Real estate investing con artistry

[jfoxcpacfp]

Awhile back (maybe a year ago), I posted in a thread that investing in real estate, along with travel, is one of the two most common goals for physician clients (not including the obvious retirement goals). I am posting this article because clients have given me nice RE investing brochures to review for them in the past. I am always hesitant to make that recommendation. (Actually, I looked up the articly when flipping through a back issue of Financial Advisor magazine, one of only two financial mag's I make time to read, today and ran across the follow-up piece.)

In case you haven't heard of the author, Mitch Anthony is one of the giants in the financial life planning movement. He is a monthly columnist for Financial Advisor magazine. I have his books, I have based some of our processes and questionnaires on suggestions from him, and I have looked up to him for many years. He is a solid, reputable, and extremely knowledgeable financial planner. His trusted CPA introduced him to the developer named in this article. To think that this could have happened to him and, even worse, to his mother, is stunning to me and really opened my eyes to the inherent risk in these deals.

I am not suggesting that all real estate development projects are crooked. They aren't, far from it (I hope). I am suggesting that it is difficult to know what you are getting into and hard to discern if you are making a good investment or being lured by the promise of regular payouts at above-market rates (18% annually, for Mitch) received by friends and colleagues who have also invested.

If a project is private, you are not protected by required disclosures that other investments (stock market) are subject to. You cannot do adequate due diligence on your own. You may be investing in a solid deal - or you may be investing in a non-liquid maze of paperwork that just hasn't reached the apex of the Ponzi scheme yet - and hasn't begun the downhill descent.

Buyer beware. I care about you guys and I want you at least to think twice before sinking significant money into an opaque investment that requires more trust than disclosure. I hope Mitch's story will give you pause the next time you're presented with a "great deal" with a developer you know little or nothing about.

[VagabondMD]

One of my good friends' elderly parents invested with an extremely well known, extremely influential, and extremely successful (by all accounts) local businessman in 2008-9 in a private real estate fund. I do not know the exact structure, but it seems to me, a monkey could have made money buying real estate in 2008-2009.

Well, over the past ten years, both parents passed away, most recently his mother about a year ago. When they were combing through her assets, they found the real estate investment was worth $40,000 (original investment was $100,000), and he was surprised. I said surely they were receiving distributions along the way, and he said that they were, to the tune of about $2000/year. Not only was the value only $40k, but he could not get at the money any time soon.

Bad luck? Incompetence? Crooked scheme? Perhaps not properly explained to me? I don't know which, but one of the most respected guys in our community managed to turn $100k into $40k at a time when buying real estate might have been the best opportunity in a generation.

[portlandia]

Interesting article, made more so by your vouching for the author's knowledge and expertise in financial planning. Add this cautionary tale to the list of why I like a portfolio of boring index funds.

[pulmdoc]

What I find striking is that the author frankly admits that the con man's pitch was too good to be true, including the promised return of 18%. However, he ignored the alarm bells in his head to the tune of $600,000. Greed and FOMO can be our worst enemies.

[jfoxcpacfp]

pulmdoc wrote:

What I find striking is that the author frankly admits that the con man’s pitch was too good to be true, including the promised return of 18%. However, he ignored the alarm bells in his head to the tune of $600,000. Greed and FOMO can be our worst enemies.

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I agree totally and kudos to Mitch for admitting his mistake and opening himself up to criticism. As he says, it was very difficult to write but he wanted to help others. Believe me, if he could be led into one of these deals by a trusted advisor, anyone could. Hubris is not rare in the physician community. I also admire that he is using his big megaphone to attempt to change the SOL for financial fraud.

But what caused my alarm bells to go off and the initial reason I posted this article is that 18% on RE developments is commonly thrown around by physicians who are looking to invest in real estate. Many seem to think that the higher return compensates for the added risk - but the risk is not of losing everything, but of low/negative returns on the back end.

I want doc’s to understand that these real estate deals are highly risky and not to assume that there is always a hard asset backing up the investment. The more sophisticated the proposition, the more opportunity the person who puts it together has for smoke and mirrors. Just because you’ve had good luck with one RE investment does not guarantee success the next time. Ponzi schemes and just plan bad deals exist throughout the rainbow of investment opportunities.

[WCInovice]

Thanks for posting.

I had previously felt very comfortable with asset allocation but more recently felt I needed to dive into real estate for a couple reasons - further diversification from the stock market and an alternative stream of income.  I like the simplicity of REITs but in my limited research I felt like most (I try to use Vanguard for simplicity) were under-represented within the funds with regard to residential/apartment/condos - seemed to be mostly commercial real estate or hotels and was missing some of the residential aspect.

So I ended up investing with 37th Parallel that advertises here on a couple of their condo/apartment offerings.  I have no clue if this will work out, and from my somewhat limited reading it seems like their returns are less than other private ventures, but they *claim* to also be less risky (relatively speaking) than other real estate endeavors.

I have a very busy practice and three young children and work lots of hours.  I just didn't have the time to do more of my research on other ways to get into the real estate sector and have no way to be a landlord or even use a management company right now.  I did see Dr. Dahle's name on the list of investors, so if this ship goes down at least I'm going down with him.

In my very limited experience now I suspect if you have the time to do your own due diligence you can get good return numbers (not 18% good), but for those of us without the time you need someone you can trust to help you vet this at the cost of diminished returns.  The hard part is finding that someone or entity you can trust.

[jfoxcpacfp]

WCInovice wrote:

Thanks for posting.

I had previously felt very comfortable with asset allocation but more recently felt I needed to dive into real estate for a couple reasons – further diversification from the stock market and an alternative stream of income.  I like the simplicity of REITs but in my limited research I felt like most (I try to use Vanguard for simplicity) were under-represented within the funds with regard to residential/apartment/condos – seemed to be mostly commercial real estate or hotels and was missing some of the residential aspect.

So I ended up investing with 37th Parallel that advertises here on a couple of their condo/apartment offerings.  I have no clue if this will work out, and from my somewhat limited reading it seems like their returns are less than other private ventures, but they *claim* to also be less risky (relatively speaking) than other real estate endeavors.

I have a very busy practice and three young children and work lots of hours.  I just didn’t have the time to do more of my research on other ways to get into the real estate sector and have no way to be a landlord or even use a management company right now.  I did see Dr. Dahle’s name on the list of investors, so if this ship goes down at least I’m going down with him.

In my very limited experience now I suspect if you have the time to do your own due diligence you can get good return numbers (not 18% good), but for those of us without the time you need someone you can trust to help you vet this at the cost of diminished returns.  The hard part is finding that someone or entity you can trust.

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You're welcome. As I said, I believe most RE developments are legit. Knowing the principals and finding trustworthy developers is a big first step, although even the good guys can lose money. Good luck!

[Hatton]

Wow.  Sounds like Madoff.  Even Peter Lynch was burned in that one.  Boring stocks and bonds are for me.

[Ghetto]

I made a big investment in my own 16,000 sq ft building. My practice occupies half and I rent out the other half.

I have very little in the stock market. I just decided I didn’t want to invest in ventures that I do not control. Therefore I won’t do investments with developers nor will I invest large sums in the stock market.

[The White Coat Investor]

I wonder if there is a risk premium here - a premium over what you can earn in an index fund for taking on this risk that is so hard to eliminate.

Of course, always remember that diversification protects you from what you don't know.

[Ghetto]

True. But I watched my father in law lose $1 million in the market in 2008 and I had several long time patients who also lost a bundle.

I’ve been investing in my practice (expansion), development of another business that is now profitable, paying off the house, some precious metals, stockpiling some cash, and a commercial building as discussed above.

Lately I’ve considered the stock market but with all time high valuations and high PE ratios I think I’ll wait for a nice crash before I get in.

[Dont_know_mind]

I avoid investing with developers. There might be parts of the cycle this might do well.

The only time I like to buy from developers is when they are liquidating.

I really don't understand why people have an aversion to buying direct property but are ok buying into a deal stitched together by a developer group ?

[VagabondMD]

 :roll:  :roll:  :roll: The White Coat Investor wrote:

I wonder if there is a risk premium here – a premium over what you can earn in an index fund for taking on this risk that is so hard to eliminate.

Of course, always remember that diversification protects you from what you don’t know.

Click to expand...

On a recent vacation, I met a man who was the CFO of a commercial real estate development company in California. It was his opinion that the best deals for the passive Investor were to buy from someone you know and trust. A couple of his clients/friends were actually on the trip within, too.

He said that on average, the profit for his deals were 12% annual return and that by buying publicly traded REITS, that number drops to 6% (on average) as the other 6% is eaten by the cost of being a publicly traded company. As he said, you have to pay the “stupid tax” to buy the additional level of protection/diversification. (He did not mean it perjoratively, rather that being on the inside of a closely held deal has a premium.)

I also asked him point blank for his opinions on the Crowdfunding platforms, and there again, he used the “stupid tax” term. :x In this case, the tax was paid to the platforms, for creating the opportunities. He did not speak against them, as I expected he would, and said that there company had, in the past, considered using them for deals but ended up getting funding directly from private parties.

I left the conversation with the same level of discomfort that I currently have investing in real estate... especially now knowing that I was destined to be perpetually subject to the “stupid tax.” :roll:

[Dont_know_mind]

Vagabond MD wrote:

      The White Coat Investor wrote:

I wonder if there is a risk premium here – a premium over what you can earn in an index fund for taking on this risk that is so hard to eliminate.

Of course, always remember that diversification protects you from what you don’t know.

Click to expand…

On a recent vacation, I met a man who was the CFO of a commercial real estate development company in California. It was his opinion that the best deals for the passive Investor were to buy from someone you know and trust. A couple of his clients/friends were actually on the trip within, too.

He said that on average, the profit for his deals were 12% annual return and that by buying publicly traded REITS, that number drops to 6% (on average) as the other 6% is eaten by the cost of being a publicly traded company. As he said, you have to pay the “stupid tax” to buy the additional level of protection/diversification. (He did not mean it perjoratively, rather that being on the inside of a closely held deal has a premium.)

I also asked him point blank for his opinions on the Crowdfunding platforms, and there again, he used the “stupid tax” term.  In this case, the tax was paid to the platforms, for creating the opportunities. He did not speak against them, as I expected he would, and said that there company had, in the past, considered using them for deals but ended up getting funding directly from private parties.

I left the conversation with the same level of discomfort that I currently have investing in real estate… especially now knowing that I was destined to be perpetually subject to the “stupid tax.”

Click to expand...

Vagabond MD wrote:

      The White Coat Investor wrote:

I wonder if there is a risk premium here – a premium over what you can earn in an index fund for taking on this risk that is so hard to eliminate.

Of course, always remember that diversification protects you from what you don’t know.

Click to expand…

On a recent vacation, I met a man who was the CFO of a commercial real estate development company in California. It was his opinion that the best deals for the passive Investor were to buy from someone you know and trust. A couple of his clients/friends were actually on the trip within, too.

He said that on average, the profit for his deals were 12% annual return and that by buying publicly traded REITS, that number drops to 6% (on average) as the other 6% is eaten by the cost of being a publicly traded company. As he said, you have to pay the “stupid tax” to buy the additional level of protection/diversification. (He did not mean it perjoratively, rather that being on the inside of a closely held deal has a premium.)

I also asked him point blank for his opinions on the Crowdfunding platforms, and there again, he used the “stupid tax” term.  In this case, the tax was paid to the platforms, for creating the opportunities. He did not speak against them, as I expected he would, and said that there company had, in the past, considered using them for deals but ended up getting funding directly from private parties.

I left the conversation with the same level of discomfort that I currently have investing in real estate… especially now knowing that I was destined to be perpetually subject to the “stupid tax.”

Click to expand...

If you could get 12% pa, 1m would be 3.1m in only 10 years!

18% pa and that 1m would be 5.2m in 10 years.

Sounds great, where do I sign to invest ?

[WCInovice]

Dont_know_mind wrote:

I avoid investing with developers. There might be parts of the cycle this might do well.

The only time I like to buy from developers is when they are liquidating.

I really don’t understand why people have an aversion to buying direct property but are ok buying into a deal stitched together by a developer group ?

Click to expand...

My aversion to buying direct (at least in terms of residential) is I don't want to be a landlord nor hire a management company.  Right now at this time in my life I want diversification into residential real estate without the time hassle and headaches.  This is probably costing me ROI but it's where I'm at right now.