Riding the Real Estate Waves or Crashing into the Shore Naked?

(Picture above of me with my Granddad in Summer of 1991, surveying the ocean waves for the first time)

First, I’m not a surfer since I live in Michigan. However, I do remember the first time I saw real waves in Ventura, California. I was 13 years old and visiting my wealthy cousins for the first time at their beach house on the Pacific Ocean. The waves would come in one by one in almost perfect rolls. The smell of warm salty sea water was in the air and the sun was shining bright.

I was eager to ride some waves, so I grabbed the only remaining boogie board and jumped into the white foamy and very salty water. I found out just how salty the water was when I tried to get to where the surfers were hanging out. I would start to paddle out, but as soon as a wave came I tried to go over it and instead it broke right in front of me. The wave caused me to tumble around in the wake while swallowing salt water for the first time. Unfortunately, this repeated itself until I drank so much salt water that I became physically ill.

Sitting at the shore feeling rejected and embarrassed, I watched the privileged surfers navigate the waters. After a while I started to see the answer to my first major mistake. The surfers would lay as flat as possible and as soon as an oncoming wave approached, they simply ducked down under the crest before it hit. This concept is illustrated below in “How to Duck Dive.”

I was now dry, beaten, and hot from the midday sun. But I knew I couldn’t leave California without riding a wave. It took a few times of ducking at the exact right time to wade out to the cool surfer dudes. I figured the next part would be easy…

                                (Danny McBride from Eastbound & Down)

After a while of awkward silence and glares from the surfers, the time came. I watched the surfers start to get into position for the big wave that was starting to grow behind me. I decided to paddle like a mad man toward the shore. I felt the wave start to suck me back into its crest, but instead of riding the wave, its full force broke right on top of me. I remember thinking how surreal it was being pushed down to the rocks and asking myself, “Is this how I’m going to die?”

But as fast as the white water had churned me over and over, it was done. My shoulder had a small scratch, but that was it. As I looked to the shore my brother and cousins were laughing and pointing at me. Now I can’t go back… I must try this again!

At this point the surfers had moved to a different location... (Probably because my goofy tall frame on a small boogie board was cramping their style.) After a few more attempts on much smaller waves, I was officially a boogie boarder.

So, why am I telling this story and how does it relate to real estate and investing?

Because everything in this world follows a cycle. From our weather having seasons to our lives - they all have a cycle. The below business cycle chart resembles waves in a somewhat predictable pattern of 7 to 10 year cycles. What goes up also goes down. If you’re interested in a great explanation of this, you can check out a Ray Dalio video. For right now, we will keep it simple.

* Ray Dalio is an American billionaire investor, hedge fund manager, and philanthropist. Dalio is the founder of the investment firm Bridgewater Associates, one of the world's largest hedge funds. -Wikipedia

The waves, in the below picture, are the cycles of the market, and we are trying to get to where the surfers hang out. There, the surfers (Smart Investors) are in position to see the market and are ready to capitalize on the next big wave. However, getting to this position is the struggle.

 First, as you can see from the unfortunate boogie boarder in the above picture, not ducking down in time is costly. Ducking down is akin to selling investments at their peak and going into cash before the wave crashes and drags you to the shore naked!

Second, you need to paddle out to the smart investors and wade in the ocean waiting for the next perfect wave. If your timing is off, you end up paddling too early or too late. If you paddle too early you run the risk of being crushed by the wave. If you paddle too late you miss the wave completely and end up watching your competition ride like a surf pro to riches.

I started in real estate in late 1999, right out of college. I didn’t even know there were waves and that I was playing in the ocean. From 1999 to 2006, I was aggressively paddling to get to the cool surfers. I was buying any house, duplex, or apartment that I could rent to college kids. All I knew at the time was that the path to financial freedom was real estate. I didn’t know that a once in a life time tsunami wave was barreling toward me soon…

Long story short, like all real estate investors at the time, we were dragged naked by the wave and crashed onto the shore. But I didn’t drown. Instead, I jumped right back into the water and tried to learn everything I could about market cycles and real estate. At this point, everything I had done was by myself and with my money. I liked the idea of being self-made and it was a point of pride for me. As the story goes, pride comes before the fall…

I used to think to myself, “why does this only happen to me and not the other guy?” But the reality is that it happens to everyone at some point in their life and it’s the entrepreneur’s journey. The entrepreneur’s journey is captured perfectly in yet another great video by Ray Dalio ….

Around late 2009, things were at the height of despair for the economy. The government was dropping money from the sky and it still wasn’t helping. There were great real estate deals everywhere, but I had one big problem - no money. Banks weren’t lending and almost everyone was turned off by real estate.

I couldn’t sit on the sidelines anymore and went to the devil for money - hard money lenders. The interest rates were 11-14% and included 2-3% points after purchase. Then if it sold too early there was a penalty, plus a penalty if I kept the loan more than one year.

I started a marketing campaign for Realtors in the Grand Rapids area that sold REO’s. I received a call from a Realtor regarding two vacant 4-unit properties that he was about to list. This was in February, which is very cold in Michigan. One of the units had a roof leak that had an icicle half the size of the bedroom hanging from the ceiling all the way to the floor. After having our contractor team look things over, we decided that we could just break up the ice while the complex was frozen and then haul it out the window. We did this after buying the property for $34K and the other 4-unit for $29K.

After doing the full rehabs and then renting all 8 units, things were coming together, and we had decent cash flow. The only problem was the financing. If I didn’t get the properties sold or refinanced, the hard money lenders could call the mortgage due or charge a large penalty to keep going. I reluctantly sold but made close to $100K. I still think about all the 80+ properties I had to sell this way and how different it would have been if I had secured investors and proper financing. Today these properties would have well over a million dollars of equity and cash flow in the hundreds of thousands. The lesson I learned is best described in this quote from John Wooden, “If you want to go fast go alone. If you want to go far, you need a team.” Below is a map of Grand Rapids properties I owned in red and purple. The light blue was properties sold to investors or flipped.

 After a while, I started getting more calls from Realtors from my marketing. I could only do one deal or so before my $100K ran out. Then I would have to sell, which I didn’t want to do. At the same time, I was preparing financial reports to show my friends or whoever would listen. Luckily, I was able to partner with my good friend from college who also happened to be a doctor.

From 2010-2014, both my doctor friend and his father invested in several small projects and homes. I was finally riding a wave and it felt great. Around early 2017, I started getting calls from the same Realtors I had marketed to before. This time it was the opposite. They wanted me to sell since there was no inventory of properties available.

The wave I was riding since 2010 seemed to be nearing the top and I’m starting to get nervous. Warren Buffet’s famous saying was ringing in my ear…

I relayed my feelings to my partners and we decided to sell. It was amazing how markets change from despair and panic to elation and frenzy. Buyers were running to outbid each other on our properties. It reminded me of when I was a Realtor in 2004, a property would be listed in the morning and there would be five or more offers on the table by the end of the night.

I had a hard-enough time trying to maintain cash flow when I owned them. How is someone else that paid twice as much going to fair? I have a feeling that these buyers are on a very small boogie board and a big wave is headed their way. Hopefully they will be able to duck under the wave in time. This article tells me that if a buyer is betting on appreciation or higher rent in the future they might be on the wrong side of this wave. Rental market

                   *Dana Point, California with Shally Hu-Aron Asset Management

Now I have graduated to a surf board and have been doing my best to learn how to surf like a pro. The above photo was taken Spring of 2018 in Dana Point, California for an IMN conference. Some of the biggest names in the mortgage debt business were in attendance for this conference, including the biggest player that can create its own waves, the U.S. Government. Both the HUD Acting Deputy, Marlene Robinson, and the Chief Economist for Fannie Mae, Doug Duncan, were also in attendance. I didn’t get the opportunity to speak with Marlene Robinson, but I did introduce myself to Doug Duncan during a coffee break.

During the coffee break, Doug Duncan was discussing the real estate market with other investors. One investor asked, “How do we expect the market to continue up when it has gone on one of the largest bull runs in history?” Doug Duncan just said plainly, “that nothing stays up forever and every market has a cycle.” He didn’t elaborate any further and the discussion changed. However, I did find this recent quote from him (shown below) that tells me where he thinks things are headed…

Both my recent trip to California, where I met the big-time market movers, and my boogie boarding past taught me a lot about life and investing. Whether I was trying to make money or trying to preserve it, I had better understand cycles.

My plan from when I was 22 years old was to create financial freedom through real estate. Now at 41 years old, my plan hasn’t changed, but HOW I plan to grow and preserve wealth has. A little over a year ago I started to look at what I was going to do with the proceeds from the recent real estate sales. I had a problem. Both the real estate and stock market are overbought and extremely risky. That’s when I stumbled into buying mortgage notes from listening to a podcast about real estate.

I won’t get into the details right now, but the simplest way to understand the concept is that banks aren’t in the landlord or fix and flip business. They are in the lending money business. Anything other than lending slows them down from lending. Therefore, they sell their interest in the property (usually discounted) for someone else to handle. They call this velocity of capital.

This is where our real estate group becomes valuable. I’ve spent almost 20 years learning real estate and have become a grizzled veteran from my time in the trenches. Although I am always learning something new, the time has come to act on this knowledge and experience and guide others toward financial freedom through real estate.

I have created a new real estate group that is designed to take advantage of the gap between banks and the open market. We help banks clean up their underperforming loans by purchasing their debt at a discount. This discount is what we use to reduce our risk beyond those that purchase on the Multiple Listing Services or through brokers.

We take calculated risks by analyzing the property, the loan, and the local market. We have assembled the best service companies and law firms to provide both guidance and security that we are managing assets properly. All our current real estate loan positions are balanced below 60% LTV. We only acquire off market properties well below retail pricing, directly from banks and hedge funds.

The water is calm, but the weather report says that choppy surf is on its way.

Are you concerned about your portfolio weathering the next storm? Are you in position to capitalize on future opportunities?