S.E.C. Real Estate Observer

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Once upon a time, a very successful developer hired me to assist marketing his one unsuccessful project. Handsomely designed, located on a prime site in one of the world’s most beautiful locations, built and furnished by skilled craftsmen using the finest materials, the project hadn’t sold and it was presently costing the developer in excess of $3,000,000 annually.

I, too, had been a principal in a very unsuccessful development project that had created a severe “net-worth-ectomy.” A lodge in the Rocky Mountains had cost me most of my cash, two years of productivity and a very valuable parcel of California land that I had pledged.

One day, while having lunch with my developer client and his wife, I was asked, “As smart as you are, Chet, how did you possibly invest in that lodge project?” My reply was “I got so caught up in the creativity of making the transaction that I forgot about the economics.” Whereupon, the wife turned to her husband and with a rueful smile, she said, “It sounds like somebody else I know.”

If we are to amass and retain wealth through real estate investing, we must understand real estate investment fundamentals, and then discipline ourselves to insure that all of the properties and projects we seriously consider are sound economically. Players in the real estate game are exposed to hundreds of properties, many of which are pretty, some in superb locations, and most of which make no financial sense. To be successful we must look beyond physical appearances and refrain from emotional decisions.

Overview

The real estate game, properly played, can be the most fun and profitable game in town. There are more moves than in chess, more unknowns than in poker, with the odds weighing heavily on the side of the intelligent player. And, unlike most money games, the real estate investor has a great deal of control over his or her investment. Players in the stock and bond markets are dependent on the management skills of unknown third parties whose motives and loyalties are often suspect. The real estate investor can choose when and where to acquire, when and if to upgrade, when and if to raise rents or subdivide or complete a condominium conversion. He can change management. But, most importantly, the real estate investor has only his own best interests at heart.

Historically, real estate has been the most profitable of investments. The reasons are simple. There is a limited supply and ever increasing demand. Inflation drives up the costs of new construction and replacement of existing structures. And, finally, the attitude of real estate owners is one of positive expectancy.

Except during brief periods of severe recession, few, who own real estate, expect to sell for less than the purchase price. We all expect to make a profit. Therefore, most of us won’t sell at a loss. If the market gets soft, the majority of real estate owners wait until it firms up. After all, historically it has always firmed up. We know we live in a cyclical economic world. Yes, real estate prices do go down temporarily. This occurs when a critical number of property owners lose confidence or must sell at the same time. This will happen if and when there is extensive overbuilding with resultant vacancies, and in times of economic downturns.

This is not to say that real estate investments don’t have shortcomings, they do. The two most glaring shortcomings are the lack of instant liquidity and required level of management. But, even these can be mitigated or in some cases eliminated by choosing certain types of investments.

Real estate ownership advantages far outweigh its disadvantages. Besides the appreciation that most long-time investors have come to expect, many real estate investments offer outstanding yields and others offer tax sheltered income. Equally important, real estate offers a unique vehicle for building and preserving one’s estate-the tax deferred exchange.

Risk vs. Return

Good financial planning requires goal setting. While creating goals, the real estate investor selects a financial target and a timetable. Aggressive goals and short timetables dictate the need for high annual returns. It is an axiom (or should be) of all investments, “the higher the return, the higher the risk.” It is not realistic to expect a very secure investment, such as a leased telephone building; to offer the same high yield as an over-financed locally owned fast food franchise. Post offices may not pencil out as potentially profitable as hillside condominium developments, but they are a whole lot safer!