Real estate books are a mixed batch. There are those that I recommend, such as Eldred and McLean’s excellent Investing in Real Estate, now in it’s fifth edition. On the other end of the spectrum is Robert Kiyosaki’s bestselling fable Rich Dad Poor Dad, a dangerous and misleading book if ever there was one.

In discussing books for investors I often end up recommending books that aren’t really real estate books, but which hold some insights that investors would be wise to heed. Nassim Nicholas Taleb’s recent release The Black Swan falls into this category.

The Black Swan discusses highly improbable events - like the occurrence of a black swan in nature – and how they impact our society. Taleb comments on our collective overestimation of what we know (and our underestimation of what we don’t), our reliance on phony experts and the general folly of forecasting.

The book isn’t without it’s drawbacks. First and foremost is Taleb’s unsufferable tone; one gets the distinct impression from reading Taleb’s prose that he’s one of those types that’s entirely too fond of the sound of his own voice. Much of the book is spent ridiculing famous figures whose theories he disagrees with - including Nobel prize winners Myron Scholes and Harry Markowitz. He lauds the guys who “get it” (from street-savvy traders to literary sophisticates) while heaping scorn on the squares (from tenured academics to pencil pushers in corporate America). It would appear that Mr. Taleb’s intention is to syle himself as an out-of-the-box intellectual maverick, but unfortunately he comes across as preening and petty.

And that indeed is unfortunate, because beneath these annoyances there is a lot to like about The Black Swan. Many of the book’s revelations are relevant to real estate investors. Among them:

We’re hooked on phony experts.

Taleb calls this the “empty suit” problem; he opines that there are many fields in which the “experts” are no better at predicting the future or producing effective results than a reasonably informed layman.

According to Taleb, there are experts who tend to be true experts and experts who tend to be…not experts.

• In the “real experts” category fall (among others): livestock judges, astronomers, test pilots, physicists, and accountants...
• In the “empty suit” (faux experts) category fall (among others): stockbrokers, psychiatrists, college admissions officers, intelligence analysts, economists, and personal financial advisers...

He poses the following thought experiment: Would you rather have your upcoming brain surgery performed by a newspaper’s science reporter or by a certified brain surgeon? The answer to this question is obvious – but it can’t automatically be projected on all professions. His follow-up question is whether one would rather listen to an economic forecast from a prominent academic with a PhD from a respected institution, or from a newspaper business writer. The answer here isn’t obvious.

This example will sound familiar to most real estate investors. Chances are you’ve heard it before – from a Realtor. Your average Realtor will consider herself closer to the brain surgeon analogy.  I disagree. There certainly are notable exceptions, but for a well prepared investor with at least one deal under his belt the vast majority of Realtors will offer little or nothing in terms of expert real estate investing advice. A Realtor can be extremely useful in helping you to get through the myriad steps to get to closing on time, but be careful about relying on him for “advice” on which market is gonna be hot, which one isn’t, and when to buy/sell. He’ll tell you that he knows, but he doesn’t.  You are every bit as good as "the expert."

So the next time you’re listening to an outook on housing prices, consider the fact that your prediction about what’s gonna happen is every bit as valid as the one you're listening to.

We don’t know what we don’t know.

We often tend to overestimate how much we know and underestimate our ignorance. This error tends to increase as we get more educated, meaning that an educated person has an even more unrealistic view of what he knows than an uneducated one. Chalk it up to our educational system’s focus on building self esteem. This has lots of implications for investors.

All industry groups produce reams of forecasts about future price movements. This is all a bunch of hooey – made even worse by the fact that industry groups aren’t unbiased observers.

This also gives investors something to think about when using a real estate investment evaluation software package – including the one offered here at EquityScout.com. All evaluation software packages rely on assumptions – the old garbage-in-garbage-out phenomenon. The primary use of a real estate evaluation software package should be to force you to consider and weigh your assumptions and think about the fundamentals of the deal. One way to do this is to look at what your assumptions mean in terms of future results, but bear in mind that this isn’t a forecast.

The only thing you know about your assumption around property appreciation rates over the next ten years is that it will be wrong. But, it’s vital to know if your investment will yield a reasonable return at a 3% rate of appreciation (as it will in many undervalued areas or if you grab a bargain) or if you’ll need a 10% or 15% rate of appreciation in order to break even (as is the case if you’re buying in many overheated areas, such as areas of California, Florida and Nevada).

You can’t see the future, but on the other hand you shouldn’t make a decision without knowing how various future scenarios might impact your investment.

Summary: I got some interesting insights from this book. Taleb takes many positions that I disagree with, but he’s a persuasive author who takes a stand, and some portions of this book changed the way that I think about certain things.

Related links

• Why I don't like Rich Dad Poor Dad

• Five things real estate investors should remember when running economic analysis

Ah, it seems like it was just yesterday when A&E TV was premiering Flip This House and the TLC Channel was launching Flip That House. Notice these were two different shows – I guess targeting two separate target audiences who were interested in either this house or that house. Free markets bring choice to the consumer, ain’t America grand?

Well now that the housing market is starting to slow in some regions flipping is starting to lose its shine. Perhaps one of the most telling pieces of evidence that the pendulum is starting to swing is that allegations of fraud are starting to pop up even in the sanitized, staged world of reality TV. One Flip This House participant evidently didn’t even own the properties that he allegedly was flipping for big bucks. If you can’t believe what you see on reality TV then whom can you trust these days?

So these are additional bits of evidence on a fact that we already knew: flipping isn’t investing, it’s speculating. Not that there’s anything wrong with that, as they say on Seinfeld, but it’s important to know that flipping is a speculative technique that works well if the market is flying and you have a healthy risk appetite.

Flipping is glam and flash – high rollers and big bucks. But that’s so 2006, so what trend are they going to selling us next?

Well one man’s pain is another man’s profit, so expect the spotlight to fall on the short sellers and pre-foreclosure investors.  Not as glamorous as the fast rolling world of the flippers since it requires the investor to manage the unpleasant task of dealing with folks who are having their home foreclosed, but in an environment of stagnating prices and embattled mortgage holders short selling can work.

Quick primer: The bank doesn’t want to get stuck with a foreclosure. I’m always annoyed when I read these exposés about banks licking their chops to kick grandma out of her house and sell it at the auction block the minute she gets behind on her mortgage payments. In the eyes of a bank a foreclosure is a black eye; banks don’t want to own real estate, especially a house that has been trashed by a aggrieved foreclosed owner.

If the owner is getting foreclosed on a house with zero or negative equity then there is little he can do. Say his house is worth $150 thousand and he owes $160 thousand; trying to sell won’t help.

Enter the short seller. He cuts a deal w/ the owner to give him the house and simultaneously cuts a deal with the bank that he’ll pay, say, $125 thousand for them to release the lien. Voila, everyone is happy: the investor gets a quick $25 thousand in equity, the previous owner avoids the indignity of a foreclosure, and the bank avoids the time, cost and expense of trying to unload the property – a process that probably would have cost them more than the $35 thousand it just wrote off.

Note that this is nothing new. People have been doing it for years. But it about to be the new thing which will be promoted online and in the media.

If the flipping phenomenon was vulnerable to fraud, this one will be as well. Two reasons:

• It’s hard: Making money flipping houses in a booming market is as easy as falling off a log. All you need is guts and the right level of risk appetite. Making money off of pre-foreclosures and short sales is hard. There are a lot of moving parts to these deals and pulling them off requires knowledge, negotiating skill and patience.
• Dealing with vulnerable people: Short sellers promote themselves as investors who help people. And indeed many of them are good, decent people. But investing isn’t an altruistic pastime, and when a dishonest investor comes into contact with a troubled owner who is looking for a lifeline there is a potential for bad things to happen.

I’m trying to look into the crystal ball on this one. I’ll revisit in a couple of months…

A few days ago I wrote a post about inefficiencies in the real estate industry, and how most investors who sell a home using a Realtor will end up overpaying if they pay a five or six percent commission.

I wrote a similar post over at ActiveRain, a real estate network populated primarily by Realtors. A fairly interesting dialogue ensued, but overall I felt about as welcome as Don Imus at a rap concert.

But no surprise there; ours isn’t an industry that embraces change. But some of the comments did illustrate the fact that working with Realtors is an important topic for real estate investors, and it’s one that’s worth spending a few minutes considering.

Just to set the record straight: I’m a fan of Realtors. The good ones are part financial analyst, part industry specialist, with a healthy dollop of psychologist in the mix. There are a couple of Realtors out there in blogland who write particularly good copy for real estate investors – particularly Jeff Brown and Chris Lengquist (Jeff might be a little in-your-face for sensitive readers; make sure you bring your sense of humor).

But, ironically, having these guys around can be a little dangerous – especially for new investors. Is it because they give bad advice. No – they give great advice – and that’s just the point. It’s a fair bet that the Realtor that gave you that magnet advertisement that’s stuck to your refrigerator right now is billing himself as an investment specialist too; but the chances are slim to none that he has the experience or background that Jeff and Chris have. Don’t be fooled; your chances of finding a Jeff or a Chris in the real world: slim to none.

So: what’s an investor to do? Well you gotta know what to expect, so here’s four things that I think you should keep in mind…

• Realtors help you get deals done. The vast majority of investors – yours truly included – are part time investors. You invest in real estate to diversify your investments, earn a superior rate of return, and secure your future – but you have a day job too. There will be times that if you try to do everything yourself you either won’t get the deal done, or you won’t run all of the traps and end up making a mistake. Here’s my analogy: I can put a tile floor in myself – but this is work that I tend to outsource. Getting help will assist you in making things happen. Hire one when you need to.
• Realtors won’t bring you deals. In my experience you’ll never get a Realtor to bring you a good deal. That’s just not the way it works. A Realtor with the ability to spot a good deal will take it for herself when one comes along. So by definition if a Realtor hands you an opportunity it means either a) she doesn’t know a good deal when she sees one or b) she does know a good deal when she sees one and this one ain’t. But hey, in her view a commission is a commission. Word to the wise: expect to find your own deals.
• A Realtor is unlikely to be able to give you good investing advice. But you should expect him to give you competent advice on buying and selling a house. I use a Realtor at times, and she doesn’t really know much about investing. And that’s ok with me; I’m not paying her to give me investing advice. I read some writers insist that investors should only work with Realtors who own real estate investments themselves, but that advice strikes me as a bit wrongheaded; you shouldn’t be depending on the person who’s going to bag a commission from your purchase/sale to give you advice on whether or not said purchase/sale is a good investment.
• Loyalty, loyalty, loyalty. Ours is a business of relationships, and creating a symbiotic, mutually beneficial relationship is one of the best investments that you can make. Your average homebuyer buys a home and sticks around a while. Your average investor buys a home, then buys another one, then buys another one. Create a relationship with your Realtor and show him that you value his services and it won’t take him long to figure out that you’ll be coming back – and there’s no way to get a service provider’s undivided attention than being a repeat customer.

The four points above apply to everyone. Here’s another couple for those of you with a few deals under your belt.

• Take charge of the negotiation. You should be in the driver’s seat, not your Realtor. Call your own shots, drive the negotiation tactics, set your own pricing strategy. Your Realtor should be there to advise and execute, not to decide.
• Cut costs when you sell. That means FSBO, flat fee, or deep discount. In the past I’ve argued that the buyer bears part of the sales commission via an increased sales price, but when you’re the seller there’s no doubt that this hits you in the pocketbook. Once you’re confident about handling the deal yourself an extra 6% in your pocket at closing is no small deal.

There’s no getting around it: there’s simply too many real estate agents out there.

I wrote in a recent post that real estate investors who work with a Realtor will generally end up overpaying for their services; if you pay a $12,000 commission check it’s highly unlikely that you’ve actually gotten $12,000 worth of time or effort out of the Realtor that supported you. And note that a healthy portion of that fee will be passed directly to the buyer – the idea that “the buyer doesn’t pay a commission” is a myth.

This isn’t to suggest, however, that agents are greedy or that they’re raking in the big bucks. Average Realtor income, according to the National Association of Realtors, is under $50,000. This is more than the average elementary school teacher but less than a financial service representative or an engineer.

Buyers and sellers pay too much in commission but many agents still struggle. What gives? The answer is simple too many real estate agents.  

But there is an odd phenomenon at work here. Usually when there is a glut of supply for services the price for those services drops accordingly. Supply and demand reset that price accordingly, delivering better value for the consumer at the new equilibrium point. However, in this case the National Association of Realtors has done everything in its power to resist the market’s natural ability to find equilibrium: everything from attempting to monopolize MLS data to doggedly defending the current commission structure to fighting to keep the banks out of the game.

I lived in Bogotá Colombia for three years. Bogotá is a beautiful city with great people and I enjoyed my time there. But the traffic is awful – mainly because there are too many taxi cabs on the roads. And the taxi drivers have to work morning, noon and night just to scrape by because there is so much competition – and that just keeps everyone on the road more hours (using more gasoline) which in turn creates more completion...and so on and so on.

The same thing is happening here in our real estate industry. As the market booms more and more agents are pulled into the industry chasing the same number of 6% commissions. And the industry’s leadership clings to the status quo instead of encouraging new business models that will evolve with the consumer’s needs.

:: So what does this mean for investors?

First of all a new business model is coming. Will it be Redfin? This question makes me think of a now forgotten company who’s stock I bought back during the dot com boom. This particular company was working on a groundbreaking new music format called MP3. I saw that this technology was going to be big, but unfortunately I bet on the wrong horse. Apple won and the stock I bought tanked.

So...has Redfin picked the right model? I think so. But will they win the race? Who knows – but the odds are against them. If I were a betting man I’d put my money on someone coming out of left field. Citibank? Google?

But for now: no investor should be paying 6% to sell a house. New options are already popping up – I'll talk about this in a future post.

Update - 11 July:  I posted this topic over on Active Rain, a blogging network populated primarily by Realtors.  I got a pretty lively reaction...

There’s no getting around it; investing in real estate means dealing with people. Building skills as a negotiator is the most important part of being successful as an investor.

Philosophers from Machiavelli to Rousseau have debated human nature, and although I’ve run across more than my fair share of jerks in my time I nonetheless reject the Machiavellian view of human nature as fundamentally dishonest and mean spirited. The guy you’re negotiating a sale with isn’t out to get you. That contractor you’re haggling with isn’t stupid or evil. People might act in ways that are fearful or greedy, but in my view most people aren't bad.  So I see it, a critical key to being a successful negotiator is initiative, backed by fearless, transparent honesty. But it this only works if you have a plan...

Not too long ago I was involved in a major corporate merger and had an interaction with a senior executive who was a direct party to the negotiations. He declared “well we all agree on everything…except for the price.” There’s a lot to that simple statement – that bottom line dollar figure can make people act in strange ways. A dollar figure is hard and concrete – you can get your head around it. But often the price is just the catalyst for conflict and the real concerns lie beneath.

In my experience, the biggest concern that the person on the other side of the table has is that she'll be taken advantage of. She can probably live with a 10% increase or decrease in the price...but she can’t live with looking foolish. Therein lies your challenge.

:: Example

I recently purchased a multi-family property. I made an offer and contentious back-and-forth ensued .  Finally we had an agreement, pending inspections. This was a tough process and it took a lot of work to get to a price that worked for me and which the sellers could accept.

Then: the inspection. I use a guy named Robert Goodspeed . He’s ruthless but fair. Meticulously thorough. If there is a nail out of place he’ll note it. I love working with Robert – if there’s something wrong he’ll find it.  I can negotiate with confidence when I have a Goodspeed inspection report in my hand, and that makes me a repeat customer. 

Now aside from a long laundry list of minor items this particular building was in solid shape. But there were three items of concern that Robert noted:

• Pier and beam foundation had recently been repaired. There wasn’t necessarily an immediate problem, but we needed to ensure that the work had been done correctly.
• There were some electrical problems in one of the units, the breaker tripped while we were inspecting
• The elevated back deck (over the carport) was not up to code with regards to the railing.

I sent the Goodspeed report and the list of three items that I needed to have repaired.  Predictably, the sellers freaked.

:: Getting into the sellers’ heads

At this point it would have been easy enough for the various personalities to take over the negotiation; for us both to cross our arms and let the deal die. What I try to do in these situations is try to put myself in the other guy’s shoes.

Time to take the initiative and take control of the discussion.  The key, in this case, was to give the seller a way to save face and keep the deal moving forward. To do this I emphasized not our respective positions (“fix it!” “no, I won’t fix it!”) but the principle at stake: in this case the purpose and intent of the option period.

I didn’t want money – I wanted assurances that everything was as they had represented it when they offered the property. The sellers cooled down. They brought out some certified, licensed inspectors: a structural engineer and an electrician.

The foundation, as it turns out, was rock solid. The electrician found a couple of problems – nothing major. And since the seller uncovered these problems with their contractor (who I approved) it was not contentious to get them to pay for the repairs. The railing on the back deck I agreed to pay for – this was an item I could have identified by site via my pre-offer casual inspection, and it was only a $1,000 item.

The seller’s initial reaction and refusal to budge was a reaction based in fear. Fear of being treated unfairly. Fear of looking foolish. And that reaction could have easily triggered a fearful reaction in me: these guys are trying to hide something! They’re out to get me! Too risky...no deal!

But by putting myself in the other guy’s shoes I was able to efficiently get to a fair solution and acquire a great property.

I usually steer away from books and websites with the word “millionaire” in the title. In my opinion readers benefit from sources that teach them how to do something well, not from advice on getting rich.

There are exceptions, however, and a notable one is Stanley and Danko’s The Millionaire Next Door, an enlightening study on how most wealthy Americans earned (and keep) their net worth. They theorize, in a nutshell, that most wealthy Americans got that way though a combination of shrewd business sense and frugal living.

My two cents is that Stanley and Danko could stand to lighten up a little; if at some point along the road I decide to trade in my ’85 escort and splash out on a new sports car then it’s not going to be the end of the world. But generally speaking their message is excellent. Americans are great at consuming and terrible about saving – this is a message the people need to hear.

Pat Kitano over at Transparent Real Estate uses a format that I like when he compares two different ideas, services, or trends. Imitation is the sincerest form of flattery, so with apologies to Pat here’s how I compare Kiyosaki’s Rich Dad series with The Millionaire Next Door by Stanley and Danko.

Note:  those of you who read my recent post on Rich Dad Poor Dad already know I'm not a fan of Kiyosaki's philosophy.  But hey, this is a blog - I don't have to be objective.  You want Fair and Balanced then go to Fox News.