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This is a book review that originally appeared in the 6/03 issue of John T. Reed’s Real Estate Investors Monthly.
Copyright 2003 by John T. Reed
Stephen Roulac (www.roulacglobal.com) is one of my favorite real estate investment experts, however, I do not write about him often because he focuses on institutional investors rather than individuals. His books tend to be excellent, but rather esoteric, as befits a man who teaches the subject in universities.
Roulac says real estate investment is a “multidisciplinary” field where “discipline” refers to academic subject. I accuse him of saying that to try to monopolize the market because he is one of only a handful of real estate experts with multiple graduate degrees: Harvard MBA, Stanford PhD in economics, Boalt Hall Law degree, CPA.
His latest book, 255 Real Estate Investing Mistakes and How to Avoid Them, is a marked departure from his previous books. It is written in highly readable laymen’s language. He says those who want to order it should do so through Amazon.com.
I am kind of a big-picture guy. Roulac is an even bigger picture guy. We both tend to write about the most basic fundamental concepts that underlie real estate investment and changes within it. He often uses academic phraseology like “the importance of place” or “societal spatial patterns” that are new ways to think about real estate for the typical individual investor. However, these phrases and words are also useful to expand your mind and gain better insights into the business.
And, like me, Roulac also sometimes writes about the minutiae of real estate investment that has to be done right. 255 Mistakes has many examples of both the huge picture and the microscopic picture. For example, one mistake is failure to set aside the cash to pay for tenant improvements in office and retail properties with vacancies. Another talks about the importance of specifying how security interests are removed when you pledge more than one asset as security for a loan. I covered that in my discussion of blanket mortgages in my book How to Use Leverage to Maximize Your Real Estate Investment Return.
You need both the big and little pictures. 255 Mistakes is a great book to read annually to clear out your brain of erroneous notions that are holding you back and to make sure you are not overlooking opportunities around you.
After 36 years in this business, I rarely get much out of a real estate investment book any more. But I learned a number of new things from this one.
Here are some examples of the brief descriptions of the mistakes:
Many of the Mistakes relate to Roulac’s institutional perspective:
Lack of liquidity is the classic knock on real estate. One “solution” is to invest in an REIT or other type of publicly-traded security in a landlord. Roulac points out one of the hidden costs of that. In a declining market, many owners of the shares will want to unload, thereby forcing the entity to sell into a declining market. An individual owner could decide to wait for a better time to sell. Similarly, you have the opposite problem when the market is moving up.
The manager of the fund is inundated with money just when the market is reaching its top and the returns available are at bottom. Such managers should “just say no” to new money at such times, but they rarely do. Rather they pay “at the top” inflated prices that produce lousy returns because they are compensated according to the amount of property they manage, not according to the return they achieve.
The book contains some interesting anecdotes. One investment advisor spoke at length a the great library of research his firm had. While Roulac was waiting in that library, he looked into a couple of the file boxes with intriguing labels. They were all emptyjust eyewash.
Many of Roulac’s “Mistakes” are classic rules that investors ought to know, but often don’t or forget, like doing construction and development without a permanent financing commitment, using before-tax numbers when the after-tax numbers are significantly different, or signing a property sale agreement without first checking out the buyer’s capacity or inclination to perform as agreed.
I disagree slightly with some of his points. For example, he says it can be a mistake to accept industry standard expenses. In my Checklists for Buying Rental Houses and Apartment Buildings, I urge readers to do just that with regard to unverifiable expenses.
With verifiable expenses like taxes, utilities and insurance, I tell readers to go right to the horse’s mouth for that property’s most recent bills and for a quote from your insurance agent.
However, I say not to rely on the seller’s expenses for repairs and other expenses because it’s too hard to tell if he omitted things (which he almost certainly did). And even if you get the complete list, he may not have spent enough.
For those unverifiable expenses, I say to use your local experience on your other properties and/or use regional and national expense studies put out by trade associations and real estate companies. Roulac correctly points out that the building in question may be different than the average building. True, but I have rarely seen that.
There is also the problem that if you buy based on better actual numbers, you may still have trouble based on those better actual numbers when you go to sell. Your buyer may rely on industry-standard expenses. A building that has lower than industry average operating expenses benefits you when you operate it, but you are far less likely to persuade buyers to pay you a premium for that building when you sell. Plus it is very difficult to get better numbers than industry standards when it comes to subjective areas like repairs.
Apparently, sometimes, big real estate owners seek financing from a financial guyWall Street or big bankrather than a mortgage guy. When that happens, it is a mistake to refuse to speak “finance” rather than real estate. Apparently each has different terminology, e.g., earnings versus net operating income. Your chances of getting the financing are enhanced if you speak “finance” to a finance guy.
The efficient market theory says that you cannot beat the market because it processes all pertinent information efficiently. You cannot process the information more efficiently, thereby achieving a better return. I would also say that the market is a sort of self-fulfilling prophecy. In other words, the market cannot be “wrong” because when you go to sell a property the market has “undervalued,” it will still be undervalued, therefore there will be no profit in your having identified it as “undervalued.”
I and others believe that the reason to invest in real estate instead of the securities markets is because real estate is inefficient. Each property is unique, there fore the number of people interested in it and processing information about it is tiny. You can “out-efficient” such a small market.
Roulac states that thusly. “In an efficient market, there tends to be less rewards for expertise and insight than in an inefficient market. In an inefficient market, expertise commands a greater premium and miscalculation carries greater costs.” Well put. I had never thought about the greater risks in inefficient markets, but he’s right.
The format of the book is that each mistake gets a subhead, a sentence stating the mistake, one or more paragraphs explaining the mistake, and a final sentence restating the mistake. The final sentence restatement was one iteration too many.
Roulac says the stages of a property are:
He further says the most appreciation occurs in the pre-development and redevelopment stages. Over my head.
Roulac says that if an investor is not willing to commit at least 15% of his portfolio to an asset category like real estate, he should not invest in that asset category at all. The reason is the difficulty of devoting an adequate amount of time to the asset class.
If you devote, say, 60 hours a week to economic activities, 15% is only 9 hoursnot enough to achieve meaningful expertise at anything. Readers of this newsletter are generally not violating that rule with regard to real estate like the people Roulac is talking about. But my readers may be violating that rule with regard to non-real-estate asset categories.
Roulac says that scholarly research says that you need more than a hundred properties to achieve adequate diversification. Makes sense. I have often lamented the inability to diversify in most individual real estate investment strategies because of the relative high cost of each property. I have also noted that there are a number of strategies that enable you to buy dozens or hundreds of properties or property interests like tenancies in common, judgments against real estate owners, slivers that are too small to build on, used timeshares, and so forth.
I should track down some of these scholarly studies and translate them to plain English so my readers can get more serious about meaningful diversification of their portfolios. Roulac’s new book is, for him, an uncharacteristically easy read. I recommend it.
Stephen Roulac sent me an advance copy, in part, to get a quote from me for the book cover. It’s there on the top of the back cover, but I was appalled to see on the top of the front cover a quote from Ron LeGranda guru I do not recommend. Please do not take my strong recommendation of Roulac’s book as a recommendation of LeGrand because of LeGrand’s appearance on the front cover of the Roulac book.