Ethics in investing is a topic that I’m interested in. This is one that I’ve written about before, both in the press and here in this blog . It’s one that I don’t think gets enough airplay – but the lessons of ethics and investing are the subplot to many of the other ideas and strategies that I write about on this blog.

Here are five discrete thoughts that have emerged from experiences that I’ve written about recently.

• Honest investors are fearless investors: I have a lot of philosophical reasons for being honest, but I also have a practical one: I’m not clever enough to keep a web of deceptions straight in my head. That’s too much work. And as I tried to show in yesterday’s post, a deception which one commits doesn’t disappear. Ever. It sticks around; you can’t un-ring a bell. But honest men have no fear of such things.
• Ethics is good business: Honesty, truly, is its own reward. Honesty is the foundation of relationships, and relationships are the foundation of business. Honest business people can at times feel that they’re at a disadvantage (how can you break even if you never screw anyone but others screw?) but it’s my observation that the world doesn’t work like this. The short term gain that one may achieve through some slimy deception or half truth rarely translates into a long term gain.
• It’s ok to evangelize ethical behavior: And that means pointing out unethical businesses. When I run into a dishonest player I tell the world about it. I try to use the same respectful, measured terms that I use when I write – but I don’t pull punches when laying out the facts. Side note: a great key to persuasive communication is to lay off the adjectives. Write a review on Angie’s list. Send a letter to your local Better Business Bureau.
• Ethical investors avoid bad deals: A while ago I wrote about a fraud scam whereby investors were sucked into overpaying for rental properties. The consultant convinced them that tenants were lined up and ready to go, and all they had to do is sign on the dotted line for their zero down loans. Of course they got tricked – and most of them ended up being foreclosed. But the full story shows that the papers which these investors signed were full of fabrications and exaggerations regarding the investors’ financial situation. While it’s true that the consultant was the one who concocted the whole confusing scheme, the investors themselves surely knew that something fishy was going on. But the investors convinced themselves that it was the consultant’s dishonesty on those forms, not theirs, and they turned a blind eye. And it was the investors, in the end, that ended up getting hammered. Bottom line: if you smell something fishy then it’s probable that the entire deal stinks.  My grandmother used to say "if they'll crook with you then they'll crook on you."  Smart woman. 
• The benefits of unethical behavior are outweighed by the risks: We read a lot about lawsuits and malpractice costs running rampant in the healthcare field, but there’s a subtext that a lot of people aren’t aware of. Bad doctors aren’t the ones who get sued. Doctors who get sued are the ones who are rude, arrogant, and dishonest. Even with matters pertaining with one’s health most Americans understand that honest mistakes happen, which means that most patients aren’t on the hotline to the nearest ambulance chaser when something bad happens. But...if the doctor was a jerk...they’ll pick up that phone in a flash. There’s no reason to assume that real estate is any different. The goodwill that you generate by treating people in a transparent, respectful manner is good insurance against getting dragged into court if something goes wrong in the future.

Back in 2006 I hired someone to perform some professional services. He was small businessman running a limited liability company, came with good references and was recommended by some people that I trusted.

We agreed on a $2,000 month-to-month retainer to do some marketing work. I paid him the first month’s two grand, he cashed my check and then disappeared. Vanished.

So here are some things I learned from this experience.

• Trust is crucial. I do business based on looking someone in the eye and shaking their hand. You can’t do business without taking risks. Trust is a big factor in my decision making process, and this experience won't change that fact.  But it does emphasize the importance of having a rock solid contract, and an organized file of every check that you’ve paid for services. A great convenience of today’s internet banking world is the fact that you can easily log on, click on a payment, and print out a front-and-back copy of the endorsed check. This guy took me for a ride, but I archived the paper trail and stayed prepared for round two.  This ain't over.   
• You can’t sue someone you can’t find. That was the big hangup in this case. I got all the prep work done to take my flaky business partner to court, but have never been able to serve him with papers.
• Don’t give up. The statute of limitations in Texas for civil cases is a leisurely four years. That’s an eternity. Take your paperwork and seal it in a file for safe keeping. And periodically take a look around – the creep might show up.  Even though you've written off the loss it doesn't cost you anything to stay on the trail. 
• Assume you’re going to court, prepare accordingly, and be ready to win. Once you track the guy down, hit him with a cool, well organized declaration explaining how you’re about to sue him back to the stone age. The other guy may be lazy and dishonest (which is why he stole from you in the first place) but chances are that he’s neither stupid nor insane. If you have your ducks in a row then nine times out of ten the guy will see the light and pay up before he suffers the indignity of being dragged into court.  The small claims court process isn’t difficult. If you’re savvy enough to buy and sell houses then you’re savvy enough to manage a small claims court case (up to $10,000 in Texas). Go get a brochure from your courthouse and follow the instructions.

Happy Ending

So here’s what happened in my case:  Every six months or so I’d take a look around for this guy online to see if he popped up somewhere. And last week – voila – there he was on www.linkedin.com, sort of a “facebook for professionals” (good website by the way, check it out.) No home address, of course, but he did list his current employer, and I was on the phone to his boss in a flash. Fear of professional embarrassment can work wonders, and now I have my two grand back – plus interest. Two years after the fact I closed the whole sorry mess in the course of a couple of days. It was like finding two thousand bucks in the back of my sock drawer.

Related Posts:

• How can contracts help me to build solid relationships?
• Real Estate Investing and the Psychology of Relationships
• You want to be a hippo, not a whale shark. 

Regardless of who you support in this election - Senator Clinton, Senator McCain or Senator Obama - this is a speech that you should watch in its entirety.  I have never before heard a politician speak this directly, or with such subtlety and complexity, about this important issue facing our nation. 

The problem with the speech is that it will be blasted into a dozen Fox-news sized ten second snippets, and a truly honest discourse on race in America is not a topic that can be reduced into sound-bites. 

If you're a supporter of Senator Obama's then listen critically.  If you're not then listen with an open mind.  Either way - listen. 

Real estate investing is a long term play, and a few days ago I introduced five ideas that I feel are key to being successful as a buy-and-hold landlord.  I've already discussed the first two - here, as promised, are the final three...

Principle 3: Take care of your tenants

Nothing beats an investment that pays you every month – that’s why a prudently leveraged real estate portfolio beats the pants off the stock market in long term returns. But that rental property will only generate revenue if there is someone living in it. Vacancies are one of the greatest threats to achieving the financial performance that you expect out of your property, so once you’ve found the right tenant you’ll want them to stick around.

That means taking care of your tenants. But more importantly, perhaps, being responsive and respectful to your tenants will also increase the likelihood that they take care of your property. This will protect the unit’s value, and the end result is that happy tenants are likely to bother you less often.

This is what you want. Answer voicemails promptly and address needed repairs quickly – this is an investment that pays off. I recently had a tenant that would talk my ear off every time I came around. He was the first tenant to move into the property after I purchased it and made some upgrades, so I had to visit a few times after he moved it to get some problems ironed out. But building that goodwill paid dividends; they took great care of the house and I hardly ever got a call.

Principle 4: Don’t take shortcuts with repairs

Trying to save a few dollars on every repair is a short-sighted strategy. Your tenants will take note of how you treat the property and they’ll act accordingly; why should they respect your house when you don’t? A well cared for property is more likely to appreciate and in the end will cost you less to maintain and cause less trouble.

There’s no economic value in delaying a repair – you’re going to have to do it eventually, and if you wait not only will the problem have gotten worse (and, possibly, more expensive) but you will also have alienated your client: the tenant.

Principle 5: Know when to say “when”

The Peter Principle tells us that an individual tends to get promoted to his level of incompetence – essentially accumulating responsibility till he gets to the point where he can’t handle it, and that’s where he stays. Think Elliot Spitzer: great prosecutor, not such a great governor. So yeah, you’re trying to build your empire, but don’t overextend yourself with too many properties or projects. Most real estate investors have jobs to support their day-to-day lifestyle and invest in real-estate on the side as a long-term wealth building strategy. Assuming that you fit into this category (that you’re not a full time investor) it’s wise to make a deliberate decision as to how much you can take on in terms of workload and financial risk. Don’t cross that line.

You can do it

A well maintained property w/ a good tenant should not be a burden on your life. On an average month the only effort that is required of me is to take the rental checks out of my mailbox and deposit them into my bank account. But the key to maintaining this balance is being diligent in all of the steps along the way.

I’ve written that I’m not a big fan of the legislation currently making its way through congress that would require lenders to cut homeowners a break as they look into the chasm of foreclosure. While I’m not against the idea of giving consumers a helping hand – particularly when doing so shores up the economy – I am against the idea of trying to characterize such moves as free, tax-neutral bailouts funded which the banks will fund. These costs are always passed on to the consumer.

But the financial world is hearing the saber rattling of the politicians (broadcast through a megaphone as we plow though this politically charged season) and this is having a fortuitous side effect: the banks are preemptively starting to get their own houses in order. Note this week’s announcement by Freddie Mac and Fannie Mae mandating stricter standards for independent appraisals – a move which is likely to trickle through to other lenders.  Loose appraisal standards have been a major contributor to real estate fraud, so this is a step in the right direction.

The industry is out to save its skin – not only to slow the bleeding which was caused by their reckless practices, but also to put a positive public spin on their progress. To this end Hope Now, President Bush’s government-led alliance of lenders is now claiming to have helped 1 million home owners fend off foreclosure.  But don’t expect this to significantly alter the tone of the various presidential candidates for whom foreclosure is a big election issue.

Move over big oil – there’s a new bad guy in town, and it may be too little to late for the lenders.

Successful real estate investing is a long term game. Following the right strategy with discipline and perseverance will allow smart investors to weather the market’s cycles and build equity. Time and leverage are your friends.

But don’t underestimate the importance of the time part of the equation. In the past I’ve compared the performance of the real estate market with the stock market. For the disciplined investor, real estate performs favorably to the stock market over any reasonable period of time, but you’ll need a few years for the strategy to be effective. If you’re only going to stay in the game a year or two you might as well buy a mutual fund and call it a day. But investors with perseverance will see their wealth grow much faster by pursuing a prudent real estate strategy than they will betting on the stock market.  So to take advantage of time you’ll need a little endurance. Sticking with your real estate investing plan is a lot easier if you’re prudent about your decisions and keep your eye on some fundamental points.

Landlording and long-term investing go hand-in hand. Being a landlord isn’t for everyone, but if you have the right personality and decision making skills then it’s a snap.

Here are five tenants tenets that I’ve determined to be the most important. Ignore these at your peril…^*

• Principle #1: Look before you leap
• Principle 2: Select the right tenant
• Principle 3: Take care of your tenants
• Principle 4: Don’t take shortcuts with repairs
• Principle 5: Know when to say “when”

I'll talk about the first two in today's post:

Principle #1: Look before you leap

Many real estate investing courses are just personal motivation seminars with a thin veneer of real estate education . These courses may serve some use if they cause you to take charge of your financial future, but you don’t want to go charging into battle without the right tools.

A great source of real estate bargains is burned out investors who’ve jumped into a project without a realistic idea of what it would take to get it done. It’s easy to underestimate rehab costs when you’re bidding on a property. Don’t let your optimism lead you down the wrong path.

When a good deal pops up you’ll often have to act quickly, but even when under a deadline there is still time to conduct a basic economic evaluation. Compare the cash outflow (mortgage plus taxes and expenses) to the cash inflow (rental income) to get an idea whether or not you should expect the property to break even on a month-to-month basis. And things break, so don’t forget to include a reserve fund that should be around 1.5% of the property value per year. The best way to maintain your peace of mind is to invest in properties that offer an adequate return, and this will require you to do your homework.

Principle 2: Select the right tenant

Before I bought my first investment property my wife ran out and rented Pacific Heights on video and forced me to watch it. Perhaps you remember this movie: Michael Keaton plays a evil con-man who rents half of a San Francisco duplex from a naïve yuppie couple then turns their lives into a living hell. Bloodshed and drama ensue.

Well it’s not a great movie so I won’t recommend that you sit through it, but I will share with you the film’s primary insight: if you’re renting a high-end property do a credit check the applicant before signing the lease. Housing laws vary from state to state, but one trait that they have in common is that they’re designed to protect the tenant, not the landlord. If you end up renting to a family who destroys your house or refuses to pay the rent then you’ll surely spend a fortune and a lot of time and effort getting them out.

If you’re renting a lower-end property then doing a credit check on the applicant is less likely to yield any useful insights since applicants for inexpensive properties may not have established credit histories. You’ll have to rely on other methods of evaluating applicants, such as references from previous landlords and from employers. Call the references. Follow up.

And lastly, learn something about the applicants when you meet them (and yes, you should meet them – don’t leave this to your realtor). Do they arrive on time? Do they strike you as someone who will treat your property respectfully?

In the end you’ll have to trust your instincts. Having a vacancy is stressful, but it’s not nearly as stressful as having a unit occupied by a tenant who makes your life difficult. It’s not a good idea to indiscriminately accept the first applicant who waves some cash in your face, tempting though it may be. Remember – housing laws are first and foremost designed to protect the tenant; they’re not designed to protect your rights as a landlord. Renting your property to the wrong person is an expensive mistake.

I'll write about the other principles soon....stay tuned. 

* once you start writing tenets about tenants you're setting yourself up for this kind of typo.