Thursday, February 3, 2011

Out of Town Investors - Beware

We recently visited with an investment promotor that was making a lot of money. Their offer to out of state investors looked amazing on paper. The only problem is, the investors they were selling to were doomed to losing money.

This promotor was purchasing $10,000 homes in rough neighborhoods with much gravity. (See my previous article on gravity.) He then did a cosmetic renovation for about $5,000 and found a tenant for the property. A fresh coat of paint can make a eye sore go away - but it doesn't remedy the rot on the other side of the paint. Based on capitalization rates/yield he then sold the property for about $40,000 to an investor from out of town and agreed to manage the property on their behalf.

Where are the problems? The homes were in neighborhoods with many many homes for sale and much deferred maintenance. In short the neighborhoods were imploding. Couple that with the fact that after the deal had closed, the promotor had made all their profits and had no incentives to insure that the property remained rented, maintained and cash flowing. It is just a question of time before management issues surface - the properties were not entirely renovated properly, the neighborhoods decaying, and attracting and keeping good tenants will soon be impossible. And finally, when those management issues do surface, the investor is from far away and has very few options to solve their problems that don't involve losing a lot of money.

Wednesday, February 2, 2011

Speculation Vs. Investments

Speculation: engagement in business transactions involving considerable risk but offering the chance of large gains, esp. trading in commodities, stocks, etc., in the hope of profit from changes in the market price.

How many variables effect the price of a stock? Management? Economies? Product competitiveness? Competition? Patents? International factors? Distribution channels? Product life? Efficiencies?

Honestly, wouldn't you have to be brilliant just to be able to identify all the variables, not to mention assess each one and how they relate to one another?

Investment: he investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value. A devoting, using, or giving of time, talent, emotional energy, etc., as for a purpose or to achieve something.

When a business owner invests in a piece of equipment, they have the benefit of a) huge expertise in their venture, b) all the incentives to make it work, c) skin in the game. Although there is certainly a element of risk, the number of variables are far "tighter" than that of a speculation.

My investment strategy is not to speculate. Rather, it is to invest giving the right individual (i.e. someone who has a tried and proven track record) the right incentives (i.e. profits subject to me making my money first).