Well I haven’t been a very diligent blogger as of late, but my excuse is that I’m now working full time for one of our presidential candidates. I’m told that mixing business and politics is unwise so I won’t specify which candidate - because If I did I would alienate 100% of my Republican readers and almost (but not quite) half of my Democrat readers. So – I won’t say who I’m working for.

But I will say that being on the road non-stop (I’m writing this dispatch on a plane from North Carolina to Puerto Rico) has acquainted me with some of the finer points of being a long distance landlord – a good reminder of why I prefer to invest close to home where I can keep an eye on things. What’s saved me is the fact that I have developed a bullet-proof relationship with an excellent realtor that I trust and with a handyman/contractor that values me as a repeat customer and not an easy mark. So although I like to keep an eye on things I realize that the world isn’t going to come unglued while the cat’s away.Good investors who have developed reliable relationships realize that they’re not indispensable - their businesses continue to run in their absence.

I right now am looking at an article in the Economist that is reviewing the current foreclosure/subprime mess that we’re in. The article considers, among other things, the ratio of rents to property values as an indicator that many regions of the country have farther to fall. This is a metric that I’ve written about before, and one that, in my opinion, is not written about enough in real estate circles. Consider it a P/E ratio for real estate which assumes that the price of a property “reflects the discounted value of future ownership, ether as rental income or as rent saved by an owner who lives in the house.” According to the popular Case-Shiller index property values would have to fall an additional 10-15% over the next year and a half for the ratio to return to the historical average of between 5% and 5.5% (it reached 3.5% at the height of the boom.)

And yes – I do understand that all real estate is local. But this stuff is important – the credit market is a tide that lifts and lowers all boats, so I for one am keeping an eye on the broader market as I think about my next entry point.

Most of you financially savvy folks out there learned early on that homeownership is an important step in achieving long-term financial security. This, generally speaking, is a truism that is pretty accurate. In the process of keeping a roof over our heads, homeowners, with each mortgage payment, are investing in our financial future. Fiscal discipline is a virtue that is often lacking in our society (just look at how our federal government has behaved for the past eight years) so this kind of automatic equity-building is a good thing.

But before you build that McMansion consider this: like aspirin and fine wine, more of a good thing will not necessarily lead to a superior outcome. Yes you should own your own home, but if you supersize it then you’ll be paying a cost.

Consider a buyer trying to decide between buying a $600k house and a $300k house (you can either double or halve these numbers depending on property values in your neighborhood). There are some that will argue that by splashing out on fancier digs that they’re investing in their future. But not so fast…buying an $600k pad is certainly better than renting a $600k pad (under most market conditions) but it doesn’t beat buying a $300k pad. Follow the numbers…

Assumptions:

• 6.5% fixed rate mortgage
• 0.75% property tax
• 4.5% property appreciation rate
• 9% stock market return. All excess cash (from tax deductions and lower mortgage payments) are reinvested at this rate.

The more expensive house generates a big gain through property appreciation – over $330k in ten years - assuming the market behaves roughly in line with the long term historical average of 4.5% per annum gains. Adding the pay-down of the loan balance and income tax deductions from interest and property taxes (which are continuously invested in the stock market), the $600k house creates around $500k in wealth over ten years.  Not too shabby.

Compare this to the option of buying the cheaper house.

The $300k house generates considerably less in terms of property appreciation over ten years vs. the more expensive home. But compare the two mortgage payments: around $46k per year for the larger house vs. $23k for the smaller one. This is an extra $23k that can be invested in other vehicles, plus savings in property taxes. When these funds are reinvested on a yearly basis then they can generate dramatic returns.

Result:

• $300k House: $506k of value created in ten years
• $600k House: $590k of value created in ten years

Extend the anaylsis out to fifteen years then the results are even wider.  And if you take that extra cash and put in into income generating real estate instead of the stock market - now you're really cookin' with gas.   

Is this an argument against the flahsier house? Well…maybe so, but maybe not. Perhaps ten years spent living in the nicer home is worth that $84k in foregone wealth. Fair enough.  Just don’t convince yourself that you’re making a strategic investment by going big. The house you’re living in doesn’t generate income – it only generates expenses. Living large is nice, but there’s a cost.

Back in December I wrote a post on the impact that immigration reform would have on real estate investors. In that article I mentioned a nasty negative local campaign for State Representative that was being waged between Talmadge Heflin(R) and Hubert Vo (D). At the time I skewered Hefflin, the Republican, for a spamming our neighborhood with a particularly stupid mailing in which he implicitly accused Vo of issuing a Texas driver’s license to Osama Bin Ladin.

Vo won the election. But now it’s Vo who finds himself in the news. And this falls squarely into the “what was he thinking?” category. Vo, as it turns out, is a genuine card carrying slumlord.

Vo is a wealthy public figure. The four apartment complexes that he owns are public places. His ownership is a matter of public record. Real, live people live there; they raise families and hold jobs. But they’re living with broken and boarded-up windows, an algae-filled swimming pool, overflowing dumpsters, and other hazards – all documented in a recent article in the Houston Chronicle.

Remember, as landlords, we’re just behind oil company executives and sub-prime lenders as people that the media loves to hate. That’s too bad, because the vast majority of us are committed to providing safe, affordable housing to the public. That’s not because we’re altruists – it’s because providing safe, affordable housing is good business. And as State Representative Vo is now finding out, running an ugly, dangerous, violation-filled property is not a good way to make a profit.

We’ve been reading about how farmers and scientists are worried about our country’s vanishing supply of honey bees. Well I don’t know about you, but here in Houston those honey bees are finding my properties just fine.

For the third time in as many years I’m having to hire a guy in a bee suit to pull a hive out of an investment property. This is a pain. Bees aren’t like other garden variety insects. You can’t just throw some spray around and call it a day. You have to find the hive, get rid of the queen, and caulk the living daylights out of the opening so the next wandering swarm doesn’t take up residence a week later.

And as an added bonus: honey bees will freak out your tenants.

So when you get a call about bees, just accept the fact that you’ve drawn the short straw. You’ll save yourself some grief by being doing it right. Meaning:

• Call a professional. Don’t try to get rid of the colony yourself. DIY will NOT save you any money.  Suck it up and pull out your checkbook.  You've budgeted for this sort of thing, right?
• Bees can be ornery. If your tenant gets attacked by a swarm of bees that you’ve neglected then you’re gonna end up in court. Even if you show up wearing your sunday best suit you're still not going to cut a sympathetic figure.
• Make sure you get rid of the honeycomb itself, not just the bees. This is for three reasons. First: a rotting hive will attract the next swarm of bees. Second: a rotting hive stinks. Third: a rotting hive will attract other critters.
• Caulk up the scene of the crime. Bees have some sort of chemical, collective memory thing going. They’ll be back, so don’t make it easy for ‘em.

It’s no surprise that the current real estate crunch is hitting some markets harder than others. Wobbling prices and sales volumes have sent a lagging shock to the rental markets, but it has been interesting to note that supply and demand have pushed different markets in different directions.

The conventional wisdom has it that foreclosed owners will be scurrying for somewhere to live, pushing up demand and, therefore, rental rates. In some areas this is exactly what has happened.  Landlords in these areas are sitting pretty.

In other areas, however, the situation is the reverse. Tightness in the financial markets has pushed many first-time buyers out of the market. Sellers, unable to find buyers, have converted low end houses into rental. Voila – supply goes up, and the glut of properties pushes rental rates down.

Some aggressive pricing and judicious screening will land a tenant for my vacancy. And as I get a good feel for where the rental market really is I’ll be looking for buying opportunities. Cycles, by definition, don’t last forever. Just when everyone is starting to feel squeezed is the time when you want to think about getting out your checkbook.

So how's the rental market in your region?

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.