… coincidentally, I have been working on a commercial RE deal in the $2.5 mill. price range, so I thought that I should simply share.
Warning: like most deals, this deal could simply fall through at the first hurdle. Let me explain by sharing the story so far:
All good real-estate transactions, in my opinion, start with finding a good broker who is working for you.
As it happens, I have a close friend who is a commercial real-estate broker who meets the ‘trifecta’ that I mentioned in that last post: (a) I like/trust him, (b) he works with commercial RE in the area/s that I am interested in, and (c) he invests heavily in commercial RE himself (buy/hold).
I have been pestering him for the last 4 years to find me a deal … interestingly, and this is something that you should take mental note of, he says that he is asked by most people he meets to ‘find them a deal’ but almost none ‘pull the trigger’ …
… so, forgive your broker if they don’t fall all over themselves with excitement until you actually close on your first deal with them 😉
Anyhow, finally a deal came up that seemed to fit my criteria. I didn’t even request financials at that stage or see the property: on the strength of my friend’s recommendation (it was a deal he wanted, but the $700k deposit was a bit too steep for him) I authorized him to put in a written offer.
I don’t recommend that you do this, you will pick up where this post leaves off …
Anyhow, the current owners occupy the premises (they were planning a sale/leaseback i.e. they sell the property to me, then lease 2/3 of it from me on a 5 year lease) and decided to first see if they could simply refinance their loan and take some cash out.
Naturally, in the current market this has proved difficult, so they have put the property back on the market … my friend is the listing broker, so I have first ‘dibs’ on the deal.
So, I am now at Stage 1: I have a deal in front of me; presumably, motivated sellers (we’ll find out, if they accept the new offer); and, I need to decide whether and how to proceed.
In Part 2 I’ll step you through exactly how I decided this was the ‘deal for me’ …
This video is essentially an ad for Robert Kiyosaki’s (Rich Dad, Poor Dad author) board game … a game that I own but have NEVER played. But, the video is also a snapshot of how you can use assets to buy consumer goods. Watch the (visually OK, but aurally uninspiring) video, then read on as I have some comments …
[AJC: Finished watching? Good …. now read on ….]
1. The assumption is that you are smart enough NOT to finance a depreciating ‘asset’ (actually, liability) and save up enough money to pay CASH for your boat: GOOD
2. Can you see how Robert Kiyosaki then suggests that you buy a cashflow positive property, using the cash that you saved for the boat as a deposit on the property instead? Robert implies that the property produces enough cash to then pay for the loan repayments on the boat: BETTER
But, Robert is suggesting that we BREAK a key making Money 101 Rule: that we should borrow to by a consumer item (this is BAD debt); Robert also suggests that ‘delayed gratifiction’ is good. So, let’s make use of this to see if we can come up with a better outcome.
Using a very simple loan calculator, I find that the $16,000 boat will actually cost us $21,600 over 4 years (assuming 10.5% interest, and $343 / month payments) …
… but, if we instead SAVE the full $750 / month that the property spins off as money in our pocket (after mortgage, etc.), we will have SAVED up enough to pay CASH for the boat in just under 2 years (21 months)! What’s more, over the four years that we have NOT been paying the boat loan, our money has been earning us approx. an extra $100 – $400 in bank interest.
OK, so the $100 – $400 extra interest we earn (if the money just sits in CD’s) is not exciting, but also SAVING $5,600 … a total of nearly $6k … surely is? So waiting less than 2 years, then paying cash for the boat, thus saving ourselves nearly $6,000: BEST
There is an exception: where the expense is a business expense it may be OK to finance … Robert gives the example in one of his books about how he was going to buy a Ferrari, but his wife (who’s obviously smarter – as well as better looking – than him) told him to buy a self-storage business instead, and use that to fund the payments on the Ferrari.
Smart … but, I’m sure the IRS would have some words about the deductibility of a Ferrari as ‘company car’ for a self-storage business 😉
There is a certain appeal to diversification, particularly when seen as a risk-minimization strategy.
Rick sums this ‘certain something’ up nicely in this recommended twist to how he would set up his own Perpetual Money Machine:
Nothing in life is without risk- but you can minimize risks by diversifying- use multiple types of wealth capacitors some properties, some stocks, even some bonds. You can further diversify with a mixture of commercial and residential properties, properties in different locations, etc.
Similarly you can diversify stocks through buying small cap, large cap, mid cap, and foreign stocks.
If you diversify you can be fairly sure that one bad event doesn’t ruin everything. Of course if the sun goes supernova all bets are off but barring that you should do fine.
And, this is certainly appealing …
… don’t forget that I have been well diversified in almost every area that Rick mentions: multiple businesses; multiple RE investments in different classes (residential; commercial; single condos / houses; multifamily; retail; office; etc.); stocks (but, no mutual funds of any kind … and, I intend to keep it that way!) … but, I don’t recommend it!
Why?
I see two problems with this:
1. You spread yourself pretty thinly – you risk becoming a Jack of All Investments But Master of None … this lack of specialized expertise (which you can, of course, try and ‘buy in’) and focus can actually INCREASE your investment risk, hence DECREASE your investment returns, and
2. You automatically consign your returns to the mean/average – not all of your investments can perform as well as your best investment …. if you are comfortable with this ‘best’ investment (or, at least one of your ‘above average’ ones) surely you would put more effort into doing more of those?
The usually arguments FOR diversification then say things like “well, look at the sub-prime and what that’s done to [Investment Class A], therefore you should also do [Investment Class B]” …
… but, they conveniently forget that [Investment Class B] tanked 5 years ago, and will probably tank even worse 5 years hence, whilst [Investment Class A] recovers.
If you diversify you run the risk of averaging your returns down.
In other words, if you can choose your investments wisely your best hedge against risk are a combination of:
a. Time: make sure you can hold the damn thing for 10 to 30 years … if you have a short investment horizon, no amount of diversification will protect you.
b. Higher Returns: if you can hold long enough, every investment worth its salt will recover – and, then some; and, isn’t a ton of cashflow a great ‘insurance’ against risk?
Of course, if you can’t choose your investments wisely, then a ‘regression to the mean’ becomes a GOOD thing … just don’t expect to get rich if you can’t develop any special expertise 🙂
Nope, Rick, my Perpetual Money Machine – which asks me to generate my active income one way (e.g. my job or business), and then create passive income in another way (e.g. stocks or real-estate)Â gives me all the diversification that I need!
You see, if you want to work on your ‘physical well-being‘ you have to define what that means …
… for you.
It will be different for everybody: for my wife it means eating strangely and exercising a lot. For me, it means, being totally sedentary, eating reasonably little/basic (except when I go out) and relying on good family ‘longevity genes’ (on my Mother’s side … hopefully, not my Father’s side of the family!) to keep me alive.
Yet, the government has managed to come up with (and, recently updated) a Food Pyramid that neatly sets out a plan for eating and staying healthy. Each ‘slice’ of the pyramid represents the relative proportion of each different food group that everybody should eat, every day.
But, the government soon found that this is enough to stop people from getting obesity-related sicknesses (cancer; cholesterol-related heart disease, etc.), but really wasn’t enough to make people, well, healthy.
What’s new about this, latest version of the pyramid is the stick figure climbing the stairs on the left hand side, like some Inca priest about to climb the pyramid at Machu Picchu for his monthly sacrifice of the young virgin (naturally, by ripping her still-beating heart right out of her chest … but, I digress).
This signifies that you can eat the right foods all you like, but won’t achieve true health unless you also exerciseyour body, in moderation.
One size does indeed fit all … at the most basic level.
Similarly with your ‘financial well-being‘ – while still a long way off being the Unified Theory of Personal Finance – we can at least lay out a basic Money Pyramid that will serve one and all reasonably well … enough to at least get you started; the bonus being that it might win me some friends back from the mainstream Personal Finance blogosphere.
Take another look at the Pyramid at the top of the post, and we can imagine the various segments as being common financial wisdom like:
1. Save 15%+ of your gross income
2. Pay down (and avoid all future) ‘consumer debt’
3. Increase your rate of savings by also allocating to your savings plan at least 50% of all future pay increases and ‘found money’ (inheritances; IRS refund checks; loose change from your pockets; money saved from quitting [insert vice of choice]; etc.
4. Buy instead of renting [AJC: which Financial Pyramid are you reading?!]
5. Invest for the long-term
6. You can fill in the other slices from your choice of any/all: live frugally; diversify; create an emergency fund; and so on …
And, this is certainly the Money Pyramid being promoted by most Personal Finance writers (other than the “Make Millions with No Money Down” and other ‘financial crackpot systems’, that I liken to the totally unbalanced “No [insert unhealthy sacrifice of choice: carbs; proteins; calories; glucose; food; etc.] Diet” diets).
The problem is, it might stop you from being poor (the financial equivalent, to not being obese) but will it be enough to make you Financially Healthy … a.k.a. Wealthy (however you choose to measure that)?
Probably not, which is why I have created the New Money Pyramid simply by adding the man climbing the stairs on the side:
This signifies that you can save money all you like, but won’t achieve true wealth unless you also exerciseyour money, in moderation.
How do you exercise your money?
Simple: you move it around! You aim high … setting a goal that has meaning to you, then:
– You invest at greater velocity (higher return),
– You leverage (the financial equivalent to exercising with weights),
… but only to the extent that your ‘heart’ (actually, your guts) can handle – start slow, get help, build up the velocity and the leverage as you get over a period of time – and, check with your ‘doctor’ before trying this at home 😉
Perhaps I just like this video because the ‘talking head’ is a fellow Aussie – although, I don’t know who he is or what his credentials are (I do know that if you watch all three of the videos listed on his blog you’ll end up with an ad for a new ‘personal finance’ educational board-game) …
… but, I do like his neat little whiteboard summary of the problem of ‘investing’ to chase capital appreciation. This was the sort of ‘wrong thinking’ that fueled the property market booms, both here and in Australia.
I am working on my first US commercial real-estate deal right now and by coincidence received the following question from MoneyMonk:
I plan to buy commercial Real Estate (strip mall) in the near future within the next 4 yrs. I want your advice on some things.
I want a property between 350-400k, I plan to put down $80K <- which will take me 4 yrs to save/invest
I want a commercial re agent to search for me, Im think Im looking at 8-10% commission to give the broker;
I want to form an LLC for my company, apply for a federal id, get a good CPA, a lawyer to form the LLC, umbrella insurance for about 1 million (u never know, The U.S. like to sue).
For as cap rate I want something above 7%. Am I’m missing something???
I also want to visit a banker and ask about financing. Is commercial re different from personal RE? for as terms?
I know any decent bank want you to show a good income, credit and some cash in the bank. What are good questions to ask a banker?
First I would like to congratulate MoneyMonk on being so forward thinking; it doesn’t hurt to talk to a Banker upfront, but my suggestion as to the very first place to start is with the following four steps:
1. Identify the type / location / price ranges of properties that you want to buy – MoneyMonk is targeting “strip malls … between 350-400k”.
2. Start researching the types of properties in the areas that you are interested – with 4 years to go before MoneyMonk has saved sufficient deposit, nothing else matters right now other than the research: LoopNet and RealtyTrac are great places to do this research.
That’s it for now; when the deposit has been saved:
3. Find a real-estate broker – you’re looking for the trifecta: (a) a broker that you like/trust, (b) one who works with commercial RE in the area/s that you are interested in, and (c) somebody who invests in commercial RE herself.
Keep in mind that the best deals are NOT usually on Loopnet /Realtytrac – they are what the brokers haven’t been able to offload, so are probably NOT the best deals around – the best deals are still probably with the brokers. It’s still an “old boy’s club”, so don’t expect your broker to bring you these deals first time around … your first acquisition is unlikely to be your best!
4. Find a property that you like / can afford / that meets your criteria and put a refundable deposit down (subject to: finance, partner’s approval even if you don’t have a partner, and due diligence).
The investment clock is one of the best indicators on the movement and condition of the finance, property and equities markets. It was first published in London’s Evening Standard in 1937 and showed the movement of markets within a decade cycle. Many people, however did not readily accept the probability of events turning out in a cyclical fashion so it took a while for some to warm to this new area of thought.
As late as last year, I was reading articles that said that we were at One O’Clock on the Investment Clock: rising interest rates and fear that stocks were on the verge of falling (and, fall they did) …
… then, something surprising happened: the clock did a ‘fast-forward’ to where I think we are today:
At the bottom of the cycle when fear and bankruptcy are abounding and interest rates are down, remember that this is the time to be positive. It is the time when there are bargains galore, ready for the taking.
The driving factor behind the business cycle is the capitalist system itself. Recessions are a way of ridding itself of excesses. Things like speculative lending by banks, high risk real estate trading and inflation. Society simply starts going a bit faster than the economy and places a lot of strain on resources. This means we are left with inflation and high interest rates. The bank then imposes a credit squeeze for a period, long enough for those excesses from the system to force inflation down.
Always remember that during a slump the price of most things will fall, but the value of cash does not. In fact, the value of cash goes up because it is measured by its increased ability to buy things more cheaply. This is the best time to hold cash and come out of those holdings when the economy is in the doldrums.
Nobody knows how long we will languish in the ‘doldrums’, and if you count the recent stock market rally as a ‘good news’ indicator it may be almost over, but it’s clear – at least to me’ … we are already in the cycle where assets are cheap … both stocks and real-estate with the added bonus that interest rates are also cheap …
… Bargain Hunter’s Heaven.
Here’s what to do:
1. Start looking for good quality companies with a strong history of earnings growth that are undervalued (did you know that GE has produced 10 years of 10%+ year-over-year earnings growth?) that are selling for low P/E (that’s the price compared to earnings … if you can pick up GE at P/E’s of 13 and hold for a long time, you have a sure-fire winner!) and HOLD. Don’t feel obligated to borrow to buy these, but increasingly, this will be a good strategy as stocks will be the first to rebound.
2. Start looking for good quality income-producing real-estate that you can afford to HOLD … these will be the last to recover (could be a 7 to 10 year cycle to fully recover) but, prices will begin to steadily increase. So, buy soon to lock in these yummy low interest rates before they, too, start to rise. The combination of low prices and low interest rates is equally a sure-fire winner.
3. Start a service business that helps large corporates – as they recover, they will need to outsource more and more services. It can be tough (corporates can be tough to deal with) but they can also pay off big and provide a ready exit strategy (as the outsourcing ‘fashion’ begins to swing back to ‘insourcing’ and your largest customers fight to buy you out).
Just don’t forget to always keep an eye on the clock …
Hey, my name is Josh and I am 24 years old and I am a huge personal finance junkie. I really enjoy reading your site so far. I was particularly intrigued about your post about renting vs buying real estate. To make a long story short, my dad owns commercial/rental property (3 housing units, bottom floor is for business) that is mortgage free. It is in a great up and coming neighborhood in Brooklyn. If he were to sell it today it would fetch in the 2 million dollar range. He makes pretax annual income of about $100,000+ in residual income from the business and the 3 housing units. I have been for the past couple of years been trying to convince him to take a loan from the equity from his property and reinvest in other commercial properties or other properties, but he refuses claiming that it is too risky. I don’t how else I can try and sell him on this. Maybe you can help? I am just trying to help my dad become more cash rich, instead of cash poor, asset rich?
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“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)
I don’t know who first uttered these words 😉 but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:
1. Little or no choice of investments
2. Have to wait to traditional retirement age to receive the benefits
3. Stuck with low-returning investment choices
4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)
5. Fees
6. Your employer may be ‘stealing’ from you
Stealing?!
Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz … thanks ‘Dusty’!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.
It found the following average fees being charged by the larger 401k funds:
Total Annual Plan Fees
Lowest      0.57%
Mean        1.32%
Median     1.28%
Highest    2.14%
(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)
Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.
Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!
I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38% …
But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?
Right?!
Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …
… Great! You are putting your financial future into the hands of your employer, 3/4’s of whom don’t even know what the plans that they are choosing will cost you!
So how do they choose the plan that’s right for you [AJC: ironic snicker]?
The study found, one of two ways:
1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”
Your employer feathers the bed of their own business relationships with your retirement money. Nice!
2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!
Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!
How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”
OK, so does this mean that you shouldn’t participate in your employer’s 401K?
Not at all … it just means that you should do the following:
1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!
2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?
3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?
4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!
5. Lobby your employer to pass back any revenue-sharing back to the employees
6. Insist that your employer choose funds that work best for you over the funds that work best for them.
What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will 😉
