The Truth About Real Estate Investing: What The Books And Courses Do Not Tell You
BATTLECALL GUEST EXPERT: Robert J. Abalos, Esq.,
InvestingInLand.com
While a trip to any bookstore on the Internet or in your neighborhood will
reveal a multitude of books on real estate investing, most fail to tell the
truth about the subject for one simple reason. Marketing. Authors and publishers
want to sell potential readers on the notion that real estate investing is a
simple and easy path to riches and wealth so people will spend their hard earned
money and buy their books. Unfortunately, real estate investing isn't simple and
it sure isn't easy.
My twenty years of experience as a real estate investor and lawyer have
taught me five simple truths about real estate investing that most of the books,
guru seminars, Boot Camps, tape and CD courses, TV infomercials, and other real
estate products never mention. My goal in sharing this information with you here
is certainly not to discourage anyone from getting involved in real estate
investing. To the contrary, I believe real estate is probably the best
investment vehicle around for building long-term wealth. What I demand, however,
is complete disclosure and honesty with readers and that is something sorely
lacking in most (NOT ALL!) real estate books published these days with
get-rich-quick scheme titles and promises of quick riches.
Truth #1: Most people who invest in real estate lose money
doing it.
Real estate investing is an inherently risky business. When you buy an
investment property, think of what you are doing. You tie up relatively large
amounts of capital into a depreciating and non-liquid asset in need of virtually
constant maintenance and management, employing extreme amounts of borrowed money
as leverage to increase equity returns, hoping to both time the market and
accurately assess the income and expenses of the property until it is finally
sold, a time frame sometimes decades in the future.
Most people who invest in real estate lose money doing it, just like most
stock market or commodity market investors lose there too. It would be too easy
to say that the professional investors, those with lots of experience and access
to ready capital and credit, lose less often than the rank novices and amateurs
who are playing Monopoly with real money for the first time but that is
certainly true. But both classes make the same mistakes, over and over again,
which usually involve one or all of the following:
- Overpaying for a great property
- Paying too much for a poor property
- Underestimating property expenses
- Overestimating property income
- Underestimating capital improvement costs on a rehab project
- Mistiming the market (buying at the top of the buy/sell cycle, for example)
- Arranging poor financing on a property that bleeds cash flow
- Miscalculating demand for a property's rental unit potential
- Poor real estate property management that cripples net cash flow
- Buying into the wrong neighborhood, part of town, or geographic area
EVERYONE who is an active real estate investor loses money doing it
sometimes, including me. ALL the greatest real estate developers of history,
from William Zeckendorf to Donald Trump, Mort Zuckerman, Sam Zell, the Reichmann
Brothers, and Harry Helmsley have lost money many times on some of their
projects. If the Best of the Best lose money investing in real estate, of course
the average truck driver or office clerk entering this field of investment can
expect to lose sometimes too. Losing money is part of the investment business,
an unfortunate but true fact of life. Even Warren Buffett, the greatest stock
picker of all-time, picks the wrong stocks on occasion. He has the honesty and
decency to come clean about his errors in judgment in his annual Berkshire
Hathaway company annual report. But most of the real estate books you can buy
never mention the subject of losing money or how easy it is to lose EVERYTHING
when investing in real estate. I can see their point in not stressing the
possibility of losses, they are obviously trying to be positive and encourage
new investors. But not mentioning the subject of losses at all is dishonest.
MOST of the people who try to invest in real estate will lose money doing it.
PERIOD. The only question is how much and over what time frame.
Truth #2: Real estate management is the worst job in the world.
I've been connected to all facets of real estate through my career,
everything from finance to sales to handling closings. The worst job in real
estate is managing rental properties by far, it is not even close. There are
many books you can buy that make the process sound easy, painless, or simple. It
isn't.
Real estate management is a full-time 24/7/365-day a year job that never
ends, it simply is relentless. Even if you have a paying tenant in a property,
you never know when your tenant:
- Will lose their job and can no longer pay you rent
- Will skip out in the middle of the night owing you money
- Will start using your property for an illegal purpose like selling drugs
- Will write you a bad check and your mortgage check will bounce in return
- Will get into a running argument with other tenants
- Will get a noisy dog despite the lease saying NO PETS
- Will get you fined by the local building inspector for something they've
done
- Will sue you for a real, imagined, or petty purpose
- Will fail to maintain the property as agreed
- Will damage the property either accidently or for fun
- Will move in their entire extended family who decide never to leave
- Will die and you're left to deal with the smelly rotting corpse
- Will disappear and you have to pay for storing their possessions
- Will have a drug or alcohol problem that upsets the neighbors AND THE LIST
GOES ON AND ON.
I was involved with real estate management for nearly ten years and have
managed thousands of rental units. I often think of writing a book about my
experiences as a property manager. I look back on all those bizarre happenings
as funny now but back then they were horrible to deal with. ALL of the above
"what ifs" happened to me while I was managing rental properties for myself and
clients. I had to do many, many often nasty evictions, have the stench of
rotting dead bodies cleaned from apartments (you never forget the smell), nearly
got shot twice by angry drug-addicted tenants, had a killer dog attack me by its
owner, received dozens of bad checks, had tenants literally burrow holes in wall
of apartments to rob tenants living next door, had tenants sell heroin out of
their rental unit and then I had to clean up the mess after a police raid broke
down the door, and much more.
This, of course, assumes you have a tenant, and they pass all the required
background, employment, and credit checks. ALL the above tenants did. The ones
that do not often threaten lawsuits and real estate management companies are
notorious litigation magnets that are in and out of court for Federal and State
discrimination complaints and other alleged misconduct. Do you know how many
lawsuits alone are filed each year by tenants who want all or most of their
security deposits back?
The notion that most tenants are good tenants is FALSE. Most are good only
until they no longer want to live in your property and then all the cleaning,
maintenance, on-time payments, and goodwill stops. There are many professional
deadbeat tenants who make their living ripping off landlords but the average
tenant is a good person who means well but eventually becomes a bad tenant due
to a job loss, emotional crisis in their life, or simply because they are moving
and just don't care anymore.
There is NO "painless" way to manage rental properties. You can hire a
professional firm to do it for you but you will virtually guarantee yourself a
negative cash flow even if the rental payments come in on time and the company
itself is honest, two really BIG IFS. When you own rental properties you are
either spending money and time looking for a new tenants or spending money and
time keeping your current tenants happy. It's a lousy job and don't let anyone
tell you how simple or easy it is. And I didn't even mention all the small
details like:
- Showing properties and how most people who make appointments never show up
- Tenants who lock themselves out of their property in the middle of the night
and expect you to let them in
- Parking problems, like Unit 101 parking in Unit 102's space
- Tenants who like their music LOUD, really LOUD
- Security problems at properties caused by tenants that jeopardize others
like jamming buzzer doors open or leaving alley doors unlocked
- Tenants who throw garbage out of the windows and play "dumpster basketball"
- Frat parties, keg parties, beer parties, and more parties
- Broken windows, shelves, doors, stoves, refrigerators, and all else
- Tenants who steal EVERYTHING including the doorknobs and outlet plates
- You get the idea, I hope
Truth #3: Rental properties are a liability, not an asset.
While owning rental properties may look good on your balance sheet, your
banker will view them for precisely what they are. LIABILITIES. Unless you are
maintaining heavy cash balances as compensation for all the mortgage and
management costs any rental property you own has, you will find it difficult to
get a normal bank loan or mortgage while owning a rental property.
The reason for this is simple. Most rental properties are not GUARANTEED cash
flow positive such as how a U.S. Treasury bond would be. It is extremely
difficult to get a positive cash flow on a rental property these days since for
the last twenty years the cost of properties has risen faster than the rental
income they will bear. There is NO linear relationship between the rise in
property values and rental rates. Just because a property rose 10% in value last
year does not mean you can raise rents 10% as well. Unless you are buying rental
properties at 75% or below of market costs or putting down heavy down payments
in excess of 20%, it is very unlikely you will have a positive cash flow on your
rental investment.
And realize that even if you do, that positive cash flow is not GUARANTEED.
It assumes optimal conditions like your tenants will pay you rent on time and in
full, you won't have unexpected repairs or improvements, and will have stable
expenses like utility costs and property taxes. This rarely happens even under
ideal situations. Take, for example, a property with a $100 per month positive
cash flow. The mortgage and all property expenses are $900 per month and the
rental income $1,000 per month. Great! But what if the hot water heater explodes
and it costs $1,200 to repair? You are now cash flow negative for the next
twelve months. What if utility costs skyrocket as they recently did in
California? Or if you own a condominium rental unit and get hit with a special
assessment or repair charge? Even the most positive of positive cash flows can
go negative in an instant.
That's why bankers require heavy cash corresponding balances on anyone owning
a rental property, often six months or more of property mortgage and expense
costs per property or rental unit. It's also why most banks have a set limit on
the number of rental properties one individual can own, say five or ten. This
point often confuses investors who routinely ask "Look, I'm successfully
managing ten rental houses right now. Why won't you give me a mortgage to buy
Number Eleven?" The real issue is that they are successfully managing ten rental
house LIABILITIES and most banks know it is a matter of time before something
snaps and without access to large amounts of cash already on deposit somewhere
the house of cards can come tumbling down.
It is counterintuitive to think that owning rental properties actually
damages your ability to get a mortgage for your own personal residence but it is
true. Same is true of your ability to get credit for a business loan or other
purpose. The only benefit to owning rental properties from a banker's
perspective is IF they are generating a CURRENT and GROWING positive cash flow
and if the owner has adequate cash (NOT credit) reserves to meet any crisis
since one or many will certainly come.
If owning rental properties is a liability, who owns them as an asset? The
mortgage companies or individuals that hold the notes on them. There is an old
axiom that says "Assets feed you and Liabilities bleed you" and that's perfectly
true when it comes to rental properties. If you own a rental property you sweat
and work and work and work to do what? PAY MONEY TO THE NOTE HOLDER EACH MONTH
to keep the mortgage current. See which way the cash flow goes? It goes from
tenant to owner but doesn't stop there. The note holder is the ultimate
beneficiary of rental property ownership. The note holders are always cash flow
positive each month (or they foreclose) but the property owner is cash flow
negative with a mortgage liability even if the tenant pays them on time.
Understand who gets "fed" and who gets "bled"?
Truth #4: Real estate equity means virtually nothing
You own any asset for only one reason and that is the cash flow it can
generate for you. Equity looks nice on your balance sheet but it is called "dead
equity" for a reason. You really can't do anything with it.
Most real estate books and guru courses measure real estate success three
ways:
- The total value of properties owned
- The value of real estate equities owned
- The positive cash flow of the properties owned
The first two measures are essentially meaningless.
Next time you see a late night television infomercial or pick up a real
estate "success" story book, see how often the testimonials revolve around
statements like "I own one million dollars of real estate." Well, that's great
if you had no corresponding mortgages. But what if you owned real estate valued
at $1,000,000 but had mortgages on those properties totaling $1,200,000. You're
in the hole for $200,000, meaning for every dollar of property you own you owe
$1.20 to own it. Bad financial situation to be in.
How much real estate you own doesn't matter at all in determining your true
wealth. How much equity you have in your properties matters slightly more.
Let's assume an investor owns $1 million in properties but has $800,000 in
mortgages on them, or equity of $200,000. That's great but so what? The ONLY
asset that matters is CASH. Try going down to the supermarket with some real
estate equity and buy a can of beans.
If you have real estate equity, you have to convert it into CASH to be
wealthy, you have no other choice. How can you do that?
- You can sell your properties.
- You can place new loans on your properties and refinance equity out.
- You can create notes using the equity as collateral and sell the notes.
BUT, in every case you no longer have anywhere near $200,000.
If you sell your properties, you will pay $70,000 or more to sell $1 million
of properties in broker and closing costs. Plus no one is going to trade you
$200,000 in cash for $200,000 in real estate equity. The "haircut" will be about
10% on a good property, more on lesser ones. So each dollar of real estate
equity is probably worth about 50 cents, but you have to sell all of your
holdings and possibly incur income tax consequences to get that cash.
If you refinance or create notes on your property you can get access to more
of your equity but there's a new problem. You've created a new monthly liability
for yourself on the notes. All you've done is trade a lot of cash now for a
larger stream of payments headed out later.
Equity is paper wealth. Being a paper millionaire is great only if you live
in a paper world. I once knew an investor in California who owned 550 rental
properties but the guy was so broke he couldn't get married. He had lots of
equity but no cash. He was maintaining hundreds of properties with thousands of
tenants and was dirt poor while doing it. His mother once told me he owed her
$400 for a new set of tires for his car and couldn't pay her back because he was
closing on two new houses that week.
CASH FLOW IS KING WHEN IT COMES TO ALL INVESTMENTS. There is NO other
standard of success or wealth. An investment is only as strong and as good as
the cash flow that can derived on a virtually assured basis from owning it.
Still, cash flow must be placed in context. When a guru in a testimonial says
"I have a positive cash flow of $2,500 per month from my rental properties" what
does that mean? It is PURE cash flow or cash flow with accrued liabilities
attaching every month? If I own a rental property with a balloon payment due in
five years, I can have a monthly positive cash flow very easily BUT there is a
corresponding liability that attaches to the cash flow that does not need to be
currently paid but certainly exists. Same is true of a positive cash flow
achieved through the use of a lease/option premium or by deferring property
taxes, mortgage interest, or other maintenance costs.
The cash flow analysis of rental properties can get very complicated but I
just hope to make the point here is that it doesn't matter how much property you
own but how much money those properties put into your pocket every month. I'd
rather own one $50,000 single family house that made me $500 per month than ten
$2 million apartment buildings that made me the same $500.
Truth #5: Most real estate creative financing techniques don't
work, are illegal, or unethical
In its usual context, the term "creative" really doesn't imply ingenious or
smart. It suggests dishonest. Those executives over at Enron employed some
"creative accounting" on their company books. Do you want a "creative
bookkeeper" managing your money? What about a "creative tax preparer" doing your
tax returns for the IRS? Maybe, if you were cheating the government and thought
you could hide the crime by fudging the numbers.
Most of the real estate books you can buy these days involve the application
of creative financing techniques such as:
- Lease/options
- Buying subject-to
- Wholesaling
- Flipping properties
- Contract assignments and more.
As you might have guessed, all are "creative" because they are unorthodox,
unconventional, and non-conservative. They are all those things for a reason.
Most are either illegal under Federal or State law or simply unethical.
Moreover, most are unorthodox because they do not or rarely work. Conventional
techniques are indeed common because people feel comfortable using them because
they are effective and are universally accepted. So-called "creative" techniques
are the opposite, people shun them and make them rare because they do not work
or because the real estate community has legal or ethical problems with them and
avoids their use.
This is not the place for a debate on due-on-sale clauses but I can say this
without hesitation and I don't know how any reasonable person can disagree with
me. I can't see how any form of investing where one person intentionally gets
another to deliberately breach a valid contract and then conspires with them to
cover up the breach through a series of affirmative acts can be called anything
but unethical.
There is no mention in any of the books that suggest these creative investing
techniques that the vast majority of lawyers, real estate brokers, title
insurance companies, and other professionals regard them as illegal, unethical,
and will have nothing to do with them. Indeed, the argument with proponents of
these creative techniques is that most of those against these techniques are
against them because they really do not understand how they work. Of course,
this is pure foolishness. Title insurance companies, for example, handle
extremely complex real estate transactions on a daily basis. They could easily
handle very simple double closings or simultaneous escrows if they wanted to.
MOST WILL NOT because they question the legality and ethics of buying real
estate when you don't have the money to close on a transaction or misleading
sellers that you are indeed the real buyer when you are just a middleman
illegally brokering a deal. It is to the credit of the real estate industry that
most lawyers, title companies, and other professionals would rather turn down
fees than participate in these sleazy deals.
There is nothing wrong with being "creative" as an investor. But certain real
estate investing techniques are not creative, they are dishonest. Any real
estate book or course that urges you to do anything where you need to worry
about being caught by anyone, or suggests you hide material facts from any party
involved in deal, or attempts to circumvent civil or criminal penalties by
playing word games should be avoided like the plague. The sophistry played by
creative finance proponents attempting to justify their twisted or non-existent
ethics simply amazes me. I recently saw a nationally known creative real estate
author in a discussion group say that civil fines imposed by the courts should
be treated by the offending investor as nothing more than a "cost of doing
business" and that as long as it is just a civil (and not a criminal) fine you
really haven't "broken the law." Simply stunning, also totally wrong.
Almost all creative finance techniques are suggested because a buyer does not
have the cash for a down payment or the credit to obtain a mortgage on a
conventional purchase. So some other device is used to "borrow" some other
person's cash or mortgage. That's what buying "subject to" is, using someone
else's mortgage because you can't or won't get your own. Sorry, but you can't do
that unless the bank says it is fine with them. Some people go ahead anyway,
many actually make money doing these deals. Many others you never read about get
burned, and often badly. With all the money to be made in real estate, why not
pick an approach you can be proud of, one that is ethical, legal, and works on
virtually any property you can find instead of some dark and secret techniques
that could ruin your reputation and your finances if exposed?
There are a number of excellent books and courses on the market that tell the
honest, unvarnished, and complete truth about real estate investing. I don't
sugarcoat the truth about the real estate business. It can often be tough and
nasty, mean and rude. No great fortunes can realistically be made overnight. It
takes hard work and dedication to make money in real estate. It takes sacrifice
and discipline in everything from saving up money for down payments and working
capital to building your credit and business contacts. But the payoff is a real
estate fortune and wealth you can be proud of having, not made at the expense of
desperate and unfortunate people but acquired through the creation and
improvement of assets leading to better communities.
Next time a real estate book or course promises you instant wealth, painless
profits, magic paths, or easy riches, think again.
It ain't so. Not even close.
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