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THE REAL ESTATE GAME – The Intelligent Guide to Decision Making and Investment
MBA Candidate at Rushmore University
Advisor: Prof. Kermit Zieg Course: FIN3282 – Poorvu on real estate finance Student: Paul L Manning e-mail: pmanning@coppernet.zm
URL: www.paul-manning.com
Credits: 3 Credits
Word count for the body of this paper is: 6,795 A copy of this paper is being sent to: file@rushmore.edu
This paper is designed to guide the potential real estate investor through the various stages of the real estate investment process. The process is set in stages, but there is a single goal to be achieved; any transaction is undertaken with the goal of earning an acceptable return on the resources, time and money invested.
It is hoped that readers will gain some understanding of real estate investments. To understand why, and how, a real estate professional makes investment decisions, we need an understanding of the dynamics of "the real estate game". There are so many variables in this game, but we ought to be able to sift through, and identify, the issues that we can control and work to our advantage.
There are so many possible investment avenues in the realm of the real estate professional, that a thorough coverage of the topic is beyond the scope of this paper. This paper seeks to enlighten the reader in two more specific aspects of real estate investing. The focus is on investment in single-family homes, using principles that apply equally well to properties in a commercial environment. The paper will walk the investor through the process of analyzing the opportunities and choosing the investment vehicle, and then managing the investment and realizing the reward.
TABLE OF CONTENTS THE REAL ESTATE GAME – The Intelligent Guide to Decision Making and Investment *
REAL ESTATE DUE - DILIGENCE CHECKLIST * "OVERVIEW OF FEDERAL TAX POLICY TOWARDS REAL ESTATE *
We need to ask ourselves a few questions in order to play this game: - Why have we chosen to play in the real estate arena? - Why is real estate more attractive than many other avenues of potential investment?
There are 4 elements to the game:
Properties - Are the assets and the opportunities in this game. They are diverse in style and construction; diverse in location and intended use; and may begin with only a plan or rough sketch. Players - The players may be traditional entrepreneurs who tend to be involved directly and usually use normal debt to play; or they may be non-traditional entrepreneurs who are evolving as the capital markets develop. These non-traditional players are often builders, service providers or financial institutions of some form. Capital Markets - Capital markets correspond to the liabilities and equity that the players use, as this is the equipment determining the game for the players to play. The game depends on the status of the capital market environment, not only as the players’ source of funding but also for their decisions on the direction of play. External Environment – This is set outside of the game, by national and international factors, including policy and regulation, international news and changes in global technology. The flow of events will generally be from the bottom to the top of this pyramid, from the broadest policy decisions toward the individual properties. For example: a large change in the interest rates set by the Federal Reserve may have enough impact on the capital markets to affect the products that the bank may offer to its clients. The withdrawal of a particular mortgage product by the banks may present an opportunity for a non-traditional player such as a property development company to offer its own deal to the market for a particular property development project. A change in one of these external factors is likely to create opportunity. "The fact is, however, that change almost always creates opportunity for those who are equipped to spot it." (Poorvu 1999, 6) Your goal is simple. You are trying to buy a property at a price below what you expect to sell it for sometime in the future. Property can provide an income that you can see now and an appreciation in value that you will only see at some later date when you come to sell the property. Most of us would tend to be players who operate in the top end of this pyramid, on the individual transaction level. We are trying to find the opportunities that exist as a result of a shift in the external factors. We are then seeking the point furthest back, away from the individual deal, where we can exert some influence. If you were able to exert ultimate influence, you would simply legislate, or decree, that all property in your county was yours alone. Such autocratic dictatorship may even exist but, most likely, will not be long lived. This (almost) hypothetical extreme serves to highlight the point that absolute influence of external factors can benefit your interests at the individual property level. More usually, our influence can only be applied to the individual property transaction. This influence is therefore reflected in our abilities as negotiators and relationship builders. Property transactions are about people transacting. "I think real estate is as much about people as it is about property. It’s people who add value or subtract value in the real estate game - whether by design or accident." (Poorvu 1999, xiv)It is important to understand that "Real estate managers are not risk takers but rather risk managers." (Poorvu 1999, xi) "Real estate is an industry characterized by 10-year cycles and 5-year memories." (Poorvu 1999, xii) Real estate is a cyclical business, locations, properties and property types all change in value over time. These cycles are the catalysts for the change that creates opportunity. In order to benefit from these opportunities we have to learn to recognize the cycles and manage the associated risks.
Real estate rules revolve around understanding the numbers and analysis necessary to be guided to a decision. Most of the calculations are not especially complex and, because of this, they are often referred to as "Back of Envelope" analysis. With practice, the calculations are used to provide a rough guide as to whether or not to pursue a particular transaction.Net Operating Income (NOI): net property revenues less the building’s operating expenses Cash Flow from Operations (CFO): NOI less capital expenditures or reserves for cash items such as tenant improvements (TIs), leasing commissions, and structural reserves. Financing Costs (FC): debt or mortgage payments of principal and interest, often in the form of a constant payment that amortizes the loan over a given time period. Cash Flow After Financing (CFAF): CFO – FC Return on Assets (ROA): CFO / purchase price The return on assets ratio is sometimes used interchangeably with the capitalization rate or "cap rate". This is the real estate equivalent to the yield on invested capital. Return on Equity (ROE): CFAF / cash invested Pre-tax ROE is also called cash on cash return CASH on CASH Return: Positive Net Cash Flow / Down Payment Loan to Value Ratio (LVR): loan amount financed / value of the property (x 100) This is usually expressed as a percentage. Annual Loan Constant: sum of the annual mortgage payments / mortgage balance. This is dependent on the term of the mortgage, and varies throughout the term. At the start of a 30-year fixed rate mortgage, the annual loan constant is a little higher than the mortgage interest rate. The shorter the remaining mortgage term, the higher the constant. For example, the annual constant on a 30-year fixed rate mortgage at 7.25% is 7.52% initially. (John T Reed – website "positive cash flow")
Let me illustrate some of the above calculations by way of an example: Suppose a 40,000 Square foot (sf) commercial property is on the market for $750,000. You would calculate that this price per square foot (psf) is below $20. This compares favorably to the $40 psf cost of building a similar property, so the deal is worth investigating further. The rentals are $2.50psf; for now we may assume that the occupancy rate is 100%, and the LVR is 80%. The loan is 80% of the purchase price = $600,000 and is financed at 8% over 30 years. This results in total annual mortgage payments of approximately $53,000. The Cash flow from operations is 40,000 x $2.50 = $100,000 less operating expenses, vacancy allowance and capital reserves. YEAR 1
Everyone is entitled to his or her own assessment of what is a reasonable rate of return. In the above example the pre-tax ROE appears reasonable and is available on a property that can be bought at approximately 50% of replacement cost. This is attractive, but further analysis can now be considered by changing variables such as the rent, the occupancy rate, and the LVR.Dropping just one variable, such as the occupancy rate, to say 80% will reduce the ROE to 6.7%. By finding additional information, and testing your assumptions, you will be able to determine whether this deal’s rates of return are attractive enough for you to invest.
Computer Spreadsheets – allow more sophisticated number crunching. Over typical property holding periods of ten years, different scenarios can be run to determine the effect of changes in income, timing of sale, change in financing interest rate, tax consequences, and return on investment (IRR and NPV). These numbers and terms are used in everyday conversation in the real estate game. Most of these terms and analyses are the foundation of decision-making in the investment process, but are not the only determinants. In fact, Poorvu specifically warns against placing too much reliance on complicated number crunching. Often the numbers can be made to look good by altering key assumptions. These assumptions may not be realistic. By keeping the analysis simple, the key assumptions can be isolated and better monitored over time.
There are at least four methods of property investment where the investor provides some equity. These vary in their degree of involvement and most players will be attracted to their preferred method based on the level of time and resources they are prepared to input. It is unusual for property investment to be available without some form of equity participation. These methods are:
Direct Purchase – is a preferred method of investment for people who are in the early stages of accumulating wealth. Limited partnership syndication – is more suited to those investors who are in the stage of perpetuating rather than accumulating wealth. These investors are typically willing to take a lesser role in the management of their investments. Multi-property funds – are usually offered to the public through the brokerage houses. These tend to be funds that are available to small investors and are often funds that do not specify the property they invest in. Public securities – are much more controlled and therefore usually have a lower risk profile. However, lower risk usually accompanies lower returns. I will discuss each of these in greater detail below.
The direct investment route is characterized by: "an individual or group purchasing a specific property, using money assembled for that specific deal." (Poorvu 1999, 108) The phase between attraction to a concept and making a commitment requires you to exhibit the skills of an accomplished general manager. You will be starting with an opportunity, and then getting information, managing money and managing your time. In the stage up to commitment, you are spending your own money. Only after the deal is secured does the outside finance come. However, because of this, it’s easy to fall into the trap of not spending the right amount of money, either to get the right people, or to obtain the right information. Experience will show that mistakes tend to be more costly to fix than to avoid. A number of key items have to be considered by those opting for a direct investment:
There is great effort required to be an active player in this game; the skills to be used are complicated and hard to develop. I have provided a comprehensive list of things to be covered in any due diligence exercise for direct investors. Please see Appendix A at the end of the paper.
It is usually of great benefit to work with the familiar, and with people that you know and trust. If you attempt anything that is too far out of your comfort zone you might get lured into something and could end up wondering what you missed that the locals already knew (and declined to take-up). It is important to be able to manage your time well, which means only visiting the properties that it will be useful for you to see. It may or may not be useful for you to gain a thorough perspective of a suburb and visit every available property. The best opportunities that you may come across may be the ones that you have made for yourself. Investigate long-term trends or plans and decide how best to use the limited time that is available. "In many cases, you learn the most from the deals that you don’t do. This is a great form of education, with an attractive cost of tuition." (Poorvu, 1999, 53) It may be necessary to limit the scope of the deals that you look at. You may only have the time and opportunity to investigate a small portion of the market. It may then be wise for you to specialize, based on location, size, property type, and so on. By specializing, you might also be able to answer the question: "Why did this deal come to me?" If you are not very familiar with a certain type of deal, you may question whether everybody knows something about the deal that you do not know. In the end there may be all sorts of good and bad reasons for the deal to come to you. The most important thing is to understand the motivation for the deal landing in your lap, and for you to be able to access all the data that you require. Poorvu puts it this way: "Be appropriately skeptical when you can’t get the information that you need." (Poorvu 1999, 56)
There is a basic rule in real estate, that has its origins in humble economic theory, "the best opportunities in real estate tend to arise when financing is most difficult to obtain." Banking relationships are important. In today’s trend of more impersonal banking, the ability to find knowledgeable managers who have the mandates to make decisions is becoming harder all the time. It is paramount that you have a banker who trusts in your ability to perform. Many deals are going to change in their structure through the negotiating process, and this requirement for flexibility is why the banking relationship is so important. A good relationship with a mortgage broker can also be a key asset. Mortgage brokers are usually motivated by commission to ensure the deal goes through and it is their business to be up to date on the different products available from different financiers. It is a good idea to be reasonable when seeking information from a banker or broker; your banker needs reassurance that you know what you are doing, and the broker will be more likely to increase his fees if you appear to be uninformed.
There are a few fundamental rules to be considered when entering into negotiations:
Investing in and managing property successfully depends upon being able to manage your own emotions and being able to connect with personalities. Successful players are those who can combine financial analysis objectively, and combine that assessment with a ‘gut feel’ for the location, property style and trends in the market. There is a certain amount of emotion attached to property transactions, particularly in the case of residential and family business properties where the seller may have spent many years developing the property. To successfully transact with such vendors will require a degree of empathy and understanding. "Gut feel" is not the same as emotion it is a degree of intuition that tends to improve with experience.
Limited Partnership Syndications An alternative method of participating in the game is through a more indirect passive approach. If you don’t have the time, inclination or skills to be involved directly, is there still merit in passive real estate investment? Most likely, the answer is ‘yes’: "real estate over time has been an excellent way to make a 10 to 12 percent return on your capital." (Poorvu 1999, 109) Syndications can be attractive to inexperienced investors just getting into the game, or to sophisticated investors who are diversifying by taking smaller parts of several properties, or limiting their involvement in a particular project. "A syndication permits the key players to tackle something that is beyond their individual financial means." (Poorvu 1999, 110) The advantages are numerous: accessing a small piece of a large property that would otherwise be out of range; protection of assets by limiting liability to the investment itself; taking a passive role in the investment as limited partners can have no role in management; tapping in to the expertise that is usually available in the syndicating company; dual benefits of higher than average rates of return plus tax shelter; opportunity to diversify by buying into several different properties and thereby spreading the risk.The disadvantages are: limitation of liability also limits control; the lack of flexibility may mean a lack of liquidity – the interest may not be very tradable; the general partner’s fees and commissions may reduce the attractiveness of the fund to you; there is a higher probability of an IRS audit if you have a limited partnership in your portfolio. There are two kinds of partnerships: the private placement type that has a membership limit of thirty-five partners. This limit avoids the scrutiny of the Securities and Exchange Commission (SEC). The returns are usually higher, but so is the risk compared to larger public offerings that have been registered with the SEC and are usually scrutinized by experts at the big brokerage companies participating in the deal.
Multi-property funds are also known as "pooled funds" and are designed to allow individuals (or institutional investors) to pool their cash resources. These funds then invest in a variety of properties, usually according to a general statement of intent, but not all the properties held by the fund may have been identified in advance. (Poorvu 1999, 119) Investors split the profits of the fund, in proportion to the level of their investment, after the manager of the fund takes the management fees and perhaps a percentage of the proceeds of the sale. These pooled funds can be either "open-ended" or "closed-ended"."Open-ended" funds are supposed to have a facility allowing redemption at any time. However, it has been noted that this redemption option has occasionally been withdrawn when investors chose to remove their funds at the wrong time in the investment cycle. This "run" on the investments had to be halted and many funds were affected in the early 1980s in this way. It then became popular for investors to choose a "closed-ended" fund that allowed investors no opportunity to withdraw their funds early, but fixed the redemption for a specific period. Since this redemption date could possibly arrive at an unfavorable point in the investment cycle, the sponsors often allowed an option to extend for a short period, say two years, that was usually enough to cover the down-turn. The capital markets have very flexible players who are prone to embrace the latest fads and fashions in the industry. In the 1990s institutions, investment banks and intermediaries formed opportunistic pools to seek out undervalued assets. These opportunity funds were often referred to as "vulture" funds and were created especially to buy bundles of properties that were being sold at distressed price levels. While this was going on, pension and mutual funds with large amounts of cash were in search of smarter and safer investment opportunities. The result was a revival of an old (and previously discredited) idea, which became the Real Estate Investment Trust.
Real Estate Investment Trusts (REIT) In 1960, the Real Estate Investment Trust Act was established in order to assist small investors to own "shares" in a large number of properties. There are certain guidelines that have to be followed: for example, there must be at least 100 shareholders; no more than 50% of a REITs shares can be owned by five or fewer shareholders (although a pension fund is judged by its plan beneficiaries); unlike a corporation that pays a portion of its profits as dividends, a trust pays most of its income out to the shareholders each year. REITs were among the financial success stories of the 1990s as they provided income, liquidity, diversification, access to higher income properties, a more diversified portfolio and possibly tax breaks. However, by the end of 1998, "many REITs had lost a third of their value from their 52 week highs, despite strong real estate market and falling interest rates." (Poorvu 1999, 139) Bricks and mortar are physically, and psychologically, stable and therefore illiquid. Although the value of a property may fluctuate on paper, this does not have a significant impact on you until you realize that value by selling the property. REITs, by contrast, are designed to be liquid, and there are no private (sentimental), or public (status) implications arising out of selling your stake in a property. The REIT model has been fine-tuned since it was first introduced. This has been necessary because there have been a number of problems with the model and the level of risk to the average investor. REITs that have gone out on a limb, overpaying on cyclical properties, will remain the riskiest vehicles to invest in. Hotels were a favorite such example that suffered from what was termed the "paper-clip REIT", in which a company could own both an operating and a real estate holding company under the same umbrella. "Congress passed legislation forbidding this vehicle, companies like Patriot American lost as much as 80% of the value of their stock, once again throwing REITs into disrepute." (Poorvu 1999, 144) The current re-introduction of the model is the fourth attempt, and by now it should almost be working correctly. A recent revival was described in an article in The Economist: Mall Content (Economist: 1st June 2002, 68) Mr. Frank Lowy, Chairman of Westfield Holdings, has built a truly global empire of shopping center malls. Based in Australia, Westfield reckons that 70% of Australians live within half an hour of a Westfield shopping center. It owns and manages 109 centers worldwide, including in Britain, New Zealand and America; these centers house over 16,500 retailers in 90 million square feet (8.2 million square meters) of space. Westfield is the largest mall operator in California, Maryland and Connecticut. (www.westfieldamerica.com) The malls are owned by trusts, listed on the Australian stock market. These trusts pay a management fee to Westfield Holdings, which is also listed. "The principle is that of a mutual fund, in which investors can buy into the fund or the manager, or both." (Economist: 1st June 2002, 68) The shopping center business has two income streams, making it attractive to investors at different ends of the risk spectrum. The rental income from the ownership of the properties is steady and low risk; the more volatile income stream is derived from the construction and management of the centers. By separating the business and the balance sheet into two parts, Westfield has developed a method of financing the business that sits extremely comfortably with the Australian investor. American investors have been more wary and Mr. Lowy de-listed his American trust last year. American investors may still recall their bad experience with REITs in the late 1980s that had ‘external managers’ similar to the way Westfield operates. Some of these managers dumped bad properties onto their investors, and now Americans seem to prefer property funds that control ownership and management under one roof. Westfield’s trusts are outperforming their peer group and, unlike the old REITs, some comfort is to be drawn from the fact that both the trust and the manager are listed. "This makes the entire exercise transparent – and arbitrageable, should the need arise. An investor who thinks the management company may be taking advantage of the trusts can simply buy shares in the former and exit the latter." (Economist: 1st June 2002, 68)
As we have already discussed, there are two alternative paths toward the real estate game. The first is to be an active player – entering the market directly; the second is to be a passive player, investing through someone else by way of syndications or REITs. It is important to determine what side of the real estate sector will be the best for you. Once this decision is made, the active players face a second decision – whether to build, or to purchase and operate an existing facility.
The phase of the real estate game that demands the most skill, and has the most reward, is development. Whether this is for hotels, warehouses, office blocks or housing estates, the management of risks remains paramount. The primary risk is whether there will be demand for the finished product when it finally gets to the market. Many developments take years to complete, maybe five years in some cases. That is a long time to be managing all the legal, financial, construction and market related issues. In terms of a career, this management is comparable to many high-powered "full-time" executive jobs. As I indicated earlier, the full story on real estate investment is beyond the scope of this paper, therefore the option of developing a property will not be discussed further. Indeed, development is worthy of a whole paper on its own. I will focus more specifically on establishment of an investment portfolio of residential properties.
When it came to real estate, rich dad had two questions.
The most important financial ratio of a piece of real estate to rich dad was his cash on cash return. (Kiyosaki 2000, 317) (Please see Addendum 1 at the end of this paper) A property that does not have a positive cash flow is a liability; Kiyosaki simply defines a liability as something that takes money out of your pocket. You cannot afford too many properties that take money out of your pocket. At the very least, you should aim to cover your cash outflows. "I’m really not trying to make a killing from my rental cash flow. In most instances, I just want to break even and let the property increase in value." (Allen 1986, 177) By contrast, you would want all the properties you can find that have a positive cash flow or CFAF. Robert G. Allen has made his money as an investor, author and lecturer. His number one best seller was Nothing Down and he has had similar success with Creating Wealth. These books were aimed at readers serious about changing their financial future. The advice that Allen gives includes purchasing two houses a year for ten years. (Please see Addendum 2 at the end of this paper.) Allen was of the view that capital appreciation would be the major contributor to his wealth creation. In fact there are a number of other issues that determine whether a property will have a positive cash flow. Positive cash flow from a rental property occurs when one of two things happens:
Loan to Value Ratio x Annual Loan Constant must be less than the Cap Rate to get positive cash flow. "In general, you will find that true cap rates on apartment buildings are around 6% to 8%. Since mortgage interest rates are 7.25% or higher, most apartment buildings have negative cash flow. True cap rates on single-family rental houses are significantly lower—like 4% to 5.5%. That’s why virtually all rental houses with normal loan-to-value ratios have negative cash flow." (John T Reed – website "positive cash flow") "Would-be investors should consider positive cash flow from the tenant’s perspective. In order for a single-family rental house to have positive cash flow, the tenant must pay more to rent the house than he would have to pay to own the same house. That is obviously a stupid thing to do. And that’s why you almost never see it." (John T Reed – website "positive cash flow") Positive cash flow in the real world is only achieved by buying where high cap rates are the norm. This happens only when markets believe that property prices are falling, so owning is not attractive. This positive-cash-flow situation is typically a brief window that lasts only six months to a year. Because it is rare and desirable it attracts out-of-area investors which in turn drives the prices up so that high cap rates are no longer available. Target property in the residential market Allen chooses the single-family home, because he prefers to specialize and concentrate his expertise in a particular market. The target properties are those that exhibit certain traits:
Allen believes that the single-family home, low in the relative price scales, offers the greatest potential for upward price movements because this is where the demand is. By investigating and operating in one sector you will be able to concentrate your expertise, and by understanding the market you will make choices that expose you to less risk. When it comes to renting out a property, it is likely that the houses in lower priced areas are always going to be in greater demand than houses for the rich. The rich tend to be less affected by cycles in the economy, and more likely to be able to afford changes in mortgage repayments. The proportion of people who rent in the lower income groups may tend to be higher since these people would find it harder to save for a deposit on a house, and may be unable to cope with an increase in repayments, forcing them to exit their mortgage. Also, for reasons already discusses, it is seldom possible to rent a larger house out at a rental that covers the mortgage repayments. Mortgage repayments and rentals tend to be more aligned in cheaper properties. Finding opportunities in residential areas is also a function of the area or suburb itself, rather than simply the property. "The most important feature of a neighborhood is pride of ownership." (Allen 1984, 82) A well cared for, small home in a suburb that is free of litter and debris is an indication of the type of person who chooses to live in the area. Chances are higher that they are people who will look after the place and pay rents on time. Target properties in the commercial market will come from a strategy of seeking opportunities in four areas:
Real estate, particularly residential real estate, requires a sound system of management. It may not be vastly complex, but the issues that need controlling are unique and important. Managing properties yourself may not be effective until you have an established system that has proven itself and you have learned from many mistakes. Paying for a professional manager to look after your interests may not be any more effective. Allen has found a compromise that allows him to maintain a degree of control but also frees his time from the more mundane issues of rent collection, advertising and repairs and maintenance. Allen has a partner who has a personal interest in the quality of this management, since he is not an employee. "The key to any good management system is finding good tenants." (Allen 1984, 172) There are basically four areas of home rental property investment that require attention:
Timing of getting in and getting out of investing and harvesting at smart times – working effectively in and around the economic cycle. Harvesting is difficult, but mostly this is attributable to the investors’ failure to plan their exit strategy. There are two other factors that make the harvest phase challenging: One is the emotion attached to certain properties. This very often clouds the facts and makes the investor optimistic that better times are ahead, when in fact they may not be: "this was my favorite property and it always performed in the past". The other is the time and expense that go into the disposal of a property. Capital gains tax also plays a significant role in the exit, and again must be planned for. (Please see Appendix B for an overview of US Federal Tax Policy.) In fact, getting out of commercial property is often more difficult than holding on. Depending on your own country’s tax structure, the sale of a property may trigger the payment of tax, on both the depreciation claimed in prior years and on the capital gain. If you also settle the balance of the mortgage you may end up with a good portion of cash that is free and clear. But the dilemma that you then face is what to re-invest in. Poorvu illustrates a specific example (that I have tabulated for ease of comparison):
(Poorvu 1999, 228)
By contrast, the refinance option maintains the original property, and the possibility of additional increases in property value, while the refinanced amount is freed up for new investment. It is also likely that a significant portion of the $125,000 difference between these two options will be sacrificed in the fees and transaction costs of the sale. So, although the culture and the system discourages sales, there may be external factors that make the sale option the most appropriate choice: the need to free up capital to do the next deal; an assessment that the market is peaking; differences of opinion between partners. Real estate deals generally stand alone so they make ideal introductions for family members to begin their business participation in a total portfolio that may comprise many properties. Again, depending on your local tax laws, there are many concessions to be explored with regards to the transfer of assets to the next generation. Gifting is an important part of this transfer and it is best to seek competent professional advice in this area if you plan to utilize the options available.
In conclusion, it should be clearer now that the subject of investment in real estate is vast. There are many authors, and many of them claim to have found the ideal method. In practice, there may not be such a thing as a single ideal method, simply because there are so many variables in this game. The answers to questions may not be as applicable in one location as they are in another. The single answer is that we should each research and learn about conditions in a particular niche that we wish to operate in. We should then learn as much as we can about that niche by going to experts. These experts need not be consulted at vast expense by attending a "guru’s" course. Your CPA and lawyer can probably tell you about some of the pitfalls before you test them for yourself. "Going to the experts is expensive. Very expensive. But it is infinitely cheaper than experience." (Allen 1986, 281) "If you think education is expensive, try ignorance." Attributed to Derek Bok, President of Harvard (Allen 1086, 280) In summary, the keys to successful investing in the commercial market are found in this quote: "The best opportunities come from buying at a discount to replacement cost, seeing catalysts such as having tenants for vacant space, discerning the possibility of converting spaces to a higher value use, or obtaining better sources of financing." (Poorvu 1999, 258) I end with the assertion that this form of investing is not too different from most other types - the world over. Real estate investment is rewarding in more than simply a financial sense, and investing should never be a gamble that you cannot afford. Playing the game is not about taking chances and risking the shirt on your back, but it is a game that can produce a winner and a loser. Understanding and minimizing risk is a skill that everyone is smart enough to learn. "I hope, too, that you possess the two indispensable complements to smarts and skills: good luck, and great timing." (Poorvu 1999, 258)
John T Reed’s guru rating websites
(Appendix and Addenda on next page)
During my research for this paper, I have obviously tried to cover both sides of each argument. I am most impressed with one particular site that I have found, hosted by John Reed. The following extracts are from two different papers available on the http://www.johntreed.com website. These extracts are included simply to highlight the fact that there are authors that purport to be "gurus", but have questionable credentials. While there may be some gems of wisdom available from such "gurus", there are certainly other areas of advice that may increase risk rather than reduce it.The following is an extract from the Kiyosaki review on the John T. Reed website ( www.johntreed.com):"The making of a financial genius • flunked sophomore year of high school and had to repeat Kiyosaki tries to make a virtue from all his failures and false starts—saying that’s how you learn and you have to get back up and all that. Fine. But couldn’t we see a little more actual success after all these great lessons were learned before we "run away to join your circus?" And how did all this screwed-up stuff happen to a guy who had the benefit of "Rich Dad’s" brilliant wisdom back at age nine? If "Rich Dad" is really a completely phony story, how much of this other stuff can we believe? What is his background really? I am impressed by Xerox salesmen as a general rule, but that aspect of his background sure stands out from the rest. Did he really do that? He claims he was a "top-five" guy at Xerox—one of the nation’s most well-managed companies at the time. Really? And this after being a bottom-five guy everywhere else!" With this in mind, extracts and advice taken from Kiyosaki’s book have been screened to the best of my ability.
The following is an extract from the review on Robert Allen by John T. Reed on his website (www.johntreed.com): "Allen himself got into financial difficulty with the IRS as early as 1984. In 1986, IRS filed a $346,395.79 lien against Allen. In September of 1987, when I wrote an article exposing his financial difficulties, he also had:
Allen declared bankruptcy in May of 1996. See my 8/96 article. In what must have been a weak moment when I was interviewing him for the ’87 article, Allen told me I "do a great job and that I keep guys like him honest." I have it on tape (with his knowledge and permission). I won’t take credit for keeping him honest—or give anyone else credit for doing that. I think Allen has an interesting story to tell. But it’s not the one he sells. He should speak about real estate investment the way a reformed alcoholic speaks about drinking. For cheaper, accurate information on real estate finance, see my book How to Use Leverage to Maximize Your Real Estate Investment Return, my High Leverage Real Estate Financing cassettes, and my newsletter articles on finance." This extract is interesting as it serves to highlight that much of what Allen may have told his readers was either never used in his own transactions, or was of limited value. Actually, some of the advice could have been extremely risky to the investor. With this in mind, extracts and advice taken from this book have been screened to the best of my ability.
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