In the many conversations I have with experienced real estate investors and those wantin’ to get started, the subject of strategy is virtually sure to come up. Leverage, assumptions used in analysis, where to invest, financing decisions and the like, become pieces in your own personal game of Monopoly. Once finding themselves honest to goodness real time, real life players? They tend to stop viewing it as a game. Go figure.
The laws of physics, gravity for example, work every time they’re tried. For good, bad, or indifferent, gravity will never cause you to fall up. Air travel is soundly based upon the laws of physics, which is why you and I don’t give it a second thought when we get into a multi-ton tube with wings in order to fly a couple thousand miles in but a few hours. Why do we trust it so much?
The laws of physics will not be mocked. We know the jet in which we’re playing poker on our laptops, bored, was built upon that principle. The same goes for real estate investing. The problem arises when subjectivity must sometimes be inserted into any particular equation.
Subjectivity? Aren’t all investment decisions held hostage, at least in part, by the literal compulsion to include subjective judgment? Yeah, pretty much. On the other hand, opting for subjective over objective analysis of location, for example, is why so many investors are in a world of hurt.
Grandpa said never invest in property you can’t drive by at will. In his day, acquiring property 1,000 miles from home wasn’t on the regular guy’s menu. Today? It’s on virtually everyone’s menu. Those insisting upon staying close to home, when other regions are easily shown as superior, are catering to an emotional need — not an objective conclusion based upon sober analysis. This isn’t to say sometimes objective analysis won’t point to home as the best place to be. It’s a school of thought. I belong to the school that teaches us to go with what our research and analysis reveal to us. What a concept, eh?
Simply put, if your local market offers a fourplex for $500,000, with an Gross Scheduled Income (GSI) of $42,000, yet 1,500 miles away lies a physically superior fourplex in an obviously higher quality location for $390,000, sportin’ a GSI of $52,500 — your decision to stay local was one based upon emotions. Many become irate when I say things like that, but when pressed to supply objective reasons for their stated preference, they do excellent imitations of trees. They’d rather reap relatively much poorer results than not be able to drive by their empires.
Get over your local market before it gets over on you.
The rationalizations of investors in love with their obviously inferior local markets provide material for my speaking engagements. I can have some fun with them, cuz I used to be them. Boiled down to its bottom line essence, the numbers tend to turn the ‘DriveBy’ crowd, as I call them, into crickets.
Here’s a very recent conversation had with a west coast investor. The above mentioned fourplex was a couple miles from his home. He liked the area, and as he said, ‘the numbers made sense’. Let’s look at his property vs the one I proposed.
30% down payment at 5.75%/30 yr. fixed results in a break even.
In a region far away — or as I put it to him, a mere 1,437 mile drive — the other fourplex mentioned above required:
25% down payment — at 5.75%/30 yr. fixed, there resulted a cash on cash return of 9.5% — about $900 monthly.
Won’t bore you with all the ways the latter property is superior. Suffice to say, the potential results in five years for the far away units are not only staggeringly better, but embarrassingly so. Still, the investor refused to entertain the possibility that it might be worth it to consider anything outside his 10 mile diameter of comfort, regardless of the qualitative increase to his ultimate retirement income. To each their own, it’s their cash. I get it.
Meanwhile, back at RealityRanch, those who keep the subjectivity to a bare minimum, not tempting the physics of economics, will do much mo betta than those insisting on obeying subjective needs — more honestly described as emotional needs. The laws of economic physics, like those of the physical universe, work regardless of who’s using them — or abusing them. They’ll supply excellent or massively destructive results with equal apathy and efficiency.
Emotions, ego satisfaction, or the need to drive by and admire your empire, don’t change the results of the laws you put in motion. Jump out of an airplane at 10,000 feet with a parachute and the requisite skill, and your experience will be exhilaratingly enjoyable. Doing the same sans parachute will have a decidedly different, um, impact. Same gravity at work in both scenarios.
View the landing in both cases as your retirement.
NOTE: I fully realize staying in your local market will, in most cases, not end up the same way a skydiver will without his chute. You get the point though, right?
The lesson here is to adhere to the laws of economics with the understanding that they work every time, for good or ill, regardless of intent. Those insisting on remaining in their own market in order to feed a completely subjective need, should never be surprised when those who don’t, enjoy vastly superior results in retirement.
In other words — don’t jump out of the plane without a parachute expecting a soft landing. Gravity doesn’t understand subjectivity.
Photo: Kevin King