And we help you manage that! And we also teach you how to self manage your properties, as I’ve talked about on prior episodes.
Of course, I never thought I could self manage properties from a distance. Certainly I know that I could self manage properties locally, but until about three, three and a half years ago, never really thought I could do it from a distance, and I am happy to say that I am doing it very, very successfully with many of my properties. I’ve talked about that first long-distance self managed property—that’s the one in San Antonio, Texas that I own. Well, guess what? The tenant that’s been there for several years now, and I’ve been managing it—he gave notice two weeks ago that he’s moving, and so I have hired a real estate agent who is a property manager there, to just do the lease up of the property. Not the management—just to lease up the property for me. And that appears to be so far, knock on wood, going very, very well. So, I will let you know as that progresses. But again, I’m self managing, and I’m just having a real estate agent lease the property for me, conduct the walkthroughs, get the keys from the tenant, take pictures of the property for me, and advise me on how much of the security deposit I should refund, and so forth.
Again, not going to the property. This is a property I’ve never seen. I’ve been to San Antonio, but that was before I bought this property! So, pretty darn good that you can do that. The next weakness is natural disasters. Now, this one’s kind of interesting. So, what if the Katrina hurricane came along, or a tornado came along, or a flood came along, or an earthquake, or you had a natural disaster? Well, the first thing is, insurance. So, you can mitigate a lot of this risk through insurance. And you have heard me say, and I’ll admit, this is sort of a snarky comment, I’ll say it again. But here it is, and it happens to be true in practice the vast majority of the time. So, the best insurance is a high loan balance. Why do I say that? Why do I say the best insurance is a high loan balance?
Well, the reason I say it is because if your lender has most of the “equity” of the property, and you have very little of it, if there ever is a natural disaster, here are the things that are likely to happen. #1: there will be an insurance claim. Your lender has a whole team of attorneys that will go and argue and debate and fight with, and maybe litigate with, your insurance company, to make sure your claim is paid, because they want to protect their collateral. This is much better than you having to do this on your own. Certainly case law is riddled with insurance bad faith. It’s a common problem.
Well, your lender can go take care of that issue for you if there is an insurance claim and there is insurance bad faith, so that’s one thing. The next thing that’s likely to happen if it’s a big disaster, like Katrina, is that the mortgage companies will actually put a moratorium on mortgage payments. And this happened during the Katrina hurricane. And what happens there, is where the Attorney General might actually make a decree saying, mortgage companies: you have to stop asking for money for six months, and give everybody a moratorium to recover from this disaster. Or, it might be something that the banks and lenders just simply do out of good will to garner good PR, good public relations. And that has happened in the past. The next thing that happens, it’s a common practice, although I’m not saying it’s right or wrong, I’m not making a moral commentary on it—I’m just saying it happens.
And that is that people just walk away. In a big disaster, when they have very little skin in the game, and very little equity, they will just walk away and say hey lender, take the house back, it’s been destroyed, and I’m not gonna make the payments anymore. And that is a rather common practice for sure. But the people with equity in their property that don’t have that high loan balance “insurance”—it’s not really insurance in the traditional sense, of course—they’re stuck. The moratorium on mortgage payment doesn’t do them any good. They can’t walk away and make it the lender’s problem. And if they have an insurance claim, they’ve got to go fight with the insurance themselves.
Now, not all insurance companies will deny claims, of course. It’s usually not a straight denial that’s the problem. It’s a partial denial, where they’ll say you know, we think the insurance claim is $100,000, and you think it’s $150,000. And so that’s the debate that occurs. So, those are some of the weaknesses. Opportunities: what are the opportunities? Well, one of my favorite is my trademark term, and that is inflation-induced debt destruction. Inflation-induced debt destruction. Say that three times fast, okay, it’s a mouthful, I know. But it is a beautiful, beautiful thing. And of course I’ve talked on prior episodes about how inflation destroys debt for us. This is a wonderful, wonderful thing. I call it the great inflation payoff. That’s another way I call it. I mean, think about it.
If you go and you borrow $1 million to buy one property or several properties—I hope you’re going to buy several with a million dollars and diversify geographically—and say you get a $1 million loan, and that loan is an interest only loan. Or those loans, if there’s several of them adding up to a million dollars. And say it’s interest only for 10 years, as an example. And say the inflation rate over the course of that 10 years is much lower than it really is, but we’ll go with somewhere in the ballpark of the “official” statistics. And the official numbers might say that that inflation rate averages around 4%. Well, we all know in reality it’s much higher, but let’s just go with the official numbers. And I can’t remember these numbers off hand, by the way, but I think in real dollars, at the end of 10 years, with 4% inflation, you’re going to owe somewhere around $660,000 in real dollars.
But think about it! Today, when you borrow that money, and you sign those loan documents, and you get your first mortgage statement in the mail, it says you owe $1 million. And remember, the loan is interest only. So, in 10 years, in the year 2022, the statement on your mortgage will still say you owe $1 million. Just like the $10 bill in your wallet is called $10 today, it was also called $10 in 1920! Well, in 1920, that $10 bill would buy you a lot more, even though the name hasn’t changed, right? That’s the difference between nominal dollars—nominal meaning in name only—and real dollars, meaning the value of the money. And so, you owe $1 million in 2022, but the question is, what’s it worth? Well, I venture to guess that in 2022, that million dollars you owe in 2022 will be worth almost nothing. So, inflation will have literally paid your debts off for you. And in the same time, hopefully you’re seeing increases in rent, and the value of the properties, at least in nominal dollars, has kept pace, or historically it has slightly outpaced, real inflation.
So, again, that’s part of the ultimate investing equation that I talk about commonly. Inflation-induced debt destruction. Okay. One of the other things, in terms of opportunities. Another one of my trademark terms: regression to replacement cost. Another mouthful. Say it three times fast. Regression to replacement cost, regression to replacement cost, okay [LAUGHTER]. So, regression to replacement cost—this opportunity is fading quickly, folks. If you want to get in on this opportunity, you better hurry. Because it is going away quickly. How do I know it’s going away? Because I see prices increasing, and I see new construction coming back. When new construction comes back, there is no regression to replacement cost, because you’re buying the property at cost, or above cost!
So, the builder can put their profit in there as well. So, regression to replacement cost simply means that you buy below the cost of replacement, or below the cost of construction, and when you do this, you don’t need real appreciation to actually occur. All you need is for the raw materials, the ingredients of that property, to increase in value to their cost. Not increase—actually, that’s the wrong way to say that. They’re not increasing in value, they’re just coming back to par. In other words, if you bought all of the lumber, and all of the glass, and all of the steel, and all of the copper wire, and all the petroleum products that go into building that house, and all of the concrete, and all of the labor that goes into building that house, and all of the refinement of those materials before they even get to the job site where they assemble your house and create your packaged commodities investment, or your assembled commodities investment—if you simply let all of those ingredients come back to their cost today, no real appreciation, just regression to replacement cost—you have already made a very, very handsome profit for yourself.
Next opportunity: inflationary value and rent increases. So this refers to the commodity value of the real estate, the land, and those construction materials, simply coming back with inflation. Well, you’ll have that. But you’ll probably have it do much better than the rate of inflation. That has happened several times in history, and it is very likely to happen in the future. And then the rent keeps pace, or actually, in many cases, outperforms inflation. I mean, certainly in most markets, rent has actually increased beyond the rate of quoted official, and even real inflation, in just the past year. And that’s because there are so many forces coming at the rental market now that make that possible, and we’ve talked about those before. That’s the bad credit issue creating renters, it’s the Gen Y issue of Generation Y, the largest demographic cohort in American history coming right into their prime household formation years and renting properties like crazy.
These people are saddled with massive student loan debt in most cases, and they’re not going to be buyers in mass quantity, or any time soon, in my opinion, because of the student loan debt problem, which really is an opportunity for us as investors. And then the last one, I kind of covered it really, but it’s said a little bit differently—acquisition price below replacement cost, and we really covered that. What about the threats? That’s the last thing in our SWOT analysis. Well, rent collapse. The rents could collapse. Obviously that would be bad; I don’t think it requires much explanation. Say rents go down. And you know, by the way, my whole strategy—the one thing that will really, really hurt my investment strategy is this: decline in population. Thus the reason we don’t recommend Michigan, okay? We get called all the time with people that want us to recommend Detroit, and we see population decline, so we don’t recommend that.
Overall in the United States we see massive population increases, both through birthrate and immigration, and these are massive increases in population. And so, the rent collapse—very, very unlikely. At least in the markets we recommend. But it is a possible threat, so we have to mention it. How about price deflation? Could we have more deflation? Well, there are only really two major people out there saying deflation, and I’ve had both of them on the show. I’ve had one of them on the show twice. One is Bob Prechter, who’s the guy behind the Elliott Wave theory. And bright guy, very interesting to talk to. I had him on the show a long time ago. And the other, but you know, I gotta give him a little bit of a hard time. My impression is, he’s starting to waffle, and sort of skirt the line a little bit, is my friend Harry Dent.
And I’m a huge fan of Harry Dent. I think he has a lot of great stuff to say. Had him on the show twice, want to have him back on the show in the future, but Harry and Bob—they’re in agreement, and I believe they’re friends, and they’re the deflationists out there, the major ones. But I kind of get the sense that Harry Dent is—he’s sort of changing his tune a little bit about that. So, stay tuned on that one; let’s keep following his work, which is great work, by the way. I’m a huge fan of economic demography, combining those two things. Because I think demographics are so, so simple and so likely to influence economics and investment returns.
The next one is one I really talked about already when I talked about rent collapse, and that is population out-migration. So, if the population is leaving a place, that is a huge threat, and it’s one that you can do very little about. You know the old saying—and I was just talking about Harry Dent and demographics—there’s an old saying: demographics are destiny. Demographics are destiny. That’s one you really want to remember, okay? If the population is declining in a place, or at least the population that is your target renter, or target buyer in the future—and again, this is one of my big problems with California, by the way, is that the population, in a net numbers perspective, in California—I believe there have been slight population declines in California, but here’s the problem. The population leaving the state is largely the educated middle class. The population staying there is the elite, ultra-rich class, who’s sort of the Hollywood set, Silicon Valley set, and some of the general business set.
I mean, that was very much true in my old hometown of Newport Beach, California. But, the population coming in is not middle class. Doesn’t have much money, or resources, or education, and it’s coming in from immigration. And so, I think this is a big problem. I think California, in many ways, is becoming, in many areas, a Banana Republic. Now, that doesn’t mean the store that we all think of as the Banana Republic. Do you know what a Banana Republic is? A lot of people don’t know what that means, that term. What it means, is it refers to a country that is usually a dictatorship where there’s a small class of elite, wealthy, rich people who run everything.
And then there’s the lower classes. Now, this is the reason I don’t recommend investing in Costa Rica, Nicaragua, all of these places that some of my competitors recommend—because I don’t know about you, but I don’t like Banana Republics! I don’t think they’re stable, I don’t think they’re safe, and I don’t want to be investing in areas where I’ve gotta put barbed wire and 24-hour security guards around my properties. That is just not my idea of a good place to invest. Disagree with me if you will. So, out-migration is a big, big threat. This is the Michigan problem, this is the California problem.
Now granted, there are still opportunities in all these places. When you refer to a place like California, a state with give or take 38 million people, there are many cities and areas of opportunity, and I’m massively over-generalizing. I realize that. But for the purposes of discussion, you have to generalize. The next threat: new inventory suppressing rents. So, say, for example, a bunch of new single family home inventory is coming online, and say, for example, a lot of these properties will be rental properties, okay? This is one particular problem that you need to be sensitive to and aware of in new developments, and we are, because remember, several years ago, I was largely in the new home business. All of our clients were buying new properties.
Now they’re starting to buy new properties again. In fact, I just went in on one of those myself, in one of our markets in Indianapolis with a client of ours. And this is a threat you just need to monitor and be aware of, okay? But the good thing is that the vast majority of this new inventory that could suppress rents—and this happens in new institutional apartment buildings, but we’re largely not competing directly with those anyway. But in the single family home world, it’s something we’re aware of and sensitive to, and it’s just a threat that you need to manage. So again, that generally is the SWOT analysis. And one more thing that I want to say in terms of opportunities, and we’ve discussed this before on prior episodes, that is the subject of Fannie Mae. Fannie Mae, the secondary mortgage market.
Basically, almost the only force in the mortgage world today. It is, in my opinion, a corrupt government-backed disaster of epic proportions. So the question is, will it continue to exist? Will it be bailed out in the future? Well, I don’t know. But if it goes away, let me tell you what will likely happen, and we’ve talked about this before. I think we will see a huge upward pressure on rental prices. That’ll be good for us. And we will initially see some pretty significant downward pressure, especially in markets where people are buying above cost of construction, i.e. California, on prices. Okay? So, again. Good and bad, depending how you play it, depending on whether you’re ready for it.
If you’re buying in the types of markets we recommend at the prices we recommend, I think if Fannie Mae went away it would be wonderful, wonderful news for us who are following that plan. But for the people who are investing in more speculative things where it’s high land value markets? Oh boy, they’re gonna be in trouble. So, anyway, there’s my SWOT analysis.
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JASON HARTMAN: It’s my pleasure to welcome one of our clients, Cy, to the show. And I’ve talked with him a few times over the years myself, and he’s been working with one of our investment counselors, and just wanted to have you hear his experience as an investor—what got him interested in investing, how he came to buy his first property outside of his own home state, and what gave him the confidence to do it, and what his experiences have been. So, Cy, welcome! Thank you for sharing your experience with our listeners today, appreciate it!
CY: Thanks for having me on.
JASON HARTMAN: So, how long ago did you get the real estate bug, if you well, and become interested in investing?
CY: It was probably about 2005, somewhere in that time frame. I guess simply, like a lot of people, I was very disillusioned with my investment returns that I was getting in my 401(k) and just my regular stock market investing, and I didn’t really understand that there were a lot of other opportunities out there and so forth. And I was very fortunate to become employed with a lending institution, and what that allowed me to do was the have the opportunity to see other businesspeople, what they invested in, and so forth, and I actually live in Iowa, so the lender that I work with predominantly works with farm real estate and farm businesses, and I happened to notice that the businesspeople that bought farm real estate were the ones that were becoming multi-millionaires, versus the ones that didn’t. They were doing okay, but they sure weren’t moving ahead nearly as fast as the farmers who bought the real estate were.
JASON HARTMAN: Okay, so just distinguish that, I’m not sure the listeners totally understood what you just said there. So, you’re saying, there were farmers, and then there were farmers who also were real estate investors—is that what you meant?
CY: Well, it’s a little bit different than that, actually. Farm ground in Iowa—you either rent it, or you own it. So as a farm business, you got the option to rent the ground, or to actually own it and farm it yourself, and own that asset. And the farmers who did that were basically have experienced a lot of appreciation, and of course they’ve been paying that off as time goes, and several have gotten themselves into a position where they own the land free and clear, or have a very low amount owed on the ground versus what the ground can produce for them as far as a return. So they certainly look at it as business. Most of them don’t look at it as an “investment.” It’s just something that they do. But farm real estate acts a lot like single family home properties in the respect that they do appreciate over time, they do provide cash flow, and it builds well.
JASON HARTMAN: And you said to me before we started recording today, you were just kind of giving me an update on what you were up to, that the market isn’t very good in terms of farmland quite yet, but it might become that was in a couple years?
CY: It wouldn’t be good for an investor, yeah. For an out of state investor, it’s not a good opportunity there. It makes sense for farmers who farm it, but it doesn’t make sense for investment purposes. It doesn’t cash flow, it’s pretty high in value right now, so, that in turn is why I looked at single family homes as far as an investment, and that’s what kind of prompted my interest, is I witnessed that the people were building wealth that actually owned real estate, and I thought, farm real estate doesn’t work for me; what kind of real estate could? And that prompted me to search the Internet, particularly iTunes, for maybe just some opportunities there, and of course I did a lot of reading, and I guess I stumbled upon your show just doing an iTunes search.
JASON HARTMAN: How long ago?
CY: That had to be—that’s a great—I’m gonna say, you probably had about, if I had to guess, maybe you had 40 episodes out at that time. And what I did was I went back to right at the beginning, and I don’t know if you can do that today or not, but I went right to the beginning and went ahead and started listening from the get go, and got myself caught up, and I’ve been listening every since.
JASON HARTMAN: Good, good! Well, thank you for being such a loyal listener, that’s fantastic! So, when you were out there looking at—you were reading real estate books, you probably searched around the Internet and found different real estate companies, and so forth. What was it that drew you to my company? I was just curious—did I have you at hello? As it goes in Jerry Maguire in the movie?
CY: Flat out, just straightforward education. Just, you really helped change my thinking on investing. I mean, looking at it as a prudent investment. Looking at cash flow strategies. I guess, you know, the rent-to-value ratio was one of the first things that I remember, that I thought was pretty unique. I really hadn’t heard anybody else share that, or talk about that.
JASON HARTMAN: And that is such a simple little metric that can save people fortunes. It’s a very simple, basic metric. But it works.
CY: Yeah, it’s a real simple litmus test. If you’re looking at a property or so forth, you can weed out a lot of things just right off that bat. Somebody throws something at you verbally and says hey, you can buy it for x amount of dollars, and it should probably rent for this—you can just kind of decide whether you want to pursue it any further by just doing that simple metric right there.
JASON HARTMAN: So the rent-to-value ratio was something you liked. And what else?
CY: Yes. And all of your 10 Commandments have been right on. I’d have to probably say, thou shalt maintain control is probably one of my favorites out of it there. Just rings true all the time.
JASON HARTMAN: Cy, you know, you’re preaching to the choir. #3 is my favorite commandment, thou shalt maintain control. Whenever you put your money with someone else, good things do not happen. And too many people have learned that lesson the hard way, including yours truly.
CY: Yep, I’m right with you. And it’s just amazing when you have control, the options and the freedom that you have there. So that just really rang true. You introduced me to PropertyTracker, which I use to evaluate the properties that I have. Actually, you were the first true turnkey investment service that I found out there, and actually, you’re the only one that I’m aware of that has a turnkey program for several states, or several different market places. And one of the true area agnostic organizations that I’ve found. Most everybody else that I’ve heard of or come across have really been hot on one particular area, and that’s the only area they focus on.
JASON HARTMAN: And see, they can’t be impartial when they’re like that, because the traditional real estate industry of course is always bound to their certain geography. But a lot of people that would consider themselves our competitors, they’re that way too. They may even say they have other markets, but they really don’t. A lot of them are just—they just sort of put those on the map to make it look like they have a choice. You know Cy, I don’t know if you were ever a Saturday Night Live fan, but when I was a kid, I used to like that show. And I remember this one skit where they go in to place an order at a fast food burger joint, and the guy would say, I want a hamburger. No hamburger, cheeseburger! Coke! No Coke, Pepsi! They may look like they have other choices, but I’ve found that a lot of times they really don’t. They don’t have any strength or knowledge of certain other marketplaces that they may even advertise, to make it look like they have choices. So. But, you know, one market that you’ve been drawn to a bit is Atlanta, Georgia. How—and you’ve got property there. How has your experience been?
CY: It’s been extremely good. That was our first out of state property. My wife and I started by buying a couple in Iowa, in our back door, to just get our feet wet, get kind of comfortable with it. And through listening to your program, it’s simply—and I could see from the numbers that we returned in Iowa versus what the projections were over in Atlanta, that we really needed to look outside of the state. And so, through your program, through visiting with Sarah—she was the investment counselor that I’ve worked with all the way through, and just looked at a few different options, and was awesome at helping you look through, and kind of helping you walk through your fears and so forth there. So the time came where we finally just said, you know, let’s pull the trigger. And you never know until you actually take action. And so, we did that, and we have yet to see the property. I think it was about—it’s gonna be going on three—well, a little over two and a half years ago that we purchased that property, and we have yet to see the property. We might sneak out there sometime this summer, but not sure yet.
JASON HARTMAN: Right. And there’s really—is there really any urgency to get out there and look at it? It’s nice if you do see it, I guess, but as long as the money’s coming in and the expenses are stable, what’s the difference?
CY: It really isn’t. We’ve just never been to Atlanta, Georgia except through the airport, and thought well, maybe it’ll be a fun little place to go, take a little getaway and see the property, and be able to write off a little vacation time there too.
JASON HARTMAN: And what do you say to people, Cy, that sort of have this in their mind? It’s funny how we are as human beings. Our nature is that if we buy a piece of property, we think oh gosh, it’s gotta be close to our house, and we’ve gotta go see it and we’ve gotta touch it and feel it. Yet we can put hundreds of thousands of dollars into these invisible “assets” like stocks, bonds, mutual funds, money market accounts, banks accounts, and we don’t see that money. We don’t go visit the corporation we own stock in. But for some reason, we’re just different with real estate. I sort of had a hard time overcoming that myself, but once I did I was sure happy about it.
CY: Yeah, I feel the same exact way as you. I just have no issues whatsoever investing in any other areas out of state. It just depends—as long as you have a good team, which that’s what gave me the confidence to go ahead and do that there, and I’ve communicated with Sarah on several different occasions after the fact, just to get advice and input and so forth there. So, I feel like there’s a great team environment there. There’s somebody that doesn’t just walk away from you after the sale is done. You’ve got a partner that continues to walk with you through the whole process. And it’s amazing to me how many people I share my experiences with in Atlanta that just look at me cross-eyed.
JASON HARTMAN: What do they say?
CY: They’re just like, I can’t believe you own a property out of state, and the tenants, taxes, and toilets type thing—what do you do if this, and how do you handle this, and you try to walk them through it, and quite honestly, I share with anybody that has an interest in hearing a little bit more about it, but I quite honestly have gotten to the point where I figure—and the statistics seems to play themselves out—that there’s a reason there’s a 1%, there’s a reason there’s a 10% of the people that are successful, and the rest of them just aren’t. And there’s a certain amount of people that just aren’t going to see the opportunity and just can’t get past their own little obstacles that they have in front of them.
But there’s—it seems like about 10% of the people that you talk to at times are like wow! Tell me a little bit more about that! How did you get around this, or how do you deal with this situation, and they take it in, they soak it in, and you can tell they’re processing it and trying to maybe see how that would fit them. And those are the people that are enjoyable to talk to, and share that experience. And it really doesn’t bother me at all, because all I know is that I’m building passive income, and actually prior to joining your network, I—and I’d say actually prior to getting into real estate—I was about 40 years old at that time, and I was really starting to get down, because I was looking at starting to do some projections with my stock investments, and it was coming pretty clear that I wasn’t even going to be able to retire at 60 years old.
It was going to be well past that. It just wasn’t going to take me there. And a lot of loans sustained me. So, when we started out with—I guess, to step back, your program was one of the few programs where you said you know what, you can retire with this by being a real estate investor, or you can really enhance your life. But you know, it’s purely passive income that can come in for the rest of your life, and that was pretty exciting to see that. So when we started, we started off with some small goals of I think the first property that we bought, we said, maybe that can pay for our annual vacation. So we hit that milestone. And the next milestone was, maybe we can hit the point where it compensates for my wife’s income, because she works part time. And we hit that goal. So the next goal I’m working on is getting up to where it can replace half of my income. And once I hit that goal, I’m going to 100% of my income, and then if anything ever happens with my employment down the road, or I just get tired and decide I don’t want to deal with the frustrations and challenges that it brings, it gives me confidence to be able to have the option to walk away from it.
Or if they decide they don’t need me anymore, it gives me that peace of mind of knowing that I don’t have to race out and find something as fast as I can to pay the bills.
JASON HARTMAN: Yeah, you know, it’s a great feeling, that security of properly purchased and acquired investment property or income property. Because the nice thing is, Cy, like we’ve talked about, it’s just always working for you, isn’t it? It’s always sort of in the background working for you. It’s so stable. It’s the most historically proven asset class. Unlike a business, which is so volatile. If you own your own business you know it changes every day, every minute, ever half hour. It’s just a very volatile thing. But the income property is just stable, and it just keeps chugging away. It’s like a big ship. And that ship—it doesn’t go fast, but it just keeps moving consistently, and before you know it, you’re at the port of call where you wanted to be. And then you can go to the next one, and that’s the great thing.
You know, the other great thing about income property is, you start to put all of these factors that really hurt most people—you put all of those factors in your favor. So for example, time passing. That hurts people, just because, who’s crazy about getting older, right? But what happens over time is you start to spend money, and you start to deplete your nest egg, and inflation occurs over time. And so, all of those things are damaging to most people. But with income property, they’re beneficial to you. Inflation helps you. It destroys the value of your debt. It increases the price of your property. For 27½ years you’ve got fantastic tax benefits through depreciation. If you even decide you want to sell the properties, you can exchange them and defer the tax indefinitely. I mean, nothing else works like this, does it?
CY: Not at all. I’m glad you shared all those things, because I was going to say, what I was talking about was one element, and that was cash flow. Of hitting my goals. That wasn’t the tax benefits that I’ve received since purchasing the property. I mean, I get close to $10,000 more back on my tax return than I was prior to doing investment income, or investment properties. So, inflation, like you say…I talk to people all the time that are just scared to death that inflation’s gonna come. And it’s not like I’m wanting it to come, but I sure don’t worry about it, because I know what that’s going to do to my investment portfolio. And on top of that, I guess I didn’t share this with you either, but prior to me starting with your guys’ network, my goal was to be out of debt completely.
And I was awfully close to it. I was down to about 20—maybe a little bit over $20,000 was all we owed on our house, and everything else was paid off, and I was pumped up about it. And then I sat down and I figured out that okay, once I get this house paid off, I’m gonna have about $600 of principle and interest that I won’t be making payments on anymore, because you continue to still make your insurance payments, you continue to make your tax payments and so forth there. So I took $600 times 12, and I thought, damn, that’s not gonna get me to the promised land. So now, I’m in more debt than I’ve ever been in my life, but I love it.
JASON HARTMAN: Now for a new listener, okay, be careful with that one. Because a new listener may be hearing this for the first time and say, what kind of quack is this Jason Hartman guy? No, that’s actually part of the plan. Of course consumer debt is bad, and I don’t recommend that. But long term fixed rate debt against what I call packaged commodities—in other words, pieces of real estate, pieces of income property that are made of the commodities that the whole world needs. You can invest in commodities, and leverage them at incredibly low fixed rates. You don’t even pay your own debt! Your tenant pays your debt for you. So what would be the big objection to debt? Cy, you and I, we outsource our debt to other people. I mean, I don’t like debts I have to pay. But when other people have to pay them, I think debts are wonderful. And then inflation comes along and destroys the value of the debt, because as the dollar goes down in value, so does the debt. The debt goes down in value at the same exact time! And that is just a beautiful, beautiful thing, isn’t it?
CY: And I’m glad you clarified that, because yes it is. Debt on the right things. I don’t have any vehicle debt at this time. I don’t have any credit card debt besides—we just buy some things to earn up some points so that we can get some rewards, and we pay it off every single month, so, there is no short term debt, no consumer debt to speak of, or anything like that that we have. It’s all long term debt fixed to real estate, and every single one of them are on 30 year fixed rate interest rates. And those rates are beautiful.
JASON HARTMAN: They are incredible. And by the way, we should mention that you’re in the business of financing farmland. That’s what you do for a living. You’re a finance guy. So, it’s interesting that that should be noted. But Cy, you’re so right. I mean, think of it. If you bought one of those properties back in 2010, you won’t make the last payment on that mortgage—or I should say, your tenant won’t make the last payment on that mortgage, because you don’t make any payments, the tenant does—until 2040. Wow. 2040. Can you imagine how much the world is gonna change by 2040? With the amount of debt we’re in, with what the government is doing to us, just mortgaging our future away? But with our plan, that actually works for you. It’s a beautiful thing, because as the government spends, that is inflationary, and boy, that inflation’s just gonna pay off our debt for us. It’s just an incredible thing, huh?
CY: Yeah. And I’ve come to the conclusion that let’s fast forward 15 years, and let’s say that interest rates are 10, 12%. Who knows whatever they are. Even if I’ve got enough cash sitting in the bank that I can pay those mortgages off, I sure don’t plan on it at this point in time. I’ll just take the cash and continue to purchase real estate.
JASON HARTMAN: Yeah, isn’t that great?
CY: There’s no reason to pay it off early when you’ve got interest rates locked in in the [unintelligible].
JASON HARTMAN: Yeah. But with the real inflation right now, in my opinion, hovering between 9 and 10%—of course, those aren’t the official statistics that the government wants to believe, but we all know in our own lives that it’s much higher. You’re getting paid to borrow right away, even if the property sat vacant for 30 years, as long as inflation is higher than the interest rate, then you’re getting paid to borrow. But it’s even better when you rent it out to somebody else. Really incredible opportunity. You know, Cy, since you’re in the finance business, I’d like to ask you, what is your outlook? What do you think the real rate of inflation is, and what do you think inflation will ultimately become down the road in a few years?
CY: Well, great question. I hear you ask all the experts there, so, I just want to state out here, I’m nowhere close to being an expert there.
JASON HARTMAN: Well, you’re talking about the guests on the shows, but experts are wrong too, a lot of times. I don’t know if I’m putting you on the spot with that, but I just thought it’d be interesting to get your outlook. I mean, what’s your perspective on it?
CY: There’s no doubt in my mind that—I laugh every time I see the CPI Index talk about 3-4% inflation. That’s just—that’s crazy. I agree with you, it’s closer somewhere in that 10-12% area. It could even be 15%. It just depends on where you’re at. But there’s no doubt things are continuing to cost more, and it’s taking more money out of average people’s pockets. But I think the scary thing is that the average person out there doesn’t even have a clue what inflation is. They do not understand it. And I think that’s where a tremendous amount of people are being robbed out there, who don’t know how to manage it, and use it to their benefit. On your other question there, I have no ideas, no thoughts on where—there’s days where I can certainly subscribe to hyperinflation and see where it could just go crazy.
I can’t remember—it seems like you had a guest on just fairly recently here who was talking about even like 25% or so, 25-50%, and I could certainly see something like that occurring. I guess that’s probably where I would shake down a little bit more on, that is, maybe it coming into that territory. Which again, I think you guys used the example on that particular episode of, just take a gallon of milk and figure, a 25% to 50% inflation rate on that—it just—it’s astronomical as to how fast prices could go up, just even at that.
JASON HARTMAN: Yeah, it’s really amazing. It really is. So, we all understand the assets we have, and I think we’ve put ourselves in a great position. And even if it doesn’t get really bad in terms of inflation, we’re still going to profit. Because, the properties make sense the day you buy them. They’ve got cash flow, and it’s the same business plan really people have been doing certainly for the past 40 some odd years. But even for thousands of years before that, to a slightly different extent. So, that’s great. Yeah. Well, hey, it’s been great to have you on sharing your experiences today. So much appreciate it. And thank you for being a client and a listener, and just keep it up out there, and we’re to help you with whatever you need, so thank you very much.
CY: Well, thanks for everything you’ve provided. You’ve just been a steady stream of education, and every single week, I’m always excited when a new podcast comes out and I get the chance to listen to it. You always learn something.
JASON HARTMAN: Well, good. We’ll keep them coming for you, Cy. Thanks again.
CY: Thank you.
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ANNOUNCER (FEMALE): If you want to be able to sit back and collect checks every month, just like a banker, Jason’s creating wealth encyclopedia series is for you.
ANNOUNCER: This show is produced by the Hartman Media Company. All rights reserved. For distribution or publication rights and media interviews, please visit www.HartmanMedia.com, or email email@example.com. Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate tax, legal, real estate, or business professional for any individualized advice. Opinions of guests are their own, and the host is acting on behalf of Platinum Properties Investor Network, Inc. exclusively.
Transcribed by David
Episode: CW 269: Facebook IPO Scandal & the SWOT Analysis of Income Property
Guest: Jason Hartman
iTunes: Stream Episode
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