A common staple of finance websites and literature is a comparison between different investing options. Stocks? Bonds? Real Estate? Where should you put your money?

The answer, of course, will depend on your resources, your risk appetite, and your goals. But for investors who still have a fair amount of runway ahead of them before they hit retirement, most comparisons fail to highlight the true benefits of investing in real estate. 

The bottom line:

Over the long run, the stock market has yielded great returns. From 1987 to the present the S&P 500 has appreciated at an average rate of almost 10% per annum, and the NASDAQ has averaged over 11%. Over the same period the average home price in America has increased at around 5.6 percent. 

This is the comparison upon which many analysts focus. One dollar invested in real estate in 1987 would be worth around $2.84 today. That same dollar would be worth $5.74 or $7.31 were it invested in the S&P 500 or the NASDAQ, respectively. But this is the whole picture

Volatility: Real Estate Bubbles vs. the Stock Market

We’ll get to leverage in a moment – that’s where these conversations inevitably lead. But the first thing to consider is volatility. 

Yeah - we know that stocks yielded an average of 10% to 11% over the past twenty years or so, but how did we get from point A to point B? Investors will remember the period from 1999 to 2002 which were rough years for the sock market. From its peak in August of 2000 to the bottom in September of 2002 the S&P 500 lost over 40 percent of its value. Over roughly the same period the NASDAQ declined by a whopping 75 percent. Eventually the market managed to shake off these doldrums, but this was a tough period for investors. 

Real estate has hit some hard road bumps too. It’s interesting to compare the severity of regional real estate downturns with the stock market collapses listed above. Global Insight periodically releases a study of market valuations in which they list, among other things, a summary of major past price corrections. The most severe being associated with the oil bust in the ’80s; fellow Texans will remember this period.

• Lafayette LA, declined by 35% over 15 quarters
• Odessa TX, declined by 28% over 18 quarters
• Abilene TX, declined by 28% over 11 quarters

All three of these markets were significantly overvalued before they fell. The lesson here being: what goes up must come down, and investors who live in regions characterized by overvalued markets have reason to be concerned. 

If you live in certain parts of Florida, California, and other overheated regions of the country, this means you.   But for the rest of you: note that the three historical cases above are the worst of the worst. There never in recent history has been a major national correction in real estate prices, and most regions have experienced continuous growth in property values for decades. Watch out for regional markets that have been spiked into a speculative frenzy - but overall, volatility in housing prices is low.

It doesn’t make sense to talk about leverage without first talking about volatility. You can use leverage to turbo-charge the returns on about any investment, but high volatility usually makes leverage prohibitively risky. 

Not so with real estate.

Aside from a handful of regional exceptions notwithstanding, real estate prices historically have marched steadily upwards at a steady 5.6 percent per annum. Factoring in leverage this return ratchets up to over 13% per annum; considerably better than stock market returns at lower volatility. 

What is leverage?

Simply put: a dollar invested in stocks buys you one dollar’s worth of stock. But that’s not the way we buy real estate. A typical investor might put $20,000 down to buy a $100,000 home. So instead of getting one dollar’s worth of house for your one dollar investment you’re getting control over five dollars worth of house. 

That’s 5:1 leverage. One buck from you, and four bucks from the bank. 

That $5 invested in the housing market in 1987 would be worth around $14.18 today. Assuming that you hadn’t paid down any of the mortgage your $1 investment would be worth $10.18. Compare that against the $5.74 that your S&P 500 investment would be worth or the $7.31 that your NASDAQ would have netted. 

The upside...

I’ve made some simplifications, but overall they’re conservative ones:

• Dividends and rental cashflow. I left ‘em both out of the analysis. But any property that you’ve had for twenty years will be raking it in cashflow-wise, whereas corporate dividends these days are pretty skinny. Advantage: Real Estate.
• Paying down the mortgage. Back in the late '80s interest rates were hovering around 10% (gasp!). At this rate a standard fixed 30 year mortgage would have paid off around 30% of its principal balance over twenty years. That’s another advantage that I haven’t included in the comparison. Advantage: Real Estate

Timing can be important and in some regions now isn't the best time to be jumping into the market, but over the long term it's hard to argue that real estate doesn't have a place in your portfolio. 

Houston has had a few recent back-to-back murder-suicide incidents in the immediate aftermath of the terrible events at Virginia Tech. 

You might have heard about the event at NASA which got some national coverage.  But unless you live in Houston it’s unlikely that you heard about a second killing, in which a tenant who was on the verge of eviction killed the property manager at the apartment where he lived.

The second event was the one that really got my attention.

Stop for a moment and think back on how you thought about landlords before you became one.  From the point of view of the tenant, you, as a landlord, are in a position of enormous power and authority.  It may not feel like it at times - especially as you’re wrestling with taxes, eying interest rates, and dealing with contractors – but you are in control from the vantage point of the families who live in your houses.  You own the walls that surround them, the roof over their heads, and provide the shelter that keeps them safe.   

You invest in real estate in order to secure your financial future.  And if you’re like me then you’re into real estate because you enjoy negotiating, you like crawling around under houses, and you’re into making deals.  But in your rush to build equity and wealth don’t forget about the lives that you touch every day – meaning: don’t be cavalier with the influence that you wield. 

This is a reminder that being consistent, clear and fair with your tenants is a key to building good relationships.  And building good relationships is an important key to being a profitable buy-and-hold investor. 

But sometimes that isn't enough.  The one thing that all of these instances have in common is that the perpetrators were mentally ill.  Dr. Peter Marzuk, associate professor of psychiatry at New York-Presbyterian/Weill Cornell points out some warning signs in a recent ABC news interview, including:

• Past history of violence
• Loneliness and social isolation
• Stalking and other antisocial or criminal behavior
• Paranoid behavior

Pre-screen your tenants well.   And even after you've done your due diligence trust your gut.  If you feel that you’re in danger then listen to your instincts.  As Malcolm Gladwell explains in his excellent book Blink, we sometimes know things even when we don’t know why we know them. 
 
Note:  The strange thing about this post is that I actually sat down with the intention of writing something funny to comply w/ Pat Kitano’s call for funny submissions for the upcoming Carnival of Real Estate.  But for some reason this is what came out.  Oh well; maybe I'll be able to write something funny tomorrow.  But to lighten it up a bit here’s a funny clip.  I’m told that I’ve been living under a rock and everyone in the universe has already seen this, but I just saw it yesterday and thought it was hilarious. 

You can take courses, attend seminars, and read till you're blue in the face - but there's nothing like learning by doing. 

Here are a few cool sites by real estate investors who are out there making it happen, and who are using blogs to chronicle their experiences. 

• Check out I bought a duplex.  A young woman late-20's talks about her adventure in landlording and real estate investing. 
• Follow a Texas investor's experience from December '04 to today at My Real Estate Investing Venture. 
• The Successful Landlord Blog follows the experiences of a landlord in Melbourne Beach, Florida. 
• And you can find everything from newbies to grizzled veterans at the Creative Real Estate Online Forum - a great place to hang around and get a new idea or two. 
• Tenants will do the craziest things, and they've seen it all over at Tenant Tales.  Entertaining reading. 
• I like Shaun from Arizona's description of his site as meant for people who want to get into this investment area but need some encouragement, help, or just a general push in the right direction.... you'll see it's really not that difficult or scary.

I have a lot of respect for investors who put their experiences, successes and and mistakes out there for others to learn from.  Visit their websites and see what you think 

 April 25th:  Omission - I forgot Fred de la Riva's excellent Working with Real Estate Investors.  A great resource, especially for real estate agents who want to specialize in investor clients. 

Last week I made a brief reference to a bad experience that I recently had with a Farmers Insurance agent.  Here's how the sordid little drama played out. ¹

 The characters

	the Investor is played by Christopher Smith
	the Lender is played by Wells Fargo
	the Insurer (aka, the Villain) is played by a Houston based Farmers Insurance Agent 2

The setting: 

The Investor makes a New Years Resolution to sell a high-end rental property and use a 1031 exchange to reinvest in a multi-family property.  He sells property the property to the current tenant and identifies a fourplex to buy, negotiates a deal, and heads to closing. 

Act I:  Week of closing

The Investor calls the Insurer for a quote.  The Insurer provides a written Farmers quote.  The Investor accepts the quote and asks the Insurer to proceed and provide coverage.  The Investor calls the Insurer several times to ensure everything is in place; the Insurer assures the Investor that everything is in order.  The Insurer says they're having some problems getting the printout, but not to worry. 

Act II:  The closing - Friday the 13th of April

At closing the Lender calls the title company to inquire about the insurance binder, which hasn't been received.  The title company calls the Insurer.  The Insurer gives verbal confirmation of coverage.  Based on verbal confirmation the Lender instructs the title company to proceed with the closing. 

But…drumroll…it turns out that the Insurer had quoted the Investor in error, but for some reason doesn't want to admit his mistake.  Farmers, as it turns out, is not writing coverage for multi-family properties in Houston. 

Instead of admitting his mistake, the Insurer scrambles around to find a quote from a third party carrier but doesn't tell the Investor; he just tries to slip a revised invoice to the title company after the closing - considerably more money for less coverage. 

However, the Insurer takes no steps to bind the policy.  None of the paperwork is in place.  Based on the Insurer's fraudulent statements the property closes with no insurance in place. 

The Investor now owns the property, but unbeknownst to him (and the Lender) there is no coverage. 

Act III: The cleanup

On Wednesday of the following week the Investor gets a call from the Lender.  "Hey man," the Lender states, "you need to call your insurance guys."  So the Investor calls the Insurer.

The Investor gets insurance with another carrier on the 18th of April, five days after closing.

 --------------------

The moral of the play: 

We like to assume that representatives of major companies will behave like responsible, ethical professionals, but sometimes this is not the case. In order to avoid revealing his mistake, the Farmers Insurance agent wove a web of lies over a five day period which resulted me assuming a huge risk. 

Had a fire occurred during the uninsured period I would have entered a hellish maze of he-said-she-said which would have made a bunch of lawyers a lot of money.  Something seemed fishy from the start; had I followed up more aggressively I would have uncovered one of the agent's lies at an earlier stage.

Footnote ¹:  This of course is a stylized account of the course of events, but my official complaints to Farmers Insurance and to the State Insurance Regulatory Agency will document the Agent's fraud in explicit, meticulous, gory detail, along with supporting witnesses. 

Footnote ²:  I debated long and hard about whether or not to reveal the name of the Farmers Agent on this blog.  In the end I decided not to.  If you're a Houston based investor and want to steer clear of this guy then send me a note via the contacts page. 

Footnote ³:  In the text above I didn't list all of the false statements that the agent made.  This is just a sample of one.  And no, the agent didn't send any forms to the title company. 

The baton passes to EquityScout.com for this week's Carnival of Real Estate Investing. 

The real estate investing muse must not have been in full swing this week and the carnival didn't get a lot of submissions.  We've been having some beautiful spring weather here in Houston, so if other areas are getting a taste of this as well then perhaps it's getting some bloggers away from the keyboard.  Not a bad thing, in my book. 

But what this edition lacks in quantity it makes up in quality:  Two Bloodhounders, an insurance warning, and a couple of tips for newbies. 

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That's it for this week.  Got a post you want to share?  Submit it to next week's carnival.   And you can check out past editions on the    blog carnival index page.

I write a blog and run this website, so it’s obvious that I’m a fan of technology.  But a part of me (a big part of me, actually) is still pretty conservative.  I think I was one of the last guys still carrying around leather a Filofax with all my handwritten notes and phone numbers – something that I’ve just recently given up.  

Set up a business checking account.  This is a step that the majority of readers will already have taken.  Sign up for online access.

Set up a second account earmarked especially for deposits, and link it to your first account.  Most major banks will allow you to do this; from personal experience I know you can do it with Citibank, Bank of America, and Washington Mutual.  

Print a book of deposit slips for each unit that you own.  Bank of America allows you to customize the slips, which lets you put the property address on each slip.  

When you sign a lease with your tenant give him or her an appropriate number of slips along with their copy of the lease (12 slips for a 1 year lease).  Instruct the tenant to deposit directly to the bank. This can be done either by going to the counter, going through the drive-through, or mailing to your branch attn: DEPOSIT.

On the first of the month go online and check your deposits.  As they arrive transfer them from your deposit account to your main account.  

• Safe. It all works because the tenant never has your primary bank account number.  The tenant only has the deposit account number, and you’ll keep this account at a zero balance by transferring the deposits to your primary account as they come in.  
• Easier recordkeeping. This method creates an effective electronic paper trail.  You can view/print/save the scanned pdf’s of the deposit tickets and checks online from the conveninece of your desk.
• Convenient for the tenant. Bank of America is big here in Houston w/ over 350 branches.  Choose a branch that gives your tenants lots of options.  Plus – they’ll walk away each time with a deposit confirmation, which gives a bit more peace of mind than dropping a stamped envelope in the mail.  

I got through my Friday the 13th closing with no problems, so I'm now the happy owner of a new four-unit property in the Montrose section of Houston. 

A last hitch was getting the place insured, and to my surprise I found a dearth of companies willing to quote me a rate.  Here in a nutshell are my experiences.  Note that insurer rules and policies vary from state to state, but here's what I ran into trying to get a policy for a fourplex in Houston:

	Nationwide:  was willing to make me a quote for a policy, but required me to switch the insurance policy for my primary residence to Nationwide as a prerequisite.  I'm happy with my current insurer (USAA) so this was a non-starter.  No quote.
	Allstate:  The "good hands" people.  Refused to insure any property with galvanized plumbing.  This property has been thoroughly rennovated, including much of the plumbing - but the building was built in the '30s, which essentially insures that there is still some of the stuff around.  No quote.
	State Farm:  Agent informed me that they consider a four-unit multi-family residence to be an apartment - meaning: commercial.  The agent referred me to a relative of his who got me a quote from a small carrier which was prohibatively expensive. .
	USAA:  I've used USAA before and have generally been hapy with them.  But unfortunately there is a limited number of non-owner occupied properties that they're willing to invest for any individual, and I'm already maxed out.  No quote.
	Farmers:  Gave me a fast on-the-spot quote over the phone at a good rate. ***see update, below

So the winner: Farmers. I'm a new customer.   ****  Update:  See below

Lesson:  I waited too late in the game to take care of this so I caused myself some unnecessary stress.  Do yourself a favor; start early and give yourself some slack time. 

**** April 18th Update - Farmers: run for your life.  I'm in the middle of a post-closing horror story that I'll write about soon (when I have time).  But consider this an official revocation of the blue ribbon that I'd awarded Farmers.  Stay tuned...

In recent posts I expressed frustration with USAA's mortgage service. First for a $50 fee per-property for pre-approval (I was negotiating on three properties, so the agent quoted me $150), then for their $350 fee to take an application and lock in a rate.

I don't believe in hogging the mic here at EquityScout, so it's only fair to give equal airtime to the response that I recently received from Chris Sandoval at USAA:

 Hello – this is Chris Sandoval with USAA. In addition to seeing your recent posts about USAA, we also received your letter detailing some pretty frustrating experiences you’ve had with USAA. I wanted to get in touch with you and your readers, and your blog seemed like the quickest way.

 

It looks like you have two main concerns stemming from your recent interaction with USAA:

 

 - A $50 fee to receive a mortgage pre-approval.

- A $350 application fee for a mortgage pricing quote.

 

 Regarding your first concern, we do collect a deposit to provide a true credit-approved pre-approval if you choose to do so over the phone – we do not collect this deposit when members seek a pre-approval on usaa.com (which most of our members choose to do). This deposit is applied toward a member’s cost when they close their loan with USAA.

 

 Regardless of whether or not you used our online pre-approval process, you would not incur a $150 charge for three pre-approvals. When we pre-approve a member, we approve the member’s credit in general. If I understand your situation correctly, you requested pre-approval for three properties by contacting us on the phone. This process should have incurred only one $50 deposit - again, the pre-approval process does not incur this deposit at usaa.com. I apologize if we did not accurately convey that to you at the time.

 

 In response to your second concern, members do not have to submit an application or a $350 fee simply to obtain a pricing quote. When members choose to apply for a mortgage with us (not when they ask for a quote), we do collect a $350 good faith deposit that is credited toward their costs at closing. This sort of deposit is common in the industry and is sometimes known as an appraisal fee or underwriting fee. Again, I apologize if we provided you with inaccurate information.

 

 I hope this information helps clarify some of the confusion caused by your latest correspondence with USAA. If you have any further questions, please don’t hesitate to contact me. Just log into usaa.com and use our secure message feature: click "Contact Us" and then click "Email Us." Start your message with "Attention Chris Sandoval, eCommerce" and paste in the URL of this blog post. I’m more than happy to help with any other questions you may have.

 

While we failed to win your recent mortgage, we value your business and the opportunity to serve all your financial needs.   ### end message

• No fee for online pre-approval; USAA only charges for pre-approvals given by phone. Fair enough, but the competition doesn't charge me to talk to them on the phone. This is an annoying policy and isn't investor-friendly.
• The $50 fee should have been a one-time charge instead of three seperate fees applied against three seperate properties. Again, not happy about paying a fee for a representative's phone time, but a one-time general fee is much more investor friendly than having to pony up for each property considered.
• No fee to "obtain a pricing quote." I'm going to interpret this to mean that USAA will be willing to give me a firm rate at no charge. Note that this isn't the story I got from the representative, who told me that she couldn't give me a firm rate unless I paid; that she could only give me a general idea.

I picked this up from the guys over at Selsius.  Tired of automated directory hell?  Don't care how to get instructions in Spanish, or that the menu has changed recently?  This service is a universal secret decoder ring for getting straight to a human being. 

• No comps: I’m buying an updated four-unit complex in the trendy Montrose section of Houston.  There basically are two types of properties that you find in the comps: teardowns and new construction.  The building that I’m buying was originally built in the ‘30s, but has been updated with new wood floors, central air conditioning, a raised outdoor deck, and a number of amenities that make it a rare building.  Which means: there’s nothing to compare it to. Which in turn means: you have to trust your numbers because there’s really not much of a “market”. 
• Time pressures: The sale side of the 1031 was triggered by my selling the property to the tenant who I was renting to.  This was fortuitous in that I avoided vacancy, sales commissions, and all of the other hassles and expenses that are associated w/ marketing a property, but it also happened a bit quicker than I had expected – which meant that  I needed to be expeditious in my search in order to identify a replacement property within the IRS mandated 45 day window. But nothing like a deadline to keep you from getting paralyzed by the analysis. 
• Challenging negotiation: The goal of a negotiation is to efficiently reach a wise agreement in an ethical way.  This is easies when there is some alignment of the goals of the two parties and they negotiate directly. Well in this case the “alignment” part was potentially there. But the other elements weren’t. First: both the sellers and I were using agents – that in itself injects two additional degrees of separation into the negotiation, which makes effective communication more difficult. Add to this the fact that the seller was not a single individual; the property was owned by a group of three physicians who had teamed up on the investment, and who, based on their disjointed and confusing responses, had conflicting agendas. Messy. Once I get this deal tied up I’ll write about how some of the Getting to Yes principles helped keep the deal from stalling. 

But...looks like we're close to the finish line on this deal.  And appropriately, the deal is set to close on Friday the 13^th.  Not that I'm superstitious or anything...

• What does this mean to me? Gibson was ham-fisted in his response to this crisis, but in the end he was negotiating from a position of power. If you put your foot in your mouth while you’re holding a good hand then it might pay to concentrate on landing your next success instead of dwelling on the mess you’re in. 

• What does this mean to me? I think I’m a smart enough guy, but when I can choose between relying on being smart and being prepared I’ll choose the latter any day of the week. Be ready to think on your feet if you need to, but in high stakes situations it pays to spend some time beforehand getting your strategy straight. In their negotiation masterwork Getting To Yes Fisher and Ury call this “generating creative options.” Think ‘em through beforehand and have them in your back pocket if you don’t want to look like Michael Richards stumbling through his ad-lib on Letterman. 

• What does this mean to me? Gibson followed up his disgraceful tirade with a box office smash and may be on his way to redemption. Richards, on the other hand, will probably never land another acting gig. Imus was smart enough to realize his situation was a bit closer to Richards than Gibson, and he acted accordingly – so this will likely be a temporary humiliation (a la Gibson) than a death sentence like Richards.  When you're in trouble, pretending like everything is ok doesn't work.  Act. 

------

Follow-up ::   Hmmm....well in hindsight it looks like I got that little detail about Imus being on the road to redemption kinda wrong.  Guess my crystal ball wasn't working too well.  But you can't get 'em all right...

• As to the Adjective: When in doubt, strike it out.  Pudd'nhead Wilson, 1894
• God only exhibits his thunder and lightning at intervals, and so they always command attention. These are God's adjectives. You thunder and lightning too much; the reader ceases to get under the bed, by and by.  Letter to Orion Clemens, 1878

• A critical skill overlooked by many Real Estate Investors

It seems a bit anticlimactic now, but New Century Mortgage Corporation have declared bankruptcy according to an announcement today on their website. 

As a sidenote: I always find it odd that companies don't clean up their website when they end up in this situation.  You can still find out about New Century's groundbreaking products and even apply for a job of you're so inclined.  Go figure. 

Negotiation is a subject that, in my opinion, does not get enough airtime on finance themed websites – particularly those dealing with real estate investing. 

Negotiating is a core skill which real estate investors must master in order to be successful. Negotiating a successful purchase or sale is only the start; other negotiations are just as critical, and many are significantly more complicated. Consider the following:

•  You need to increase the rent on one of your units but want to do so without damaging your long-term relationship with a reliable tenant.
• You need to get a lower rate from a trusted contractor on a rehab job in order to stay under budget.
• A loft that you own belongs to a homeowners association which wants to replace the roofs on all of the units in the complex, requiring all of the owners to pony up. Most of the other owners support the measure, but you've calculated that it's not in your financial best interest.
• Your tenant has just purchased a new home and wants to break his lease, which would create an unexpected vacancy for you.
• Your tenant is pressuring you to make some renovations to the unit that they’re renting, but you feel that it’s already fairly priced for the current condition. 

These aren’t hypothetical situations; they’re a sample of specific issues that I’ve had to deal with over the course of the past several months. 

When placed in these positions people tend to take one of two routes. The hard style: we’re playing hardball so it’s my way or the highway. The goal is to win. And the soft style: the goal is agreement, be flexible and compromise. Like Rodney King said – can’t we all get along?

Well both of these approaches are sub-optimal. The hard guy wins a few battles, but in the end he loses the war.  He grinds his relationships into powder, walks away from good deals, spends lots of time in court, stresses himself out and damages his business. The soft guy keeps his relationships intact, but often ends up getting taken to the cleaners.  

There’s a third way. In their seminal tome Getting To Yes Roger Fisher and William Ury outline an approach which they call principled negotiation - negotiating based on principles as opposed to staking out positions to be either defended or yielded. Getting To Yes is one of those books that I re-read every few years, and it’s guided me through all of the situations I mentioned above in addition to helping me in my day-to-day life. Everything we do, essentially, is a negotiation. Gonna ask your boss for a raise? Or perhaps your employees are going to ask you for a raise. How about setting your kid’s allowance, or deciding where to take the family vacation. In all these cases you want to efficiently get to a wise decision which concludes amicably. 

This is a book that I recommend to real estate investors. In future posts I’ll be referring to some of the principles in this book and how they apply to situations which investors face. 

• Getting to Yes by Fisher and Ury at Amazon.com