Investors are Still Making Money in Real Estate

[powayseller]

My landlord was just here to make some repairs, and he gave me a whole new way of looking at real estate. With some creative thinking, you can still make lots of money in real estate. For how long though?

My landlord is working w/ land developers in Riverside County. They get entitlements on raw land, which increases the value of their property. A 9-acre parcel which they purchased for $1.3mil in November 2005 is in escrow for $2.2mil! I didn’t know you could still make money in RE in CA. He said you can’t in SD, but in other areas, yes.

He also bought houses in Baton Rouge right after Hurricane Katrina. Baton Rouge is a 45-min. drive from New Orleans, and after the hurricane, the city about doubled its population. Housing prices shot up, and my landlord found a few good deals, six I believe. He is cash flow positive on those rentals.

My landlord is a smart guy. And he hates reading. Everything he does is by thinking and doing, hands-on. He has never heard of Robert Kiyosaki, is not looking for houses in Texas, and is done buying properties in SD. I hope he continues to do well.

So I stand corrected about RE, and I really feel like I know very little after all this.

Has anyone else thought of making money in developing raw land? I remember a forum participant who retired off his last land deal in SD. Any comments?

[docteur]

Yeah, you can still make money in real estate. But it’s a lot harder to do in a falling market, than in a rising market and the risk is much greater. And you have to add value via the subdivision process, through vertical development, etc. Just buying and waiting for appreciation will not cut it anymore.

I think your landlord is dealing in special situations and because land in Riverside is topping, he may have just caught the tail end of the market. It’s going to start falling in value and those kinds of deals will be harder and harder to come by.

I am the guy who retired off my last land deal (after 30 years in the business and lots of risk as well as going bust a few times, I walked away with a boatload of cash) but believe me, I would never tell anyone to go into the land business at this point in the game, because it is far more difficult in California than it has ever been.

First off, the entitlement process is incredibly onerous and environmental constraints add a lot to the risk and cost of subdividing land. Your landlord is basically doing a flip or bought a piece already entitled. There is no way he would have been able to get subidvision approvals that quickly (unless he did a down and dirty parcel map, which is four lots or less, not a major subdivision, which is five or more lots).

His homes down south were purchased after a special situation (sort of like a mini-market crash but with a local flavor) but if this market tanks on a national scale, those “good deal” homes are going to turn into alligators pretty quick.

As an aside, I think Kiyosaki is a total fraud. I knew him years ago and he was an absolute flake. He doesn’t know dink about developing or investing in real estate. And that story you posted about the guy who wants to pick up deals in Carlsbad that ran in the Sunday Union (I read it too) and invests with a guy named De Voos (SP?) — well I read his book too and threw it out, it was such dribble. What a load of dung that thing was.

If you want to know more about Kiyosaki, De Voos or any of the hundreds of other real estate scammers out there, go to the link below and read what John Reed has to say about him/them. (Read is an honest, tell it like it is, real estate investor and writer with impressive credentials and his books tell the truth about this business):

http://www.johntreed.com/rateseminars.html

Also, if you haven’t already, you should read my post at the link below, which contains information from someone in the land acquisition and development business, working for a very large public builder:

http://piggington.com/almost_20_000_on_mls_in_sd#comment-1385

Lasty, I really enjoy your posts and your candor in admitting that sometimes you may get a little too aggressive in your predictions. You are just trying to sort this all out, as are all of us. I mean who knows what is really going to happen?

At least your prognostications are based on lots and lots of individual research — I have no idea how you have so much time to read, let alone post — I am retired and can barely keep up with this website.

Real estate has been wonderful to me but I think it’s time has come to an end (for the little guy anyway) for the next decade or so (at least in California and maybe the rest of the US).

Having said all that, if you are going to invest in real estate, I would find reasonably priced apartments (multifamily) with realistic cap rates or lots of rental upside. Again, John Read will tell you the truth about buying those kinds of properties. As for me, I’m in short term treasuries (30-90 days) and will remain so until a clear trend emerges and it’s time to start buying again (which could be years).

[privatebanker]

Docteur,

Do you have any insight to the land entitlement madness that’s occuring in Las Vegas? I know someone who quit their professional career a few months ago to do this and acts like this will always be a thriving business with astronomical rates of return.

I think it is very suspect (equivalent to day trading telecom stocks) and can come to a staggering halt in the near future. In turn leaving them with a bunch of worthless land and a major financial predicament.

What are your thoughts?

[powayseller]

Yes, the landlord’s joint venture in Riverside had 80% of the entitlements completed. He and his group completed the remainder, and are waiting for the next city meeting to get the final approval. This is expected at the May, latest the June, meeting. I hope the buyer has a contingency for this all going through.

My landlord also told me that buying raw land and getting entitlements on it is the best way to make money in RE. He no longer buys houses to flip and rent in SD.

As far as my time, I spend too much time on reading. I spend several hours every day reading. But I don’t work, my kids are in school all day, so I basically have the mornings to clean the house, do my errands, work out, and read. Yes, I am one of the few women I know who actually cleans her own house. I am surprised at women who expect their husbands to work, and then just want to hang out, go to the gym, and call out for pizza. I think the husbands would get resentful. I don’t watch TV or shop too much, so reading is my vice. If you wish to call it a vice.

My internet reading consists mainly of piggington.com, and then I browse the links (but not the comments) on TheHousingBubbleBlog, and check out The Big Picture, BubbleInfo.com, RealEstateDecline.com, Patrick’s Blog, Bob Casagrand’s monthly report, and EuroPacificCapital. Some days I look at RealtyTrac’s foreclosure list. Most of this goes very quick, because I either browse the content, or select only the content dealing with the broader economy. I skip over repetitive stories. I really got into this topic late last year, when I researched whether we should sell our house, and am excited about all I’m learning. As long as I stay excited, I’ll continue reading on this topic. Last year at this time, I was practicing piano one hour per day, and I played at my kids’ piano recital (Fur Elise). So I’m not completely one-dimensional. If I were working, I would not have the time for this, that’s for sure. I’m reading Hot Commodities and Sell Now. My bookshelf is full of books on parenting (#1 priority for me), cookbooks, and the economy/investing/finance. Our whole family loves reading, so my husband and my 3 kids each have a National Geographic, newspaper, or book on their nightstands at all times. I spend too much time on this site, and I am sure my participation will decrease somewhat as time elapses from the sale of my home, the catalyst that brought me here.

[docteur]

I think you nailed it in your comparison to daytrading. It’s relatively easy to seucre entitlements (low barrier to entry) in Las Vegas and what you are seeing are the last lemmings to go over the cliff.

Unlimited or easily subdivisible land has no real value and a market can become saturated quickly when amateurs are entering the market (and your friend quitting his day job is a huge red flag that’s its time to try something else).

Only when there are major constraints (politically, environmentally or physically) does land become more valuable.

[docteur]

Ok, now the sale makes a little bit more sense. However, he still has to finish his final approvals in May or June, which could be a bad time if this market really starts to erode and folks become gun shy.

I remember the last downturn in the early 90’s, I lost ten million dollars in profits (and a lot of my investment capital) as my buyers bailed out of land escrows one by one over a horrible 90 day period (I thought it would never end). It can happen with lightening speed and takes on phenomenal momentum when everyone decides its time to exit.

Most of those in the market today have never really experienced that kind of downturn, where the fear takes on a life of its own and drives folks to make desperate, irrational decisions. We aren’t there yet, but an old land guy like me that’s been through two previous downturns can sense it in the air…kinda like when the weather starts to change just before a tornado hits…it’s not too far off.

Back to your landlord, remember, being in escrow is a hellova lot different than closing (as we all know) and your landlord’s buyers may get squirmy and just bail out of the deal. Then your landlord will have lost momentum and will have to start all over to find another buyer, in a rapidly decaying market. (Due diligence on a land deal can take 90-180 days, depending on how complicated it is and that is a lifetime in a falling market). I sure hope he got a very large, non-refundable deposit.

Again, land entitlement (subdivision) has a long lead time (in California anyway) and if you don’t hit the market just right (selling on the way up) you can lose your rear or if you are well capitalized, you can hang on through to the next market, which could be a ways down the road, but that scenario seriously compromises your return on investment (and can oftentimes make it negative).

Buying raw land and securing entitlements used to be the best way to make money in real estate, but only for those who understood the process and carefully calculated the risks (which very few people do). I have seen a lot of folks lose their shirts in this business, including old pros like me.

There just are so many unknowns and cities and counties, not to mention the federal and state resource agencies (the environmentalists), are constantly changing the rules while you are going through the process. Oftentimes the yield you thought you could get at the beginning of the process is way less (or none at all) when you get to the end of the process.

In the old days, I typically wouldn’t even look at an entitlement deal unless I could earn at least 40% IRR (return being commensurate with risk). On my last deal, I captured a 60% compounded rate of return on my capital but was in that deal for 16 very long and scary years. Fortunately, my timing worked out because Lady Luck was on my side. I had many a sleepless night over that one though.

It’s an incredibly risky proposition to start an entitlement process at the end of a market run (where we are now) because you are buying overvalued land and trying to add value in a falling market (essentially swimming up stream). You must start the entitlement process after a market has bottomed and is on it’s way back up (again because of the long lead times) because you may get to the market too late and miss your profit window. In the land business there is a very fine line (dictated by timing, which is often dictated by luck) between being a hero and being an idiot (I know, I’ve been both).

Lastly, thanks for the great links. I can tell you are an intelligent woman with an insatiable curiosity but you temper that with having your priorities in the right place (family first). And please, don’t let your participation on this website wane, I really enjoy your insights and opinions on all the subjects you address, not just the real estate market.

[powayseller]

Thanks, docteur, I liked you from your first post. My landlord said the approval is practically in the back pocket, since it is 99% done. The zoning (?) approval is just a formality. He’s part of an group in this project, where he put up the money, and the other guys are pros in entitlements. The guy from whom they bought in November, had held it himself only a short time. He didn’t get into the whole story. I didn’t want to ask, but was curious if the buyer could back out of escrow, if he sees land values falling between now and June.

Regarding the Baton Rouge property, I told him to be careful; ARMs are leading to foreclosures, and that could lower the value of his properties. As I finished the sentence, he must have become very nervous, because he broke the piece he was trying to fix, right then, and ended up having to leave without completing the job.

Overall, he told me you can still make money in RE, but you must work with pros who know what they are doing. At this point, he just puts up the money, and lets the RE pros do the leg work.

He has been in the RE business over 20 years, starting with foreclosures. He won’t deal with those anymore, since you don’t know what you’re getting (no inspections).

I perused the John Reed links, and it’s great! Thanks so much. And thanks again for the compliments. And now I must end my web surfing for the evening…

[Bugs]

The type of investor that can actually pull off a land entitlement flip is not the type of buyer whose driving this or any other market. Definitely the exception to the rule.

It remains to be seen if this investment group is that type of investor. I’d like to point out that “in escrow” is still in escrow until that escrow closes. More than one land development deal has fallen through at literally the last moment. What’s happening around the time this deal is set to close may very well kill it. I’ll bet at least some of the partners are sweating it right now.

There’s a reason land development can be so profitable and that’s because of the extra risks involved with projects that require a lot of time. The people who can make it happen really deserve to make that kind of profit for all that work and risk. Even the pros get burned sometimes, and it doesn’t take many losses to wipe out the gains.

[Anonymous]

Docteur

Your knowledge is invaluable so I for one vote that you post any thought that you might have at any time!!!!!!!! On a serious note, I would like to get your thoughts on the following. I just went into a web site that had a “local conditions” report update for any area in the country. When I went to Orange County it had a list of 10 or more local brokers, and every single one of them was a cheerleader. All disputed any chance of a drop, and talked about what a great time to buy it is right now.

I understand that they are sales people and are not going to be negative as they are just trying to further their own fortunes. Some of these people have to be smart enough to see that things are changing. However, I wonder what an RE veteran like you thinks when he sees things like this?

I know from my business in futures that brokers should never be listened to as they are all wanna be traders, who cannot make money as traders, so they become sales people. Is this also the case in RE? All these people wanna be developers, but cannot cut it so they go into sales?

[powayseller]

My landlord is expecting 6% annual appreciation for SD SFR, and I agree that his land entitlement deal remains risky until the papers are signed and the money is transferred. I asked him what kind of risk he has to take on that deal, to get a 30% return in 6 months. He said it was a high risk, but one he thought was worthwhile. He told me he made millions in RE. I responded, “But they are paper profits?” “Yes”, he replied, “but profits noentheless”.

Having heard all that, I was wondering how long he could afford carrying my rental house. I mean, the whole house of cards can topple, right? I have no idea how leveraged he is. So I asked if I could change from month-to-month to signing a year lease. I believe if he sells the house, the new owner would have to honor the lease. If he loses to foreclosure, what happens? That is the pitfall to renting a house, as I mentioned before.

I agree that docteur, as well as the other investors and bankers ought to write to their hearts’ content. I was also glad to see some newcomers in the forums this week.

[docteur]

Bugs – you nailed it. A deal isn’t done until you cash the check and even then, there is always the possibility of a stealth lawsuit. It’s a very risky game – thanks for the acknowledgement.

I have seen big builders walk from hundreds of thousands of dollars in “hard money” at the last minute. I used to sell land to those guys and more than once, I watched a huge commission evaporate because a deal went sideways.

One bad loss can wipe out years of profits and conversely, one good deal can set you up for life. The trick is knowing when to quit…

[docteur]

Shakespeare said it best “Me thinks the lady doth protest to much” (or something like that).

Too much cheerleading means they are trying to convince me of something that just isn’t so. That type of activity comes from a growing feeling of desperation. I think those ten see that things are slowing down and they have to ramp up the hype in the coming months as their income beings to fall. They are trying to “sell” you on the notion that the market is still strong. My BS meter goes crazy the louder the cheerleading becomes.

When a market is roaring, no one needs convincing. Most people know it. So, the louder they cheer, the more suspicious I become. And brokers are great indicators of market activity because they can sense the slowdown, as they are right in the thick of it. The phone rings less, the listing don’t sell, negativity creeps in, so they all work hard to keep one another “up”.

I have held a brokers license for 30 years and sold one house about 29.9 years ago. I just couldn’t take it. The emotional roller coaster of selling that little dump in OB almost killed me. Yikes!

When there are parallels between cheerleaders and salespeople, well, the home team is losing and no amount of screaming and yelling is going to make it otherwise.

The beauty of dealing with public buiders is there is no convincing necessary – the numbers and the market are non-emotional. It is what it is (and is of course subject to interpretation) but a good broker is simply a facilitator (in the commercial realm anyway).

And now that I think of it, most good brokers in the residential realm (earning north of $ 1 million per year and I know a few of them) try to list quality properties at a fair price, then no cheerleading is necessary. They are what I call “quiet professionals.”

“Just the facts Mam”…that’s what really sells me anyway. Regarding those ten brokers, I guess the fact that you said “every single one of them was a cheerleader” was very telling of the state of mind of residential real estate brokers. I think the fear is definitely creeping in and the best indicator of a market is the feeling we get in our gut when someone is selling us something, no matter what it is…a hard sell is just that, a hard sell.

[docteur]

Just a quick comment here, then I have to hop off to a Family Easter celebration…

I have always believed that profits aren’t profits until you book em. Until you sell and have the cash in the bank its just more BS. Equity can evaporate faster than you can imagine and most people calculate their equity incorrectly. They just subtract debt from market value. Well, what about selling costs and taxes (that can steal up to 50% of your equity, depending on the quality of the gain — long or short term – unless you do a 1031 exchange.) Real net worth is cash (liquid and/or cash flow). The rest is just BS until you convert it to cash or cash flow.

I once heard an intersting concept that totally ignored the proverbial “net worth” calculation. It was called being “infinitely wealthy”, which means you have enough cash flow to live the way you want, without having to work and that continues indefinitely. For some its $ 50,000 per year, for others it might be $ 1,000,000 per year (or more, which is hard for me to imagine). You should determine what is it for you and then create it. The process of doing that is a good one and in most cases you will create more than you need, then you can share your wealth with others who might be less fortunate than you.

In answer to your other question, if you enter into a one year lease, yes any new buyer would have to honor that lease, unless the seller or the buyer bought you out of that lease, which is a pretty rare occurance in residential real estate.

If the house went to foreclosure, the lenders rights would trump the lease because they are senior to the lease. If your landlord gives you a year lease, he probably intends to keep the property as leased properties are hard to sell (unless it a great lease for the buyer and its a rental). If he doesn’t, he wants to sell, and that’s always the risk you run being a renter. Always secure a lease if you intend to stay for a while and if negotiated correctly, you can actually lock in some discounts on the rent…

[powayseller]

Docteur, how can I negotiate the discount? When we rented while building our house, I offered to pay my landlord for one year of rent in advance, about $30K, for a discount which we would determine together (at that time, CDs were paying less than 3%). She said she wasn’t interested. Is there another way to do this, that the landlord would want? I’m also asking him to install A/C. I can’t believe I missed that one…I thought everyone had it! So he’ll raise my rent by some mutually agreed amount, depending on the estimate for the A/C. I figure if I pay him half the cost of the A/C over the 4 years I’m here, it’s a fair deal for both of us. He pays half for his A/C, but gets the increased value for his house. And I won’t have to move (no way will I live on Poway without A/C).

[powayseller]

Good point on the profits. I asked my landlord about this as well, when he told he has 2 benefits of owning rentals: cash flow and depreciation. “But you’ll have to pay back the depreciation in taxes when you sell”, I countered. “Yes, but we worry about that later,” he laughed. So, there you have it. Count the millions in paper profits, someday they evaporate, and you are stuck with paying taxes on the little that’s left. He’s a really nice guy, and I hope he figures out how to make money in the declining market. He’s been doing this since the 90’s in SD, so he knows RE can go down, foreclosures happen…

[Author]

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