In the last year or so, we've all become reacquainted again with the Sovereign Investor, that individual (or syndication of individuals) with untold wealth who snaps up distressed assets for pennies on the dollar. Of late, the Sovereign Investor hails from China or the Middle East (unless he's Carl Icahn), and sinks a tremendous amount of money to gain a significant stake in a struggling company. In recent months, private money has most notably flooded the financial sector. Last week saw the collapse of Lehman Brothers, the consumption of Merrill Lynch, the bailout of AIG, and the restructuring of Goldman Sachs and Morgan Stanley. All of these things are going to have a devastating effect on all layers of the economy, from the value of the U.S. dollar, to the value of your 401k.
This really got us thinking about what it means to be sovereign. What if you don't have millions of dollars in cash lying around, waiting to be invested? Why should your ability to build and generate wealth be held at the mercy of your company's contribution to your 401k? For those of us who weren't born with a trust fund, for those of us who didn't sell a start-up for a huge profit, now is the time to start actively participating in our own financial independence. Given the fact that we are a real estate investing and consulting company, it should come as no surprise to you, the reader, that we feel the best way to do that is through real estate investing. Let's review some of the reasons why:
Leverage: You have 40,000 hard-earned dollars to invest. You could chuck it in something safe. Like a money market. But, it turns out even that may not be the way to go (Click Here to read why).You could use it as a down payment,which would then give you control of, say, $200,000 worth of real estate; if it's a well-performing property, this, theoretically, should yield something in the neighborhood of $2000, or 1% of the purchase price each month. Or you could use it to buy $40,000 worth of stocks in a couple of companies, or put it in a mutual fund; but what are the chances that your initial investment of $40,000 will yield $2000 a month?
Hedge Against Inflation: When Chairman Bernanke and Secretary Paulson haul out the printing press in an effort to bail out the economy, it will inevitably drive down the value of the dollar. While you may be able to buy less at the shopping mall as a result, the upside is that your debt will also be worth less.
Less Competition for Great Deals: As the economy gets worse, and the media coverage more frightening, there are more and more people who are not in a financial or emotional position to invest in real estate. Also, you will find more opportunities to pick up bargains from people who were not in a position to buy in the first place. It can be scary to move against the herd, but making this educated decision can yield higher benefits under current market conditions, than they would when the market cycles up again.
Use Your Asset to Pay for Your Liability: In purely financial terms, your home is a liability. You put money in, but really get no tangible monetary benefits (of course, the spiritual or emotional benefits are another matter altogether). When you drive your new $40,000 car off the lot, you never be able to sell it for more than the purchase price. An investment property is different in that it 1) should pay for itself, and 2) should yield passive income which can be put towards paying off your liabilities. In fact, before you purchase that liability you've been wanting to acquire (i.e. a new Lexus Hybrid), it may be a good exercise for you to think about how much asset you need to buy (i.e. a real estate investment) to pay for it.
More Control: There are a number of factors that you have absolutely no control over when it comes to the performance of your investments. If you opened a high-yield savings account with a great interest rate a couple of years ago, you would know that your interest rate today is much lower. If your broker loaded your portfolio with financials, you'd be in a problem right now. You don't control the global demand for oil; there's nothing you can do if your discount brokerage charges you for every move you make, or don't make; you don't know if the CEO of the company you just invested in is about to come under scrutiny for questionable back-dating practices.
Investing in real estate is closer to the bone. While you were not planning on a flood destroying your duplex, you also have insurance to cover you in the event that it does. You may get a disgruntled tenant who decided to throw black paint over all of the walls and carpet, but that possibility could have been seriously mitigated if you took the time to make sure that you had a reputable property managment company. Sometimes bad tenants can get by good property managers; you need to know what your management will do if that happens.
Regardless of your investment vehicle, you need to do your own due diligence. It's your money, so it's your responsibility. Due diligence is not just about researching what companies are expanding in OKC, or how many students are enrolled at Texas State University in San Marcos. It's about developing a long-term strategy, and not getting confused with every tactic you see advertised. It's about building a team of advisors around you who you trust, and who have demonstrated a high level of knowledge and professionalism. It's about taking the time to understand and practice the standard formulas: Cap Rate, Cash On Cash, etc. It's about flying out to the market that you are investing in, to see the property that will help you generate more wealth, to get a sense of the neighborhood and city, and to establish a relationship with your property manager. Successful real estate investment requires your active participation. And the more due diligence that you conduct in the arena of real estate investing, the more direct impact you have on your own bottom line.
For related information, click on the links below:
The Giant Pool of Money (a broadcast of NPR’s This American Life explaining how the mortgage meltdown happened)
