Can you guys help me with your opinion on a couple of questions I have? If I have a million dollars in cash and I want to invest it in something that is highly secure, what should I do with it? Now for my next question: If I can invest my money into a deal that is collateralized by very solid real estate and I will make 10-14% interest, is this a better deal than what I can get by following an investment strategy in stocks? Why, or why not?

The upside in the real estate investment deal is that if the deal goes sour, I can gain control of the real estate as recourse. If my stock investment strategy goes bad, I'm left with nothing.... but on the other hand, I can't compound my money in the real estate deal like I can with stocks.

Please let me know your opinion. I realize that these questions may seem uninformed, but I'm asking them for the sake of intellectual purposes as well as some healthy discussion.

--Ben

Ben,
First let me say that I think this is a difficult problem. In fact if you'd like, I'll handle it for you. Just send me the million and you don't have to worry about it anymore.
Seriously, I think the important thing is to clear up some assumptions in your question and that will probably make it clear enough for you to know what you want to do.
Real Estate: The money is collateralized by highly valuable real estate. What that means to me is that it's expensive right now. That doesn't make it valuable. What would make it valuable is the cash flow from it. However, if the cash flow is secure it's not likely that the tenent will default and leave you with the property so I don't think you can count on it necessarily being valuable when the renter defaults. The only situation in which you will be left with valuable real estate after the the cash flow is gone is that the renter was a bozo and someone else is waiting in the wings to pick it up and make a gold mine out of the location. If you think the guy's a bozo it's not a valuable deal so the assumption leaves me a little flat.
All your eggs: The other problem is the all the eggs in one basket problem. I'm not a big fan of diversification just to diversify. In fact if you know a lot about a business and have an edge stay right there. But I have the feeling that if you were a real estate insider you wouldn't have asked the question and I'd be worried about putting everything into an area where I wasn't an expert.
Safe from what?: The other thing you're asking about is safety and I have to ask, safe from what? In government bonds you are safe from default I suppose but are you safe from the prinicple being made worth less by printing extra money to pay you the interest you're owed? If your next door neighbor had the US Government's balance sheet would you loan him $1M? You can't avoid risk, it has to be managed. Ask you're self what risks you're comfortable with - what risks you know how to handle. How are the risks interrelated? For instance; the BB strategy that several of us are taking a look at. The big risk is a crash. If we're short the market because of the COT that hedges that risk.
Diversifying systems: That gets me to what I've become comfortable with and what I've learned from Larry. If I have everything in one system, I get nervous. If I'm diversified across systems and one isn't working out, it's likely that others are and that I'm not losing large amounts of money. I might not be getting much income at those times but I'm not losing either. Here's just one thing that's been working for me. I'm short DIA and long CEF in a ratio of 1:1 in dollar value when I opened the position. I believ in being short the market but have been frustrated by my inability to hold a short position in money I want to have a stop on. The ratio has allowed me to maintain the position without loss as the DIA has risen. I bought the position at a 20:1 ratio and it's still just about there. In the same time frame a naked short DIA position would have me losing money and I'd have gotten out. While that money's doing that other money is using the BB strategy and other money is following the COT while some is in other precious metal postions. It sounds heavy long metals and short the market but that's a confluence of systems at the moment. If the DIA:CEF ratio turned the other way that system would reverse and the other money would independently follow the COT whatever it did.
Sorry this is so long winded. I'm sure someone else will give you a more readable answer. I just wanted to raise some questions.
h

Howard,

Thanks for taking the time to respond to my questions. I agree whole-heartedly with the points that you have made. When I asked the questions that I did, I really was looking for an insight into the perspective of someone who is perhaps more stock investment oriented than I am, as you are. I actually work a lot with and love real estate and posed those questions to see how someone such as yourself views real estate as an investment vehicle as compared to your current investments in stocks.

As you pointed out, there are a lot of assumptions that need to be clarified. When I said, "solid real estate", I was mainly referring to something like an apartment building that sits in a very stable area, has ten years of historic occupancy rates at 90% or more and puts out a very high cash flow, with little or no appreciation. With retail commercial buildings, if you lose only one or two tenants you are "screwed" if you are over leveraged or have lent someone a sizable amount of money and left with the property as collateral. There are definitely real estate investments that are more "solid" than others. Really, the same can be said of stocks, but one thing that can't be said of stocks is that if a stock becomes worthless, you literally have nothing. Not true of solid real estate that isn't overly leveraged.

The problem I would have with sticking a vast sum of money into someone else's building is that I am losing control of my cash and, as you pointed out, put too many eggs in one basket. I guess, in a way, the same can be said of stocks as well because I am not in control of the operations of the company, but it would certainly be easier to diversify.

For the layman, making 10 percent per year in the stock market is unheard of. The pros will definitley outperform that, but you won't really find anyone who can consistetly make more than 20% per years trading stocks. Likewise, if you are a real estate pro and had a million dollars to play with, you could perform, much, much better than 10-14% per year..... but not everyone is a pro!

If you are a layman and someone gives you the opportunity to invest your money in a peice of real estate like what I described above, wouldn't a 10% or more return on your money be attractive? If a layman wanted to invest the same money with someone who could trade it for you in futures, about the best you could do is find an outfit that would give you around 10%, right? But, what are you left with if things go sour?

Obviously, I am speaking in terms of highly paid individuals who don't have the knowledge or time to do their own investing...

I'd love to hear your feedback.

--Ben

Ben,

I’ve been staying out of this one because my position on real estate is well documented. But I was intrigued by you comment, “if you are a real estate pro and had a million dollars to play with, you could perform, much, much better than 10-14% per year.”

The people who manage REIT’s that invest in commercial property, are they considered “pros”?

Larry

Larry,

Are managers at McDonalds considered chefs?

I understand your point about the REITS, but wouldn't you agree that they are sanitized to the point where the returns are minimal because of the high regulations put on them and their enormous overhead?

I guess the debate goes back to what is "investing in real estate." Are you buying and holding property, or are you doing some sort of a development project? Are you going for cashflow or appreciation? I know some real estate guys can take a million dollars and double or triple their money on the right project. Recently, I have been working on a devolment project and have had to go out and search for investment partners to do the deal. I have had numerous rejections from higher-end real estate developers because their return over three years would "only" be 25% on $4 million. Their rationale? The opportunity cost for them to do my project is too high because they will make more money faster in development projects in Las Vegas or South Florida. Why spend three years to make a million dollars when you can make twice as much in half the time in Florida before you even turn a shovel load of dirt? Obviously, these guys could end up losing their shirts because of the highly speculative nature of what they are doing, but it sure makes it hard to attract people to invest in more modest projects.

Anyway, wouldn't you agree that you have the same type of thing in the stock world? My investments will be far too "sanitized" if I give my money to Fidelity or Merril Lynch, the same as a REIT, but if I seek out the right trading systems and do my homework (as you have taught me), I'll far outperform a mutual fund.

--Ben

Ben,

Yes, I do know that individuals can outperform the mutual funds. But you said "but you won't really find anyone who can consistetly make more than 20% per years trading stocks."

I don't know where that comes from but let's go with it. I know that there are mutual funds that have done 13% or better for many, many years. If there are no individuals that can do over 20% and individuals can beat mutal funds, I guess you're saying that individual stock traders can do somewhere in the 13%-20% range. Hmmm.

But I really am trying to nail down this issue about real estate returns. I keep hearing real estate investors (for some reason, real estate investors like to compare what they do with stocks, yet stock investors never compare what they do with real estate) saying that you can get these fantastic returns with real estate without taking much risk and you can get these great returns over the very long term. But I never see any empirical evidence of it. All I hear is anecdotes.

And yet I keep seeing data that says that stocks have trounced real estate over a very long period of time. So I'm just curious about the disconnect. I asked about REIT's because that's where I can find empirical evidence.

How about if I do this. I know how to read a prospectus. So if I backed out all the management fees and selling costs of a good a good REIT and looked at the long-term performance would that be a fair comparison? Or are the REIT portfolio managers just dumber than individual pros? (you compared them with McDonald's cooks) They used to come to my office when I was with Merrill and they seemed pretty smart to me. But I may have been fooled.

Some day I would really like to get to the bottom of this. With stocks it's out there for everyone to see. But with real estate, I've just been left with taking people's word for it. REIT's that invest in a similar way with expenses taken out should be in the ball park of what kind of returns have been available.

Larry

My goal is to try to nail this down before the bubble pops. Because I know after that, nobody will want to talk about it.

"I have had numerous rejections from higher-end real estate developers because their return over three years would "only" be 25% on $4 million."

By the way, if that's not evidence of a bubble I don't know what is. I used to have developers as clients. I've seen times when they'd kill for 25% over three years.

Be careful, Ben. Be really careful.

Larry

I wasn’t going to jump in on this one because I’m not a real estate guy – but when I read:

“… one thing that can't be said of stocks is that if a stock becomes worthless, you literally have nothing. Not true of solid real estate that isn't overly leveraged.”

This assumes several things – one, that you’ll actually hold a stock as it plummets all the way to zero. Two, you have that kind of money to buy property without a loan (so you’re not overly leveraged). Three, that real estate will always have at least SOME value.

But as Robert Kyosaki says in “Rich Dad” book; real estate is not an asset – it’s a liability unless you’re MAKING money from it. You will have carrying costs and property tax with real estate and if you can’t meet those costs you will either sell for a terrible loss or declare bankruptcy. People do lose money investing in what they thought was “solid real estate”!

What if you discover you’re holding a piece of land that covers a toxic dump, or that the adjoining property is going to become a pig farm or crack-house next year? The small town where I’m from used to have a violent crime rate of 0%. Now there are several Meth Labs that set up shop in residential homes – there are drug deals, shootings even murder in sleepy little neighborhoods like the one my mom lives in! Nobody saw that coming when they bought those houses a few years back.

Real estate investors think this is crazy talk and that a little sleuthing can uncover these problems – but nobody knows what they don’t know and you CAN’T know what someone else is going to do in the future!

Of course this is also true of companies – dirty CEO’s, fraudulent accounting, etc. The reason I’ve decided to stay with stocks is they are highly liquid (at least the ones I trade are). The second I smell hanky panky I dump – I can be out of ANY trade in a matter of seconds.

I know I don’t know what I don’t know! But what I DO know is where the exit is and how I get there FAST! I sacrifice leverage for nimbleness. That’s just me.

Big money can be made in real estate – I know this, I’ve seen. But I’ve never seen anyone make big bucks in ANYthing without being either shrewd or lucky. Luck usually runs out in time and being shrewd works in ANY business venture. It’s not so much a “R.E” vs. “Stk” issue as it is a personal issue.

Van Tharpe says that the search for the Holy Grail is ultimately an individual’s search within.

-ja

Speaking of reits, I have a small position in Wells REIT which is a non-leveraged portfolio. All buildings were paid for with cash and the tenents are govt or big companies with excellent credit. The pershare price is $10 and the pegged return is 7%. Recently they sold about 16% of the portfolio for a profit. They sent us our portion as a return on investment so that there are no tax consequences (see how they have my best interest at heart?).
So here's what I don't understand: we bought X shares at $10 and they sold X*.16 for $10+Y per share . We got back $10*.16. Where did the Y*.16 go? Turns out Mr. Wells doesn't own much of this reit, but he does own wells investment advisors and wells realestate management all of which get cash for services from the reit.
There is no way I can swim with sharks in any market. I'm just not a killer. I need to be a ramora eating the stuff that falls out of whales' mouths. That's why I like the COT.
h

This is a topic that's fascinating to me, i.e. the comparison of stocks with real estate. I would echo the sentiments that with RE investing you are not buying the property so much as the income statement for that property. There are essentially four ways to make money in RE: rental income, loan amortization, tax shelter, and appreciation. A savvy RE investor treats each investment as a business and makes money in at least 3 of the 4 ways mentioned. The thing that concerns me about RE today is that many people are banking on appreciation alone and are using highly leveraged financing vehicles such as interest only mortgages to buy their homes. There are going to be many people in trouble as interest rates rise and the appreciation is no longer there. Speculation is the last leg of a bubble, whatever the investment. When the dominant topic of conversation at cocktail parties is a particular investment, the smart money probably has already left. Why is it that when our 401k's double in 2 years, as was often the case in the late 90s, or when our house doubles in value over 5 years, we think we are all of the sudden genuises? I guess you can't fight human nature, all you can do is try to understand it and profit from it.

Thanks for all the great input. Larry, thanks for your feedback and advice on using caution.

I've mentioned this before on another post a while back, but I think that a very important point that I'd like to bring up is that while it is obvious there is a bubble in some areas of the country, is there a bubble in places like Amarillo, TX, Tulsa, OK, Fort Worth, TX, or Austin, TX? I think not! How could there be? The appreciation in these areas has been virtually non-existent if not negative. Yet, there is something that troubles me and that is the fact that markets in these areas are largely being driven by a construction boom of new homes.

This leads me to a probing question... Is there a bubble in low-income, (Section 8), blue-collar areas that produce high cashflow and NO APPRECIATION? I'm not talking about slums here, either, I'm talking about areas where hard-working people live, but just don't make a lot of money.

I don't think there is a bubble in these areas..... but if there is, the whole refi-boom/new constuction boom/economy driven by people taking money out of their homes to go spend rather than invest, has set our economy up for a doomsday scenario.

If you invest in real estate for appreciation rather than cashflow, you are merely gambling at this stage in the game.

Herein lies one of the biggest advantages of stocks over real estate, and that is your ability to get out quick before everything crashes.

--Ben

Another thing is that those hard working people who are barely hanging on and affording section 8 housing may not be able to pay the rent after a period of recession or even faster with stagflation. Even income may not be safe if people can't pay the rent.
h