Monthly Archives: May 2009

Give Nothing Away for Free

I heard someone once say that people rarely value anything they get for free.  In order to truly appreciate something you must have some skin in the game.  However, the rules of the game are changing.  A mentor of mine once told me that wealth can be created competitively or cooperatively.  The competitive individual believes the pie is so big and the only way to get more is to take a bigger slice.  The cooperative person will just make the pie bigger.

 A surefire way to fail in any business is to give nothing away for free.  If you worry about losing a buyer, seller, client, partner or colleague because of the information you give them, or decide to withhold from them, then chances are you are already headed in the wrong direction.

 The fastest way to build trust and rapport with people is to share valuable, no strings attached, information with them.  If you are a real estate investor and are dealing directly with a homeowner in foreclosure do you explain all of their options?  Before I get a contract signed by a homeowner in foreclosure I make sure to educate them first.  They need to know that a short sale can adversely affect their credit, that they could be eligible for a federally sponsored loan modification, and that there other investors out there like me that could offer them a better deal.  Of course, these disclosures provide me some legal protection.  But, that’s not my primary reason for this line of questioning.

 By the time I get through with this educational session the homeowner in foreclosure is practically begging me to buy the house.  I have successfully made the transition from a greedy real estate investor to a sensitive consultant because I gave them all of the information without being asked.

Will I lose a deal from time to time?  Yes.  But, acts of goodwill have a tendency to be rewarded in the future.  Coincidentally, I learned just about everything I know about pre-foreclosure, buying at the courthouse steps, subject to deals, lease options, seller carry backs, promissory notes, hard money, title insurance, wholesaling and rehabbing, FOR FREE, from a local real estate investor who believed in paying it forward.

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Treat Your Business like a Hobby

Hobbies are expensive.  I used to really be into wakeboarding.  In 2005, I bought a $60,000 wakeboard boat and over $1,000 in wakeboard equipment.  A single roundtrip to the lake cost me over $100 in gas.  In just my third outing in the new boat I tore my ACL while attempting a simple trick on my new wakeboard.  Since I had private health insurance and a large deductible the knee surgery cost me $5,000.  It took me a year to recover from surgery and I used the boat about 5 more times after that.  Last year, I sold the boat for $20,000 less than I paid for it.  It reminds me of a popular saying, “the two happiest days in a boat owner’s life is the day they buy it and the day they sell it.”

 Are you treating your real estate investment business like a hobby?  In many ways I did.  Although I studied my local real estate market, networked with other real estate professionals and spent thousands on real estate education programs, I never really operated as a business.  Here’s why:

  • I didn’t have a business plan.
  • I didn’t adopt an exit strategy for the business.
  • I never used or understood important financial tools like balance sheets and cash flow statements.
  • I had employees but no organizational chart or training system.

 If I had done these things would that have prevented my real estate investment business from collapsing?  Probably not.  I’m certain Bear Stearns, Countrywide, GM, AIG, and Indy Mac Bank operated like a business and they still went belly up.  My point is that if you operate like a real business your chances of success are increased exponentially.  You will:

  • Work more efficiently because you have a plan.
  • Be more aware of shifts in the real estate market.
  • Attract more sophisticated investors.
  • Retain, motivate and inspire better employees.

 To write a business plan, I suggest Business Plan Pro software and the book, The Plan-As-You-Go Business Plan, by Tim Berry.  You can use Quickbooks for help preparing financial statements.  For help reading them I suggest Warren Buffett’s book, Warren Buffett and the Interpretation of Financial Statements.  Finally, when building a staff and creating systems I highly recommend The E-Myth by Michael Gerber.

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Invest for Appreciation, Not Cash Flow

There are plenty of ways to lose millions investing in real estate.  But, investing for appreciation and not cash flow has got to rank very high on my list of sure fire ways to lose a bundle.

I’m a big country music fan.  George Strait is one of my favorite artists.  He had a hit recently called “I Hate Everything”.  A friend of mine (I’ll call him Roger) and I were at a local bar discussing real estate investing recently.  He bought three houses in 2006, one of them in Arizona and the other two in New Mexico.  He told me that he’s losing over $1,100 a month in negative cash flow and the value of his properties are down over $100,000 because of the housing bust.  Roger went on to say that he hates real estate investing.  He said he has no interest in buying rental property again, doesn’t want to learn any more about real estate investing and would like to change the subject immediately.

 At that moment I couldn’t help thinking about the George Strait song.  He sings, with passion, about hating his job and life.  My buddy Roger hates real estate investing with the same passion.  So I asked him, “If your rental properties made you $1,100 a month, would you still hate real estate investing?”  He said no, of course not.  Then I asked him if he would care that his portfolio lost $100,000 if he was receiving net cash flow of $1,100 per month.  He gave me another no answer.  That’s when I made my point…there is never a wrong time to invest in real estate, only a wrong way (I stole this line from a mentor of mine and he probably stole it from someone else.)

 Robert Kiyosaki likes to say that if you own something that costs you money it is not an asset.  In 2006, I owned $16 million in single family residential real estate that was costing me over $30,000 per month (this included overhead expenses.)  Talk about negative cash flow.  At the time I was overcoming this huge deficit by “cash chunking”, a term a real estate investing colleague of mine named Sue Walker introduced me to.  I’m sure you’re familiar with the concept of cash flow…your assets generate income through rent payments, interest, etc.  Well with “cash chunking” you sell your assets periodically to generate income. 

 Little did I know that the housing bust was looming and median home prices were about to plummet.  It was about this time that I learned another important lesson…real estate is not a commodity; it is an investment (I stole this one too from a hard money friend of mine and I’m certain he stole it from somebody else.)  Once it got tough to obtain financing my “cash chunking” business quickly went out of business.  In order to sustain a full-time real estate investment business model you need a reliable, consistent cash flow stream that doesn’t involve selling illiquid assets that you hope will appreciate.  This is very difficult to do. 

 In my search to learn how to do it better next time I made a surprising discovery.  The best and brightest in real estate investing have a cash flow producing business of some kind to cover negative cash flow and potential losses.  For example, Robert Kiyosaki is in the education business.  He uses his profits from his business to invest in real estate.  I have a friend who owns a property management company.  He devotes a portion of the cash flow he generates from his fees to buying rental property.  In your case your job may be your source for cash flow.  My point is get the cash flow business going first, the real estate investing business can come later.

 And if you’re like me and went from “cash chunking” to blowing chunks, remember what Henry Ford once said, “Failure is simply the opportunity to begin again, this time more intelligently.”

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The Loan Modification Mess

the loan modification messEveryone seems to have an opinion about loan modification.  If you ask a politician, government official, or member of the media most of them will tell you that obtaining a loan modification from your lender is as easy as picking up the phone.  In the very next breath they will tell you that all loan modification companies are scams and if you pay an upfront fee you will get ripped off.  Unfortunately, for millions of distressed homeowners across the country neither of these statements is completely accurate.  This is a story from an April 17th investigative report on ABC News:

Maxine Waters, a California Congresswoman, recently attempted to help a few of her constituents get a hold of their banks in order to re-negotiate the terms of their loan. What she thought would be a simple telephone call turned in to hours of being placed on hold and speaking mainly to automated voices.  After hours of trying to help Congresswoman Waters said, “The average American trying to negotiate a loan modification will not be able to get it done.”  While the federal government and banks say they’re trying to help homeowners avoid foreclosure through various help lines and more, an ABC News investigation has found that the process of reaching out for help can be disorganized and frustrating, hardly consumer friendly, even when a prominent member of Congress is on the line.

I went through a very similar situation with my own home.  When I fell behind Indy Mac Bank said because of the type of loan I had all I could qualify for was a repayment plan. I was told I would have to make a $3,200 payment for six months.  This was twice the amount of my original mortgage payment.

That’s when I decided to take a calculated risk.  Even though the Arizona Attorney General’s Office, the Arizona Department of Financial Institutions, and the federal Making Home Affordable websites all told me not to pay an upfront fee to a company to keep my home from going into foreclosure and modifying my loan, I did it anyway.  Why?  Because everything they told me I was supposed to do (attempt to refinance, call my lender, and apply for the Making Home Affordable Plan) wasn’t working.  I figured I may as well take the opposite approach.

But, I didn’t just run out and pay the first loan modification company I found (they are easy to find these days – you’ve probably seen all the billboards, the annoying little roadside signs or heard the radio ads or seen the TV commercials – its no wonder the industry gets such a bad rap).  No, I did what every smart consumer should do before making a buying decision:

  1. I got a referral from someone I trusted.
  2. I reviewed the business’s proof of performance information (i.e. approval letters from lenders).
  3. I checked for complaints.
  4. I toured their place of business.
  5. I talked to their employees.

 The company checked out.  And guess what happened with my loan?  They stopped my foreclosure, obtained a more favorable repayment plan for me and are now modifying my loan. 

As for all of the warnings from the government…remember what Thomas Jefferson said, “I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.”

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Be a Novice in Your Market

I read a story over the weekend about a young man named Billy Jinks.  He’s 19 years old and owns a limo company that grossed $1.4 million in sales last year.  I’m not going to go into detail about the article (you can read about it at http://www.azcentral.com/arizonarepublic/business/articles/2009/05/09/20090509biz-mr-limo0509.html), but I would like to use his story to illustrate my point in this post.

 Billy started learning about the limo business when he was 5 years old.  By the time he was 14 he was attending industry conventions.  Why?  Because Billy wanted to know everything there was to know about the limo business.  At a very young age Billy became an expert in his field.  There are others out there like Billy.  Mozart and Tiger Woods are both considered child prodigies.  But, their real secret was that they worked very hard to become experts in their area of study (see David Brook’s article, Genius:  The Modern View at http://www.nytimes.com/2009/05/01/opinion/01brooks.html?_r=2).

 My real estate business failed in part because I was not an expert in my business.  Sure, I had some flashes of brilliance from time to time.  One of my favorite stories is about a vacant home I found in south Scottsdale that was in foreclosure.  With some serious detective work I found the owner living in Hebron, Indiana.  The house was scheduled to be sold at a trustee’s sale two days after I finally got in touch with her.  She had a huge judgment on the property too.  Through careful negotiation I got the judgment released for a small payment. 

 But, the clock was still ticking on the sale.  I had to be sure I could get the transactional documentation back from her in time.  Rather than counting on FedEx or the US Mail I jumped a plane to Chicago, rented a car and drove 3 hours southeast to Hebron.  We met at a Holiday Inn Express (insert a joke from the commercial here) at 11p that evening, she gave me the signed documents and I gave her a check.  I called one of my wholesale buyers from the airport in Chicago the next morning and I had a contract on it by the time my plane landed in Phoenix that afternoon.  Everybody made out well on that deal.

 In June, 2006 my brief reign as a real estate expert ended because of rising inventory levels, the sub-prime meltdown, investor paranoia, El Nino, global warming, acid rain and black cats.  Prices had hit their peak and I was still buying like crazy.  I figured as long as I was picking properties up for 70 cents on the dollar I was safe from a market correction.  But, if I had been following inventory levels and absorption rates (the amount of homes on the market divided by pending sales), I would have discovered that the music had stopped.  In Maricopa County, Arizona we went from 8000 homes on the market in mid 05’ to 60,000 homes by the summer of 08’.

 Here’s how I plan to become an expert again in my market:

  1. By constantly tracking the inventory levels and absorption rates in the city, zip code and neighborhood I want to invest in.
  2. Monitoring the price per square foot trends in the city, zip code and neighborhood I want to invest in.
  3. Reading everything I can about the city, zip code, and neighborhood I want to invest in.
  4. Networking with everyone who knows about the city, zip code, and neighborhood I want to invest in.

 Eric Hoffer said, “In times of change learners inherit the earth; while the learned find themselves beautifully equipped to deal with a world that no longer exists.”  That is wise advice.  He must have stayed at a Holiday Inn Express.

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Begin with the Beginning in Mind

Let’s start with a few cliches’ shall we?  I’ve heard “begin with the end in mind” and the old standard “no one ever plans to fail they just fail to plan.”  My favorite comes from the movie, The Hunt For Red October.  Fred Thompson, the actor-turned-senator-turned potential presidential candidate, said to Jack Ryan (Alec Baldwin), “the Russians don’t take a dump son without a plan.”

Did I have plan?  Sort of.  Did I follow it?  Not really.  I got into real estate because I wanted financial independence.  That’s it.  And in January of 2006 I could have had it.  I owned $16 million in real estate (single family homes) with about $8 million in equity.  I could have sold everything off and owned my own home and 10 rental houses free and clear.  That would mean being debt free with passive income of at least $10,000 per month.  Not a bad life.

Forget about the real estate market going up or down for a minute while I fill in the blanks.  In January of 2006 I had what I thought I wanted.  I COULD HAVE BEEN DEBT FREE and had $10,000 a month in passive income.  But, I didn’t follow my loosely formulated plan.  I kept going because:

  • I was only 34 years old, what else was I going to do with my life?
  • I had a staff of 8 people, what was I going to do?  Fire them?
  • I had investors who were counting on me for above average returns.
  • I believed that worst case scenario the market would drop 20% and I would still be ahead.

These were all noble reasons to stay in the game, indeed.  But, what I didn’t know is that the real estate market had hit its peak in August of 2005.  While prices hadn’t started to go down yet (pricing is always a trailing indicator), inventory levels were skyrocketing.  By the time I figured out what was happening it was too late.  I kept going and here’s the rest of the story:

  • At 37 I’ll probably have to work until I die to pay off all of my debt.
  • I had to lay off the 8 people who I cared about so much because my business collapsed.
  • My investors lost all of their money just like I did.
  • The worse case scenario was even more worse and the market dropped by almost 50%.

The morale of my story is this…know EXACTLY what you want BEFORE you start investing in real estate.  Do you want to replace the income you currently have?  Do you want to build long-term wealth?  Be very clear about your objectives and write them down so you remember.  That way you’ll know when the time is right to exit stage left gracefully.  If you do this everyone will win, even if it doesn’t seem like it at the time.

I remember Napolean Hill’s quote about planning.  He said, “reduce your plan to writing.  The moment you complete this, you will have definitely given concrete form to the intangible desire.”

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5 Ways to Lose a Million in Real Estate

Over the next week or so I will attempt to explain how to lose a million dollars (or more) in real estate.  I’m certain there are more than 5 ways to do it.  I’m also sure that others have lost a million more gloriously.  But, after going through the experience myself I came up with this list:

  1. Begin with the beginning in mind.
  2. Be a novice in your market.
  3. Invest for appreciation, not cash flow.
  4. Treat your business like a hobby.
  5. Give nothing away for free.

Many so-called real estate investors (I call them speculators) were wiped out in o7′-08′.  But, I didn’t speculate and I still got creamed.  How did it happen when I had strict buying criteria and wouldn’t touch a deal unless I could close it for 70 cents on the dollar?  Remember the game musical chairs?  Well, someone pushed pause on the IPod and I didn’t have a place to sit.

As a professional real estate investor since 2002 I’ve made my share of mistakes, which I will share with you.  My hope is that you can learn from them and prosper.  Remember what President John F. Kennedy once said, “only those who dare to fail greatly can ever achieve greatly.”

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