Thursday, January 11, 2007

The First Secret of Investing (part one of a series)

So, you want to be a real-estate investor.

Are you sure?

Yeah, I know all about the national publications that talk about how easy it is and how much money you can make, and I know about the infomercials that tell you how easy it is and how much money you can make (I love to watch these). There are lots of companies that will recruit you to be "a real-estate investor", when what they really want you to do is to buy (and to sell) their "educational materials" about how to be a real-estate investor. What you are about to read has nothing to do with any of that, except to use them as negative examples.

But there are secrets to real-estate. Instead of selling them to you for thousands, I will tell them to you one at a time for no money at all, and all you have to invest is 15 minutes of reading. Ready?

The First Secret of Real Estate Investing: cash is king.

I once sat through an "investors" meeting where the presenting guru told us that you don't need money to make money. This is perhaps true, else how would anyone have money at all, but it isn't true the way he wanted us to think. What he meant was, "I know you're all broke here or you wouldn't be in this meeting, but we know from experience that we can get blood from turnips much harder than yours, so if you'll just close your eyes to almost all objective reality, I can finish this thing up with a sale." He then proceeded to try to sell us all thousands of dollars' worth of investment education, which I would personally have advised everyone in the meeting to either 1) save or 2) keep for investing if they still wished to try it.

News flash: if it's that easy to do, it doesn't pay. This is an economic law. This is not to say that it might not be easy for you to do, if you are different than others, but if you are in all respects the same as everyone else, and it's that easy for you to do it, then it is that easy for everyone else to do it, too, and why would that pay? It might be easy for Kobe Bryant to play basketball the way he does (it isn't), but it isn't easy for me to play that way; in fact, it's impossible for practically everyone on the planet, which is why it pays Mr. Bryant so well to do it.

I, on the other hand, know lots of places to get money to buy real estate. I know more of these places than almost anyone, which allows me to get money more easily than other people, which means that I can do deals faster and easier than other people, so I can make money at it. In fact, it's cheaper for you to pay me to find you money than to find it for yourself (and it is, absolutely, cheaper), so I can leverage my expertise and knowledge to make a living. On the other hand, it would be best for me to pay someone with electrical expertise to fix my wiring. I can make my own food, but since I am only a slightly above-average cook, most everyone can cook as well as I can, so why would they pay me to do it?

In the same vein, if buying and selling real estate is really so simple a child could do it, why aren't my children doing it and earning their keep? The reality is, of course, that the easy deals are so easy anyone could do them, but they also don't pay very much (I am speaking here about market generalities, not about any specific deal you happen to know about - remember that the plural of "anecdote" is not "data"). It's the really hard deals that make the most money. Accumulating cash is hard (by cash I mean non-institutional money, free capital that can be moved from one place to another without the necessity of getting a loan), therefore deals that require cash are the hardest deals to do, and that is about 90% of the investment deals that exist. The more cash the deal requires, the harder the deal is to do, because it's so hard to get that much cash in the first place.

If you have cash, then, you can get to deals that mortals can't, and those deals will make money more often than not. Why? Because the seller in the deal, the guy that is not making the money you're going to make, has limited leverage. He has a property that doesn't have a big market, since the market of people with lots of cash is tiny indeed. Small market=small demand=low price (again in generalities). Since the only way to make money is to buy low and sell high, low price is key to investing profitability. You have cash, you're part of a small market, you get prices nobody else can get.

This is true even if some of the deal is financed, because that financing is going to be contingent in large measure on what percentage of the real-estate value has to be borrowed against. The smaller that percentage is, the better the loan for it. So those with cash can not only reach properties nobody else can, they can get those properties for less money every month than other people, meaning that their cashflow is going to be better, meaning that again, they can buy properties and make money where others might buy the same property but lose money on the deal.

Be smart. If you're going to be a real-estate investor, the first thing you need to do is accumulate cash. As much of it as you can, free of necessity to repay if possible. There are myriad sources of this cash; almost everyone can accumulate it and many can do so shockingly fast, but it often takes a professional to show them how.

Do you have to? No. You can get in the game with nothing down. You will not win that way in the long term, though, unless you are prepared to sell your soul, and if you are, stop reading this blog and go away. If you want to do it right, follow the secrets.

Secret 1: Cash is King. Remember that. It will save you about $5000 in "education" all by itself.

Next time, the second secret of investing: The 3 Cs.