This review originally appeared in Real Estate investor’s Monthly.
A number of readers asked for my opinion on Value Investing in Real Estate by Gary Eldred, so I bought a copy at my local book store.
He has the letters “Ph. D.” after his name. That’s always scary and although this book is more down-to-earth than you would expect of a college professor, it’s still too ivory tower. If I had a Ph.D., I would not mention it unless I was speaking at a college. You lose too much credibilityand rightly so in most cases.
What is value investing?
I am not a stock market guy. Eldred apparently is to a large extent. He says value investing in the stock market is the approach advocated by Warren Buffet and Ben Graham. Graham wrote the books The Intelligent Investor and Security Analysis (1934co-authored by David Dodd). Do these books have any value for real estate investors? Based on what Eldred says they say, I would say, “Yes. They offer some interesting insights into investing in general.” But Eldred’s book spends far too much time proving why stock market books that he does not like, e.g., Jeremy Siegel’s Stocks for the Long Run, are wrong and why income properties are better investments than stocks.
The main problem with the book is that it urges you to become a real estate value investor, but never defines that precisely enough to be useful. He’s like the people who tell you to rent only to “good” tenants and to get a “good” attorney and all that, but neither define “good” nor tell you how to find such people.
Here are a bunch of useful insights I found in the book:
- “When the facts are wrong, it can’t be called learning.” Robert Shiller from his book Irrational Exuberanceapplies to the vast amount of bogus real estate investment information now prevalent.
- “…[many] misusing the term ‘investment’ to cover the crassest and most unrestrained speculation.” (Graham and Dodd in Security Analysis) Also true in real estate.
- “…[High ratios] weren’t just discounting the future, they were discounting the hereafter.” (Graham in Intelligent Investor)
- …the danger of paying the wrong price is almost as great as buying the wrong [property]…An investment in the soundest [property] may be made on unsound and unfavorable terms.” (Security Analysis) And usually is, I would add.
- “For most investors, trying to pick winners [i.e., stock picking] remains a loser’s game.” True, and not just for “most” investors, but so is trying to time markets in real estate, which Eldred advocates.
- Says an absentee owner manages her own rentals without local help by flying in and running an open house for a weekend. Interesting, but you would have to work very hard to make sure the open-house asking rent was correct for current market conditions. Too low and you lose income. Too high and your open house draws no traffic.
- “…value investors don’t need to swing until they see the near-perfect pitch.” (Warren Buffet) Good advice. In fact, my book Youth Baseball Coaching says the same thing about the first two strikes.
Eldred’s book also has many statements I think are dead wrong:
- Chapter 1 is titled “Value Investing, The One Best Way.” Reminds me of the Catechism I had to memorize in Catholic school. As I recall, the first question was, “What is the one true church?” and the answer we were required to give was, “The Catholic Church is the one true church.”
It is absurd to discuss real estate investing in such dogmatic terms. There are lots of ways to skin the real estate cat. Pick the one that best matches your strengths and weaknesses.
- Quoting Graham, “…investing… upon thorough analysis promises safety of principal and an adequate return.” Bull! Investing is gamblingsloooowly. There is no safety. In real estate, we also get to manage the business, which creates other opportunities for profit. The great stock market sage of my youth was Bernard Baruch. When asked once what the stock market will do he answered, “It will fluctuate.” Right on! No safety. No adequate return. Just fluctuation.
- “The price you pay must always be significantly below appraised value.” Actually, that’s just one way to make money in real estate. The other two are to upgrade the property so it’s worth more or to buy properties with double-digit cap rates at their market value.
- Eldred complains that those who tout stocks leave out the transaction costs when computing return. True, but Eldred does the same with real estate where the transaction costs are higher as a percentage.
- “If you don’t want to manage your own properties, delegate the job to a professional property management firm…” Never do that. They almost all neglect the properties and take kickbacks.
- “Though no one knows for sure, my best guess as to the annual rate of rent increases is around 4% to 6%.” Say what? We do too know for sure. The Census Bureau (www.census.gov) tracks those figures to the tenth of a percent. So do organizations like the Institute of Real Estate Management and the National Apartment Association. This guy has a Ph.D.!?
- “Income properties offer the ultimate protection against an ever-shifting rate of inflation.” Bull! Not as long as there are rent control and overbuilding. Either of those two forces cause income property values to fall during inflation.
- “[When the rate of inflation declines], rents stabilize, yet owners can refinance at lower rates.” Only if they have no prepayment penalties in their mortgages and market interest rates are significantly lower than their old mortgage rate.
- “In the 1980s and early 1990s, several regional real estate markets suffered…[but]…rent levels for established properties did not fall in any significant way.…” This guy’s nuts! He’s talking about Texas and Oklahoma. I owned “established” properties there then. They had been built in 1968 and 1970. My rents fell around 30% because brand new properties with individual washers and dryers were obviously more attractive than my “established” properties.
- Trade price for terms. This is a bad old chestnut from the seminar circuit. Eldred actually is on both sides of this. He denounces it at one point, then advocates it at another (p. 138)
- “Before you avoid high [property] taxes per se, compare [government] services.” This is what happens to you when you hang around college campuses too much. You start thinking there is such a thing as a lot of good government. In my experience, there are well-run towns and badly run towns and there is no correlation between taxes and good government.
In South Jersey when I was there, Brooklawn had the highest taxes and was a crappy little town. Collingswood had normal taxes, but insisted on hiring only experiencedand therefore more costlyteachers for its schools. In CA, property taxes are the same statewide because of 1978’s Proposition 13, but the quality of the towns and services varies widely.
- “…no checklist can anticipate every feature you might want to evaluate…” He must not have seen my Checklists for Buying Residential Houses and Apartment Buildings or its out-of-print sister Office Building Acquisition Handbook. The Journal of Property Management called the latter a “checklist to end all checklists.”
- On page 159, Eldred says you should make sure the site placement of a property you buy conforms to the standards of feng shui. Right, and always have a dried goat’s heart in a yak-skin bag around your neck when you inspect property.
- A few lines after telling you to install new cabinets or appliances, he sums up by saying “little things can mean a lot.” Little!? If you have to install cabinets and appliances, you’d better have bought the place real cheap.
- “Over time, builders pull back and gradually excess inventories diminish.” Never happened in the history of the universe. Lenders pull back. Builders never do. Witness Oklahoma and Texas in the 1980s.
- Has five hypothetical income property deals, all with cap rates over 9%. What year is that from? 1968?
- Says to use conservative income and expenses and high cap rate when preparing an offer to enhance your margin of safety. Yeah, and to make sure you are never the winning bidder. In the real world, you can accomplish this only by making bargain purchases from tenants in common, probates, and such.
- Says condos are positive cash flow investments. On what planet?
Much of what Eldred said sounded like it came from my writings. Indeed, he end-noted me twice in the back of the book. Problem is he paraphrased me a lot more than he end-noted me. Isn’t that a no-no for a Ph.D.? My books are a better source of my approach than Eldred’s paraphrases.
An NFL blooper film shows coaches yelling from the sidelines during games to their defenses, “Watch the waggle! Watch the counter! Watch the draw!” Finally, one exasperated coach yells, “Watch everything!” And that is one of the great problems with Eldred’s book. He tells you to check stuff like housing starts, permits, market rents, employment, etc., etc. But there comes a point where you realize he is telling you to check everything. You can’t do that because you don’t have time and even if you did, it would be the old drinking-from-a-fire-hose problem.
Real real estate investors like the late foreclosure investor Paul Thompson checked title, neighborhood, and called the auctioneer the day before to make sure the auction was still on. The number of variables he checked was finite because the time available is finite. He also generally knew his local market like all good investors, but he did not endlessly “drink” from the “fire hose” of all the real estate data that could be gathered.
This “check-everything” advice is characteristic of ivory tower analysis paralysis. Eldred would no doubt say he is a real investor with properties and real world experience. Fine, now how about bringing your writing in line with your real world experience. Reduce the number of steps down to a realistic number.
Speaking of realistic
Speaking of realistic, Eldred also commits the crime of telling you to seek safety in various impractical ways. For example, he says you can safely borrow if you maintain cash reserves of three months’ gross rents. You do need to be able to absorb the shock of unexpected expenses, but three months’ gross rents is a bit much.
Back in the late eighties when I owned 58 units, that would have been about $60,000. I cannot think of anything that could have happened to my buildings that would have cost $60,000. And if it did, I would use some cash and borrow the rest. Reserves do not all have to be in cash.
There are occasional gems of insight in this book, more from the classic stock market authors he quotes than from Eldred himself. In general, his value-investing concept is extremely muddled and vague. Basically, he thinks you can time the market if you have a monstrous volume of trend data. He is also too bureaucratic and ivory tower, telling you to have an “investment plan, a market strategy, a legal strategy,” etc. One of my graduate business professors called this “managing from the 50th floor when you only have a two-story building.”