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Bigger Pockets The Book on Rental Property Investing by Brandon Turner

Posted by John T. Reed on

I was asked to join a Facebook group called the USMA [United States Military Academy, a.k.a. West Point—my undergraduate alma mater] Real Estate Group, and I did, briefly. I was asked to leave by the head of it and I did. He said I was too self-promotional. 

Another member, Realtor® Todd Heatherington, seemed to do nothing but promote himself when I was there, giving his contact information any time anyone sought a Realtor® anywhere in the U.S. (Typically, a Realtor® who refers you to another Realtor® gets 10% of any commission you generate for the Realtor® to whom you are referred. Some Realtors who are prominent hardly ever list or sell houses anymore. They just refer and live entirely off the referral fees.) I linked to my books or web site in some of the long posts I contributed to the site—like I do here and at my Facebook Wall. (https://www.facebook.com/johntreed.publishing)

Recommending Rich Dad Poor Dad?

While there, I was surprised and embarrassed by the level of discussion. For example, one guy recommended the book Rich Dad Poor Dad by Robert Kiyosaki. Jesus! Here is my article on that:  https://www.johntreed.com/blogs/john-t-reed-s-real-estate-investment-blog/61651011-john-t-reeds-analysis-of-robert-t-kiyosakis-book-rich-dad-poor-dad-part-1

Get-rich-quick cult members

Others scared me by talking about real estate investment like the get-rich-quick gurus, thereby indicating they had fallen under the spell of those guys. I am the greatest critic of those scam artists: https://johntreed.com/blogs/john-t-reed-s-real-estate-investment-blog/61653315-john-t-reed-s-views-of-various-real-estate-investment-gurus-part-1 I have appeared on 60 Minutes and Good Morning America and Larry King Live talking about them. Also I helped the Canadian Broadcasting Corporation and Smart Money Magazine do their stories on Kiyosaki. https://www.youtube.com/watch?v=HTuNMgQwdsc 

Kiyosaki is childlike

There is much discussion in that CBC program about Kiyosaki using Russ Whitney’s organization to sell and teach his Rich Dad Poor Dad seminar. He seems surprised that they knew that. I told them. If you watch the Rich Dad Poor Dad seminar in Canada then read my article about what happens to you at the Whitney free seminar, you will see almost an exact match. http://www.johntreed.net/Whitneyfreetraining.html

I have called him childlike. You can see a stunning example of that in the CBC video where the reporter said even though our cameras were still running, Kiyosaki still kept talking about his partner, Russ Whitney’s Whitney’s Information Network misbehaving. But Kiyosaki lowered his voice to a conspiratorial whisper as he did so—like Trump joking to an audience at a live rally being broadcast on TV, “Don’t tell Hillary I said this.” Only Kiyosaki, now a 71-year-old man, was not joking. He seemed to think that when you whisper on a national TV broadcast, the viewing audience will not hear you—or Whitney won’t. WTF?

I was also in Money Magazine, the New York Times and many other periodicals discussing this subject.

See also: https://johntreed.com/blogs/john-t-reed-s-real-estate-investment-blog/63395139-real-estate-b-s-artist-detection-checklist-part-1

Bigger Pockets

Anyway, another source mentioned frequently at the USMA Facebook wall was Bigger Pockets. I never heard of them. They are a book and podcast company. I bought one of their books—The Book on Rental Property Investing by Brandon Turner. 

Turner says he turned 30 in 2015. That is a bit young. He says he bought his first property when he was 21. I bought my first at age 22. I was a cadet at West Point when I was 21. We were not allowed to buy real estate.

My first book was written for my own use only when I was in my early 20s—before I bought my first property actually. It was simply a collection of all the things I got out of reading every book on the subject, not my great insights on real estate investing from my meager experience at the time. The Realtor® who sold me my first property was so impressed by that “book” that he offered me a job.

Apartment Investing Checklists

Later, when I was 32, I was writing articles for the newsletter Real Estate Investing Letter which was published by Harcourt Brace Jovanovich. They asked me to write a book they could give out as a premium for renewing. I suggested the checklist I had created in 1969. It was published as Apartment investing Checklists in 1978. 

I have since revised and improved it and still sell it as Checklists for Buying Rental Houses and Apartment Buildings, if you will pardon the self-promotion. My second book on real estate investment was called Aggressive Tax Avoidance for Real Estate Investors.

I wrote that at age 35, but again, it was not based on my great insights as a 35-year old. It was based on my reading all the books I could find on real estate investment taxation, most of them law books sold to lawyers. That book is now in its 20th edition it includes the Trump tax cuts. I have sold over 100,000 copies of that book.

I wrote a broad, big-picture book like 30-year-old Turner’s—when I was 63—it’s called waiting until you are qualified

Did I ever write a book as broad as Turner’s The Book on Rental Property Investing? Yes, a number like Best Practices for the Intelligent Real Estate Investors which does include my great insights on the subject. But I wrote that when I was 63, had graduated from the Harvard Business School with an MBA and had 23 years of landlording experience and working for several years also full time as an agent and property manager.

So that is why Mr. Turner might not be qualified to write such a book yet, but let’s see if he got it right in spite of his youth and inexperience, to borrow a phrase from Ronald Reagan.

Has-been investors who don’t know the game has changed

I think Mr. Turner mentions me in the book, although not by name: on page 5 of a 2016 paperback edition, he says,

I can’t tell you how many book I’ve read by has-been investors who no longer invest and are teaching tactics that no longer work because the game has changed. I only want to teach what I actually do.

In at least one of his on-line posts he mentions my books. I can tell you how many of my real estate books he might have read: 20https://www.johntreed.com/collections/real-estate-investment

I actually bought a rental condo with my wife and son last year. The son lives in it. So the “no longer invest” is not quite accurate in my case.

Name them

With regard to the phrase “teaching tactics that no longer work because the game has changed,” name them. I say that is one of those things that might be true, but you can’t just allege it. You have to say where I taught a tactic that “no longer works because the game has changed.” Name the book or newsletter or Web page where I did that and quote the tactic.

Intellectually-dishonest debate tactic

Alleging that is #3a in my web article list of intellectually-dishonest debate tactics: https://johntreed.com/blogs/john-t-reed-s-news-blog/60887299-intellectually-honest-and-intellectually-dishonest-debate-tactics Note that I did not do that to Turner. I am going to explicitly identify where he got real estate investment wrong, perhaps because of his youth and inexperience, not try to get my readers to assume he cannot get it right because of youth and inexperience.

Disadvantages of ‘still doing it’

This is not the first time I have heard that “I’m better than you you because I am still doing it not just writing about it” criticism. I wrote an article about it years ago. http://www.johntreed.net/cando.html There are actually some disadvantages to writing about something when you are still doing it. For example, when I was investing and writing, I was reluctant to talk about landlord-tenant litigation or toxic contamination for fear it might be used against me in court with regard to my rental properties. My book How to Manage Residential Property for Maximum Cash Flow and Resale Value, 7th edition, was used against me in a tenant lawsuit.

A number of organizations that offer investment advice actually prohibit their advisors from recommending assets that they own or are about to buy to avoid conflicts of interest.

I once recommended that it was time to resume investing in Texas apartment buildings—after having recommended against it for years. A subscriber then accused me of trying to move the market to raise my own property values. Could Turner maybe be accused of that? Not by me. It was a silly accusation. Especially when I recommended against it for years. But I cannot say that some real estate investment advice seller might not erroneously think that he could move the market and thereby personally benefit.

I do not believe the current crop of braggadocious ‘flippers’

Finally, I find a whole lot of what is said on line by guys who claim to be currently investing successfully in real estate to be not believable—especially when they say they have positive cash flow or claim some extremely profitable flip. What’s the address, I ask. The response is almost always silence. Are Mr. Turner’s property addresses listed at his web site? Mine are. http://www.johntreed.net/Aboutauthor.html (That list does not have my recent condo acquisition because my son lives in it.

Retired does not mean dead or demented

Also, investment advisors who are writing about assets they do not currently buy and sell are not dead. They keep up to date in general by various means including their relationship with their readers being a two-way street. For example, I never had a web site for my rental properties, but I have had one for my books since the 1990s and have recommended that my rental property owners have a web site for their properties or whole portfolio.

Full time in real estate investment in his twenties: Hello, Rahmen noodles

Turner says he quit his job and jumped into full-time real estate investing when he was in his twenties. He does not say how on page 4. Maybe later in the book. I am skeptical of that. I would have liked to do that. I was an Army officer for four years then a real estate agent for two then a property manager in my twenties. During that time I bought eight units in five different properties. That was pretty damned good. I then entered Harvard Business School at age 29 and bought twelve more during my first year at Harvard. That was really good.

Could I have gone full-time in investing then? No. Why not? Twenty units did not produce enough cash flow to live off of. Do 20 units produce enough now? Hell, no! It’s worse now. 

I would like to know the addresses of Turner’s properties that he owned when he “jumped into full-time real estate investment.” I suspect he is leaving out a whole lot of relevant stuff—like maybe living on Rahmen noodles three meals a day and living in his parents’ house or other similar details.

The numbers don’t work to go full-time in twenties

At one level, full-time real estate investing is arithmetic. When you quit your job and go full-time in your early twenties, the numbers don’t work. I am open to his correcting me, but I need to see proof of his unlikely claim.

His first chapter is titled “Why I love rental properties.” I expect I speak for tens of millions of current and former landlords when I answer, “Apparently because the novelty has not worn off yet.”

Being a landlord is an interesting new challenge at first, but bad tenants and bad resident managers and being sued and laws that get worse by the year cannot honesty be described over the long term as an object of affection.

The four ‘ations’

Am I saying that all tenants or managers are bad? I did not say that. Some are. And although I was extremely selective—one tenant said it had been easier for him to get a secret clearance in the Army than it was to become one of my tenants. Sometimes your screening of new tenants and new hires fails. Sometimes the prior owners bad tenants come with the building when you buy it. It is a tough business and gets tougher by the year because of the four “ations:” legislation, litigation, regulation, and taxation.

The novice’s love of playing with a sword he does not know has two edges

Turner loves leverage—that is other people’s money (get-rich-quick guru talk). Uh huh. Been there done that more times than Turner. Long enough to have learned that leverage is a double-edged sword.

It is great when your rent income is enough to make the payments in a recession. But the more leverage you use, the less of a downturn in rents it takes to make you unable to make your payments.

At that point, you wish you never heard of leverage. See my book Distress Real Estate Times, 3rd edition for the part of learning how to invest in real estate that Mr. Turner has not yet had enough of. That is where I tell you what it was like to be the captain of my real estate ship during the S&L Debacle “hurricane.” Hint: losing money is not the same as making money, only with a minus sign in front of the numbers. Rather, it is a whole other thing.

Ability to hustle for greater returns

Turner says real estate investment is better than other investments because he can use his time and abilities to hustle for greater returns. Uh, I probably said things like that at his age, but that is really true of entrepreneurship; less so of a capital-intensive investment like owning rental properties.

I would like to hear him supply some examples to back that up. And what abilities did he take to landlording? He is a self-taught, muddle-through, on-the-job “apprentice” without a mentor. He is making it up as he goes long. Taking advantage of his expertise is an aspirational statement when he is in his twenties. When he is in his 30s and 40s, yes, he will then likely have expertise in landlording, but in his twenties, he was almost certainly reinventing the wheel.

Luck is a huge factor in real estate

He implies some real estate investors in their twenties do better than others because of abilities. Nah. The abilities differences are barely perceptible. The performance differences come from timing and property choice. One of my college classmates and I each bought a house at the same price—around $375,000—and the same time in 1983 in the San Francisco area. He sold his in 2017 fo about $4 million. Mine is worth about $2 million.

Was that because of his greater abilities? No. He happened to pick an area—St. Francis Woods in San Francisco—that jumped way up in value. My area, the suburb of Alamo, did not go up so much.

I actually never cared for St. Francis Wood. Cold, clammy, blustery, horrible public schools. Actually, he and his family felt more or less the same. Cold and clammy is cold and clammy. He moved to La Jolla. Where we live in Alamo has much nicer weather than San Francisco and fabulous public schools.

In real estate, luck plays a much bigger role than hustle in a non-landlord business. Hustle applies to my publishing business. If Turner wants to profit from his time and abilities, the landlord business is not the place to do that, unless you pursue an activist strategy like those I advocate: bargain purchases or adding value

Driftwood, raft, or power boat

I have described investing in stocks and bonds as like being on a piece of driftwood. You go where the currents and wind take you. Investing in rental properties is like being on a raft with a sail and a rudder. You have more control than on the driftwood, but you are still and the mercy of the wind and currents to an extent. And in a hurricane, your sail and rudder are irrelevant. Being in your own business like my publishing business is like being in a powered boat that you built. It goes where you want, although it is still wise to avoid being out in a hurricane.

‘People always need a place to live’

Turner says demand will never end. Zat so, rookie? I’m guessing you missed the REIT disaster in the early 1970s, the recession of 1975, the recession of the early 1980s, disaster in Texas and Oklahoma in the 80s, etc. He would have been born in 1985 so I guess he has an excuse.

I checked his index in his book to see if it contained the phrase “doubling up.” He does not have an index. Item #13 in my Real Estate B.S. Artist Detection Checklist is no index in his book.

In recessions, tenants double up. That is they either stay home or move back home with their parents. Or they take on one or more roommates. They also shrink the amount of space and the number of apartments or houses they occupy. In other words, his statement that demand will never end is total B.S.

Here is the rental vacancy rate for the U.S. going back to the 1960s:

https://fred.stlouisfed.org/series/RRVRUSQ156N As you can see, it varies from 5% to over 11%. And that’s for the whole country. For local and regional, that is, where you invest, rates vary far more widely.

Often not enough people who need a place to live which pushes you underwater

And if you use other people’s money and high leverage, you can quickly have a vacancy rate—or more precisely, a revenue decline so large, that you cannot make the payments. You can only withstand such revenue downturns if you have a loan-to-value ratio in the 30% to 50% range.

I put 25% down on my TX apartment complexes in the 1980s and had to deed both to the lenders because the demand that Turner says will never end ended. That was the perfect storm of the oil glut, Tax Reform Act of 1986, and S&L overbuilding of apartment complexes that far exceeded demand for new housing units. I lost $750,000. Turner rode that one out in diapers and pre-school. That perfect storm is also not in his “index.”

Not unlike the Pollyanaish get-rich-quick gurus

One of the main mantras of the get-rich-quick scamsters is it’s easy to get rich in real estate. Cons need to seem true to the mark. In this case, many people have made easy money on their home or know someone who did.

Turner is overly sanguine about how easy it is to succeed in real estate investing and how safe it is to the point where if you look up “confirmation bias” in the dictionary, you may find his picture next to the definition.

Sometimes up, sometimes down, sometimes no movement

In the 20th Century, the early part of which we do not have good statistics for, it appears there was no appreciation to speak of in the first 20 or so years, then real estate prices collapsed and stayed collapsed for decades. A study based on NYC real estate ads during that period found a 90% drop in real estate values.

After World War II, we again had no appreciation to speak of until around 1971. I had bought my first property in 1969. It and all the others suddenly shot up in values starting in 1971.

I paid $14,000 and sold it six years later for $36,000. That property, which was then a house that had been converted into a duplex at 16 Harvard Avenue, Collingswood, NJ 08108, is now a single-family again and Zillow says it is worth $360,095.

Since 1971, the pattern has been various spates of overbuilding, recession, boom and collapse. If you were able to hold on until the end of the various recessions, you generally got back to where you started or better. But the notion that market-wide appreciation is an American birthright is wrong.

Overwhelmed by too many vacancies and rent drops

Even with a conservative 75% loan-to-value ratio I was not able to hold on through the S&L Debacle price collapse in income property during the 1980s. (Had I owned single-family houses or duplexes in the same locations, I would have been fine.)

Dangerous roller coaster

Real estate investing is a roller-coaster ride and, in the last 118 years, has been a long-term disaster at times and a boon at times. Turner’s breezy self-confidence, ignorance of past history, and unshakable optimism about its future tells you less about real estate and more about Turner’s lack of experience and lack of study of real estate history. My book Best Practices for the Intelligent Real Estate Investor has a chapter on “The history of real estate investment” with numerous time lines showing prices, tax laws, and other events. 

My middle son proofread that book and said it is not as pro-real estate investing or “real estate investing is great” as he expected. That is because it is an honest book written by a guy with 41 years experience who knows how difficult and risky real estate investment is, as well as how profitable it can be. He would not have made that comment if he had read Turner’s book.

Turner says real estate is ‘fairly stable and predictable’

The alleged “stability” of real estate is an optical illusion caused by how long it takes to get an appraisal done.  Look a the Zillow value or other Internet appraisal  service of a particular property on a daily basis. (I am aware that there are people who denounce Zillow any time it is mentioned. Spare me. It used to be comically inaccurate. Lately, I have found it to be close enough for these sorts of discussions.)

One very important factor in real estate values is interest rates. Are interest rates stable? Hell, no!

If they are not, then real estate prices are not stable either, because they very much depend on interest rates. Here is a several year graph of mortgage interest rates. https://fred.stlouisfed.org/graph/?g=NUh

And interest rates are not the only factor that determines real estate values. Every additional factor you add makes real estate values even less stable. It is a capital asset. As such its price varies with interest rates, recessions, booms, timber prices, copper prices, unemployment, laws and regulations like Dodd-Frank.

‘Fancy punk drunk on greed’

Turner says that in the subprime crisis, rental property owners who were investing for long-term gains did not suffer like those who were trying to be “fancy” ...or “punk drunk on greed.”

That is about as wrong as it can get. I read the books The Big Short and The Greatest Trade Ever. You should, too. It does not get much “fancier” than buying credit default swaps on subprime collateralized debt obligations in a market where normal individuals are not allowed.

Furthermore, the heroes of The Big Short were not long-term investors on those CDSs. Indeed, some who recognized the opportunity too early did not make big profits. The phrase “long-term” is not an abstract, easy choice like making a selection from the desert menu. It is like choosing between a sprint and a marathon on a track team. Marathons take stamina. In finance, stamina means lots of liquid assets in the bank and a relatively low loan-to-value ratio.

In finance, long-term also requires extraordinary courage and nerves of steel. As the value of your long-term asset soars and plummets, you have to remain in the asset. Millions panicked during the Subprime Crisis, as they did in the Great Depression and the dot-com boom and all the other busts.

Saying you are in favor of long-term investing is a demonstration of talk is cheap. Show me the property records that you bought a property before the s*** hit the fan and that you continued to own it for the years it took to pull out of the dive.

Now let’s discuss “punk drunk on greed.” The book title The Greatest Trade Ever refers to a handful of investors who got punk drunk on profits in the billions. The main winner, John Paulson, a fellow Harvard MBA, made $20 billion for himself personally and for his investors. The others made smaller amounts but still jaw-dropping amounts in the billions or close to it.

The least successful of The Big Short investors made more profit in this one trade than Turner and all his non-greedy, long-term readers combined will ever make in their careers.

Long-term?

By using the phrase “long-term” Turner is claiming that real estate investment is always profitable if you hold the property for some period of years. He did not define it. He needs to. I will guess he is claiming all investors who held for at least five years came out ahead. Again, he is welcome to specify a different period, but he needs to define the phrase “long-term.”

In fact, those who invested long-term in, say, 1922, had to wait until something like 1960 to break even. Since annual rate of return on investment is a fraction—profit divided by number of years the asset was held. I submit that the non-greedy long-term investor who did that, if any, did not get his financial genius secret decoder ring.

Texas was another long-term disaster in the 1980s and 1990s with regard to income properties. It fell disastrously, and stayed fallen for years and years and years. Again, being long-term there then took enormous amounts of cash and hear inhuman patience. And the reward such as it was was a lousy rate of return per year for the period.

In short, holding a property for at least five years is no guarantee that you will make a profit, much less an adequate rate of return. Real estate investing is not so easy as that.

The cycle

Turner says real estate is cyclical and that “Once an investor learns to identify this cycle, the old adage of “buy low, sell high” becomes much easier to achieve.

Bull! First, do not use the word “easy” when giving advice on real estate investing. Second, there is an organization that monitors the cycle: The National Bureau of Economic Research. http://www.nber.org/cycles.html

As you can see from the actual data, yes, there is a cycle, but predictable it ain’t. Indeed, the current expansion is one of the longest in history. Turner with his predictable cycle theory should have baled out of the current expansion years ago. That would have been a bad idea in retrospect.

In fact, the correct advice on cycles is so well known the phrase “the impossibility of timing markets” gets 325,000 hits in a Google search. Here is the first: https://www.forbes.com/sites/simonmoore/2016/03/07/the-myth-of-market-timing/#38efb2c8461e

Turner nexts extolls the virtue of the varieties of building types in real estate, specifically “houses, small multifamily apartments, large multifamily apartments, office buildings, high end, low end, Section 8.” I said above that I lost $750,000 on income properties in Texas in the late 1980s and early 1990s, and that I would not have lost money had I owned single family rental houses in the same neighborhoods.

That is an example of intelligent diversification in real estate. If I had it to do over, though, I would not have diversified by also owning single family there. I should have owned only single-family, not single family and multifamily and/or office. Income property was a bad category because of the Tax Reform Act of 1986 and the S&L Debacle overbuilding of income property in TX and OK.

I am not aware of any time since WW II when owning all the types of property Turner lists would have had you better off than just owning rental houses. I would also note that few actual investors own such an eclectic portfolio. The vast majority specialize in one type of property. And those who did not probably wish they had.

‘Simple and straightforward’

Another virtue of real estate investing according to Turner is that it is “Simple and Straightforward.” The hell it is. Just look at the transaction costs and what they are for.

You can buy $5 million worth of stock or index funds for what? $4.95 at Schwab? Buying $5 million worth of real estate costs about 2% to 5% says Zillow. On $5 million purchase price, that is $100,000 to $250,000. On a sale, Zillow says the cost averages 6% or $300,000 on a $5 million property. 

And what do you get for that? A list of complexity too long for this article: survey, deed, lawyer, title insurance, loan fee, etc. etc. Real estate is extremely complex, made more so by each property being unique. In contrast, stocks and bonds are fungible assets available in quantities of millions thereby resulting in minimal transaction costs and delays.

Landlords get sued

Landlords probably are sued more than any other category of business. There is nothing simple or straightforward or cheap about lawsuits.

Turner claims to buy properties for $80,000 that are worth $100,000. I wrote a two-volume book about that. https://www.johntreed.com/collections/real-estate-investment/products/ho-to-buy-real-estate-for-at-least-20-below-market-value-volume-1-by-john-t-reed

https://www.johntreed.com/collections/real-estate-investment/products/how-to-buy-real-estate-for-at-least-20-below-market-value-volume-2-2nd-edition-by-john-t-reed

I hope Turner proves that he does that. My books are full of actual case histories and I name the names of the investors who did them.

OK to trade on inside information in real estate?

Turner says trading on inside information is illegal in the securities markets. True. And he says it’s not illegal in real estate. It is illegal in some cases. For example, if you have a fiduciary relationship with an owner and you place your own interests above those of the client, you have probably broken both the law and the ethical code of your profession and you can lose your license as a result.

Turner says if he learns about light rail coming before others he can buy property that will benefit from it, When I was between my two years of Harvard Business School, I got hired to write real estate investment articles along with another fellow student. He used to work for the Baltimore government. He got secret information that a section of Baltimore was going to be redeveloped with federal money. He bought property in that neighborhood before the redevelopment became public.

In the event, the redevelopment never happened and he sold the property at a loss. Once again, Turner with his youth and inexperience, posits mildly interesting theories, but lacks the knowledge and street time to know the risks of such inside tips.

‘Don’t have to be present to make money in real estate’

Turner says you don’t have to be present to make money in real estate. True, if you buy REIT stock. But Turner is advocating buying in fee simple with your own name on the deed.

Residential rental units require about 4.6 hours per unit per month. Does that all have to be done by the owner? In the beginning, it probably should be so you know what your employees have to do when you get bigger and need employees. But having employees does not mean you never have to be present. 

There is an old saying that “the best fertilizer is the shadow of the farmer.” Same is true in landlording. You have to check on your employees. And if you never go around to your buildings, the lawyer for the tenant who sues you will beat you over the head with that at trial—“absentee landlord with a no-show job.”

Recruit, train, retain, evaluate, counsel, and fire ain’t a hammock

If you have employees, you have to recruit, train and retain the good ones and evaluate, counsel, and fire the bad ones. They also sue you. You also have to do all the human resources stuff like disability, unemployment, withholding, keeping pay competitive, health care, pensions, etc. Having “people” is difficult and time-consuming, not a ticket to a hammock.

The four types of financial change in real estate investments

Turner has a section on the “Four Wealth Generators.” I will call them more accurately the four ways that real estate can change your income statement and balance sheet. If I were going to try to mimic Turner’s get-rich-quick terminology it would be the Four Ways Real Estate Can Hurt or Help You Financially.

They are

  • change in property value
  • positive or negative cash flow
  • mortgage amortization that occurs below the current market value of the property
  • change in your income tax liability

Property values have risen and fallen in the last 118 years. You can affect that if you buy a property with unrealized potential that can be cost-effectively realized by changing the property. Absent that, your property value is like a leaf in the wind. It goes where the market goes. You can neither predict nor control it. If you pick a specific period in the last 118 years and investigate, you can see how just owning property would have served your net worth then. Some were positive, others negative.

Leverage, that is a loan-to-value ratio higher than zero, multiplies your return—greatly. Unfortunately, it can be both negative and positive. There are some sophisticated—maybe Turner would call them “fancy”—techniques that can limit your downside without limiting your upside, like non-recourse mortgages, being on the edge of insolvency, or deedless techniques like owning a call option instead of the deed. See my Best Practices... book for more on that sort of thing.

Cash flow generally disappeared from residential rental properties in the early 1970s. Why? Property value rose much faster than rents and remained there. For example, my first property in 1969 cost $14,000 and the total monthly rents were $230. That is a gross monthly rent multiplier of $14,000 ÷ $230 = 61. My current house has a 2018 Zillow value of $1,906,778 and a Zillow rental value of $5,622 for a gross monthly multiplier of $1,906,778 ÷ $5,622 = 339. 

About 55% of the gross rent in net operating income (rent minus operating expenses). Cash flow is rent minus operating expenses minus mortgage payments. When the mortgage about goes up more than five times the rent increase, the mortgage payments not only consume all of the net operating income, they also force you to subsidize the building’s cash flow out of your savings and/or other income.

So how come so many real estate investors and gurus today claim they have positive cash flow? They are lying, or they have a very low loan-to-value ratio or they are using a lease option to rip off an unsophisticated tenant. See my book Single-Family Lease Options. Lying about positive cash flow borders on universal for some reason. It assumes the persons being bragged to are ignorant of how it really is in the landlord business. Most are ignorant and wonder why they are the only ones with negative cash flow.

Mortgage amortization is not necessarily a benefit. It only makes you better off when the property value exceeds the mortgage balance before you made the amortization payment in question.

Amortization really sucks as money flows go. It is taxable income that you must pay tax on right now even though you do not get the benefit until you sell the property for more than the mortgage started out at. Only the interest portion of the mortgage payment is deductible. The amortization proportion is not. Turner mentions it, so I do too, but it is not worth mentioning in the early years of a mortgage.

Turner says , “I like to joke that i could work a minimum wage job for the rest of my life and never save a penny, and I would still retire a millionaire because my current property mortgages are being paid down by my tenants each and every month.”

Bull! Rental properties with mortgages above about a 50% loan-to-value ratio have negative cash flow in the vast majority of cases. You need savings or excess salary to cover the negative cash flow. Your tenants are only paying down your mortgages if and when you have break even or positive cash flow. You are only in that situation when you have huge percentage of equity, and that lowers your return on equity.

Also, there are periodic busts in real estate. If you had breakeven cash flow before the bust, it goes negative during the bust because your vacancies go up. You can generally fix that by lowering your rents down to the new market value, but then you are no longer at breakeven cash flow and that means the tenants are no longer “paying down your mortgages each and every month.”

Turner says rental properties provide tax benefits, without specifying how in the first chapter. I am the author of the book Aggressive Tax Avoidance for Real Estate Investors, which is now in its 20th edition. Real estate’s reputation as a great tax shelter is a vestige of the pre-1986-period.

The tax benefits were from delaying paying the tax. Those were more valuable when savings account interest rates were in double digits or high single digits. In recent years, the value of delaying paying taxes was as low as savings interest rates, that is, .1% or .2%. 

The Tax Reform Act of 1986 contained the hated passive loss limits. Those prohibit deducting rental property losses from any kind of income other than passive income. What is passive income? Roughly positive cash flow (which I say is rare) and proceeds from the sale of a property. You can finally deduct suspended losses on a property when you dispose all interest in it. 

Nowadays, Turner and a great many other investors claim to be “flipping” properties. Really? That would make them “dealers.” Dealers cannot deduct depreciation, take advantages of capital gains tax rates, or use tax-free exchanges—which are by far the main tax benefits in real estate. They have to pay ordinary-income tax rates on any profits—which are the absolute worst rates.

Nowadays, most people use IRAs and 401(k)s to shelter income from taxes. But if you put rental properties into an IRA or SEP or 401(k), any tax benefits of real estate per se are wasted, redundant. And IRAs, etc. do a very bad thing tax wise. They convert long-term capital gain income into ordinary income!

It is amusing that Turner, who says a bunch of “has-been investors are teaching tactics that no longer work because the game has changed.” Because when he starts talking about tax savings in real estate, he is saying things that were true in the pre-1986, pre-IRA era, but no longer are due to the Tax Reform Act of 1986 and pension laws and so on. If you’ll pardon the expression, the rules of the game changed, when the hip young Turner was in elementary school and before he was born. So why is he talking about real estate tax benefits like some 1970s syndication promoter?

He says on page 14 of my copy of his book, “I pay far less taxes than most Americas, despite earning more income (both passive and active) than most.”

I am extremely skeptical that he pays far less taxes than most Americans. He is a flipper, i.e. dealer. They get zilch tax benefits. I am also skeptical that he “earns more income (both passive and active) than most.” He said he went full-time in real estate investing around age 30. I said that suggests he has been subsisting on Rahmen noodles since then. It has not been a positive cash flwo business since around 1970. If cash flow is rare, where is he getting the “earning more than most?”

Turner says you should not depend on increase in value for your investment return when you buy. Ditto tax benefits.

I see. That mantra regarding “don’t rely on the tax benefits” was widespread during the peak of the tax shelter era—1970 to 1986. It was bull then. It’s still bull. I never heard it with regard to price appreciation until Turner.

So he is saying the only reason to buy a rental property is to get positive cash flow. Since I just showed that positive cash flow is all but mathematically impossible, that leaves no investment reason to invest in real estate.

Also, here is the response I gave to that back in the tax-shelter era. Who the hell do you think you’re kidding? To buy a piece of real estate, you have to outbid all the people in the universe. How the hell would you ever be the winning bidder if you are not going to take appreciation or tax shelter in account when figuring out how much to pay? You’re not.

If you assume zero appreciation and zero tax benefits, you would be outbid by the vast majority of buyers who are assuming great appreciation and some tax benefits. The fact is the vast majority of real estate investors in small properties since 1971 have assumed substantial market appreciation will occur during their ownership and indeed, that is their only reason for buying at all. They assume the appreciation will be so great that it will reimburse them for all the negative cash flow during ownership and then give them a great profit. You cannot bid against such people successfully if you assume zero appreciation. Your offer will be laughed at.

Either you are in the market or you are not. If you are in, you have to outbid all the others in the market to be the winning bidder. When the other bidders, even just one of them, are foolish and relying on appreciation, you have to pay an assumes-great-appreciation price. My advice is to stay off that beaten path and only buy bargain purchases that the normal idiots are afraid to buy—or to buy properties that have unrealized potential that is invisible to the normal idiots.

‘Natural’ appreciation

Turner says there is “natural” appreciation and “forced” appreciation. Neither of those adjectives is the best way to describe. I call what he is referring to with the word “natural” as marketwide appreciation. A rising tide raises all boats. But more accurate is what I said above: market values of real estate properties change over time—in both directions Turner misleads by omission when he only talks about appreciation. He seems to think appreciation sometimes pauses briefly but never reverses. The hell it doesn’t. There was about a 30% drop in the late 2000s because of the Subprime Crisis.

That word “natural” also seems to suggest that it is in the nature of real estate to appreciate. That depreciating or even mere failure to appreciate would  be “unnatural.” That is often the view of those who came of age at the beginning of a rise in prices. People who graduated from college in the late 1990s still think the dot-com boom is normal.Indeed, he says that: 

“Natural appreciation is the natural tendency for prices to rise over time.”

He’s nuts. As I already mentioned, there are many years in the 20th century when there was depreciation or no increase in values. We also had both in the 21st century. He attributes this “natural” phenomenon to “inflation, scarcity, and good ole American greed.” Further evidence that he is not going to get his financial genius secret decoder ring any time soon.

Inflation

Inflation is a factor. It also raises interest rates so it is often a wash.

He does not mention but growth of the population is another factor but only if the increase in population exceeds the increase in the supply of housing And it is not population growth per se that increases demand and maybe values. Is it household formation growth. If a couple have a son, and he stays in their house until he is in his forties, there is population growth when he is born, but still no housing demand growth forty years later. Ditto if he gets married and has kids and still lives in that same house. That is probably rare but it illustrates the difference between population growth and growth in housing demand.

‘Scarcity’

Scarcity!? What the heck is that? Wave after wave of overbuilding has swept through real estate during my career, the worst was in TX and OK in the S&L Debacle in the 1980s and 1990s. Instead of studying scarcity with some tree hugger professor in college Turner should have studied economics, like the Law of Supply and Demand.

And oddly, in real estate, it is the supply of construction loans that is key. The idiot builders will build anything they can get a construction loan for.

In TX in the 1980s, I believe there were two brand new apartment complexes that were never occupied and were donated to the local fire departments who deliberately burned them to the ground in order to practice fire fighting and to get rid of a nuisance that was attracting children and criminals. Turner being not yet born or in diapers at the time may have caused him to miss that little “scarcity” episode. I wish I had missed it. It cost me $750,000.

‘Good ole American greed’

Folks, we have had good ole American greed since the 1700s. We have also had many episodes of real estate price collapses during American history. How come the existence of greed did not prevent those? In fact, greed is omnipresent and ever present. It is not a factor in price changes. That which does not change does not cause change—for example in real estate values—almost by definition.

What Turner is incompetently stumbling through is a discussion of whether there have been any structural changes in real estate that incline it toward appreciation. You won’t find that important phrase in his index either.

Actually, there have with regard to metro area property other than TX, OK, and AK. That is the revolution in land-use regulation. It started in 1926 with the Euclid v. Ambler Supreme Court decision that said zoning was not unconstitutional. It is unconstitutional, but the Supreme Court lacks the integrity to say so. Then there was the second wave of that revolution arguably started with the California Coastal Commission referendum vote in 1972.

Existing building owners hate new construction

The basic problem is owners of existing buildings are anti-new construction, try to build in any U.S. metro area outside of TX, OK, and AK and you will be hit in the face with demands for permits, environmental impact studies, moratoria, blackmail in the form of having to improve unrelated roads or schools, etc. Angry neighbors carrying pitchforks and torches (almost) will scream at you at meetings claiming you want to increase traffic such that their children will be killed.

All of this NIMBY nonsense has a tendency to increase the value of existing buildings at the expense of raw land values or plans to greatly change an existing land use. This does not apply to TX, OK, or AK or rural areas where they still think new construction is a good thing.

But this structural change—which Turner might call a “the game has changed” factor if he thought about it—does not prevent overbuilding, which has recently occurred even in places like San Francisco which one would suspect has a “use a backhoe, go to prison” law.

‘Investing in location where appreciation is likely is a wise move’

That subhead is a piece of Turner financial genius on page 13 of my paperback copy. Reminds me of Will Rogers’s advice on stocks:

take all your savings and buy some good stock, and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.”

I have written statistic-filled articles from time to time about how one of the cheapest home markets in America had the most appreciation that year and the most expensive markets did not appreciate as much.

In all financial markets—real estate, stock, bond, commodities—it looks tantalizingly easy to just buy the “right” asset at the “right time” and thereby make huge amounts of money. In fact, it requires a crystal ball. Throughout my career, I have seen what I call the Chamber of Commerce speech where people in a given area predict with certainty that their area is the center of the universe and about to boom—then it doesn’t.

I already gave you a link above about the futility of trying to time markets. The less time you have been in the markets, the more you fall prey to the seeming ease of picking the right asset and buying and selling it at the right time. It is a mirage that back testing (https://www.investopedia.com/terms/b/backtesting.asp) will usually cure. If Turner or anyone else gives you a formula for timing markets or picking the “right” assets, back test it. That is, apply it to some time in the past using what was known at the beginning of the period. 

The strategies I advocate either have built-in profit because you are buying the property in question for at least 20% below its current market value (https://www.johntreed.com/collections/real-estate-investment/products/ho-to-buy-real-estate-for-at-least-20-below-market-value-volume-1-by-john-t-reed) or because you can see unrealized potential that can be harvested by cost-effective improvements to the property (https://www.johntreed.com/collections/real-estate-investment/products/fixers and https://www.johntreed.com/collections/real-estate-investment/products/how-to-increase-the-value-of-real-estate-2nd-edition-by-john-t-reed). 

Adding value

What Turner calls “forced” appreciation is called “adding value” in the industry. I think the word “forced” may be a manifestation of Turner having studied real estate at the feet of one or more of the get-rich-quick gurus. They talk like that.

I wrote two books on adding value: Fixers and How to Increase the Value of Real Estate. The former is what it sounds like—making cost-effective physical improvements to the property after you buy it—really quickly. How to Increase the Value of Real Estate is about all sorts of other ways to add value like getting better zoning, moving the building, escaping rent control, and so on. You can see the table of contents of each book at my web site.

Some physical improvements to well-located but neglected or under underutilized properties can be done profitably. Most are unprofitable. You generally need to turn disasters into fixers, not fixers into perfect properties to make a profit. Most actual investors do the latter—unprofitably.

42 years to write

Here are the first three paragraphs of my book Best Practices for the Intelligent Real Estate Investor:

“This is a book that took me over forty years to write. I have written more than twenty real estate books—more than sixty if you count editions. Those other books cover property management, income taxes related to real estate investment, mortgage financing, lease options, and all sorts of other narrow real estate investment topics.

“Why, you might wonder, was this book on the fundamentals of real estate investment not the first book I wrote.

“Because it’s easier to understand narrow subjects like income taxes and property management than the big picture of real estate investment. But now, after 42 years, I finally feel I understand enough about real estate investment to explain it to current and would-be real estate investors.”

My impression from starting to read Turner’s book is that he has not yet figured out the big picture, as you would expect from a guy with five or ten years experience—in a ten-year period when house prices have generally gone up (2005 to 2015). He also seems to figure he does not need to understand it, but only to sound like he does to novices. Fake it til you make it.

His fans need to ask him for the addresses of his properties then research them. You can do a lot of that now just on the Internet. Just remember one important figure in mind: 55% of gross rent is net operating income (rent minus expenses before mortgage payments). See how many Turner properties you can find where the mortgage payments do not exceed 55% of the gross rent. When they do, you have negative cash flow.

 


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