One of the mantras of the FIRE (financial independence, retire early) community is the owning of income property. With rare exception, investors do it all wrong, taking on extraordinary risk for no reason.
Side gigs are handled the same way. Whether you run a full-fledged business or a side gig, you probably make the same mistake real estate investor’s do.
Americans love to invest at home. There is a tendency for people from all countries to focus their investment dollars in the domestic market. The comfort of understanding the local business climate clouds the investor’s judgment. American’s are the worst. For decades I have recommended 70% S&P 500 index fund/ total market index fund and 30% international index funds for my American clients. This is still weighted heavily toward U.S. companies. The diversification in broad-based index funds with a third of the portfolio in international is a good mix in my opinion. Small business owners and real estate investors rarely make such a sound decision.
Stay Close to Home
I am just as guilty on this issue as you are. When I started my real estate empire (I owned way to darn much) I bought locally only. When I needed more opportunities to keep the empire growing I expanded the circle from the local city to the county to NE Wisconsin. Hundreds of buildings and not a one was outside NE Wisconsin! Stupid.
I see the same thing today. People want some side income to accelerate their retirement date so they buy a couple rentals locally. Unless you are lucky enough to live in a market where real estate prices are conducive to profits for investors, you are taking extraordinary risk to keep things close to home. Most markets are not prime for income property investment. It takes work finding the right property at the right price in the right community.
Imagine owning income property in Detroit in 2008. Your idea of diversification was to buy a handful of properties around town. Then reality set in. Real estate prices collapsed along with the local economy. Many areas of the city never came back. If you were lucky you might have owned properties in “good” parts of the city. Then again, areas of town where most income properties reside are not always the “best” parts of town.
Luck plays a role in our success. In my instance I invested heavily in the local market and sold before things went south. My idea to sell was based upon burnout, not some high level of intelligence of when to buy and sell real estate.
Spread It Out
Most investment property owners in my office make the same mistake I did. It usually works out because NE Wisconsin has been a forgiving real estate market for the most part. RE values declined around 2008, but rents and occupancy rates stayed solid.
A few clients are smarter than me. They invest in income property over a national footprint. Today, most markets are not priced for income property ownership. The numbers just don’t work. A serious investor understands her local market might lack opportunity for investment. If she is smart she will look to other markets for opportunities.
Keeping it close to home is comfort food to the investor’s mind. We can visit our property anytime with little effort. We can save money by doing repairs and maintenance ourselves. We can manage our own property, too. These actions bring down the cost of ownership while valuing your time at a low level. (Remember, every property cash flows if you pay cash for the property and do all the work yourself.)
Smart investors hire the work and management done. Smart investors invest and refuse the siren’s call of doing every job themselves. (Jack of all trades, master of none.)
Investing in communities where rents justify the purchase price of a property is vital to successful real estate investment.
The longer I write this blog, the more people I meet who own several properties in several areas of the country. The wide distribution of their holdings increases the chances they will always be successful in this area of their portfolio. Issues with one property will not spill into other properties. Regulation changes in one city will only affect one property, not the entire portfolio.
Best of all, by having RE investments a great distance from home, the tendency to “take care of it yourself” is diminished. Property managers are required when investments are spread out. Like an index fund, you let someone else handle the bull work. You are the investor only. You buy right and let the managers do their job while you buy more awesome investments.
Do as I Say, Not as I Do
“Forgive me Father, for I have sinned.”
It has been a while since I went to confession. Actually, I am not Catholic so I never went to confession so now is a good time to clear my conscious of past sins.
You heard my confession on concentrated real estate investments. It gets worse. Business owners focus on local markets more than RE investors! Sometimes it works out. Then again, sometimes 2008 purges a great number of businesses, destroying a small business owner’s lifetime of work.
Once again I was lucky. I started my practice and focused solely on the local market. In the early days any out of state tax returns happened by accident. By 2000 I knew this was an issue. I expanded my reach to all parts of the country. Little did I realize the importance of such a decision. By increasing my skills preparing taxes in all the states, I prepared myself for the day when this blog would deluge my office with non-local tax returns. Good thing I had experience to draw from.
The hard part for my firm is hiring people qualified to do such returns. Employees make the same mistake of limiting their skill sets to a local market. Then reality sets in. Mix and repeat and you have a clear picture of the timeline of most people’s lives.
By 2005, nearly a third of my tax clients were outside the local area serviced by my practice. Today over half my clients are non-local.
Show Me the Money
Why do I share this information? Simply, profits. The comfort gained by remaining local only not only increases risk of failure, it keeps profits lower.
We will use my practice as an example again. Preparation fees are quite reasonable in my vicinity. This is great for clients, but terrible for the owner if you want to earn a decent living doing what you love. Certain clients are more profitable than others. Other areas of the country have better preparation fees.
Let me be clear, this is not about screwing the client over profits! Higher fees allow me to hire more people at a higher wage, meaning I can attract more qualified tax professionals. Even offering a higher wage doesn’t guarantee top-notch tax pros. God knows I have struggled finding people performing at my level in the tax arena. (Imagine the difficulty in finding high level professionals for seasonal part-time work!) But if I don’t offer the higher wage (and have the resources to do so) I will never attract AND keep high quality people.
My fees are not much different for clients in different states. My fees ARE higher when people have larger returns that include multiple states. Revenues and profits rise because I have a much larger pool of profitable clients to draw from. A local plant closure will affect only a few clients. As a result my firm is more recession proof than ever before.
Readers of this blog know I tend to be a slow learner. I want to hold on to preconceived notions as long as I can before fessing up. My real estate holdings and tax practice concentrated efforts locally. Not so with this blog.
Admittedly, it is easier to think with a larger geographical footprint with a blog. Readers come from all corners of the world. I now have tax clients from Russia, Peru, Spain, the United Kingdom, Canada, Australia and more. Understand, these are Americans living abroad. Over diversification can spread a firm too thin. I do U.S. taxes only! And a lot of Americans live outside the U.S.
Can you image how stupid I would look if I wrote this blog for the local community only? My readership could be counted on fingers and toes. Local folks don’t always appreciate my humor for which I humbly refuse to apologize. The entire population of the county I live in is under 50,000. My monthly page views are approaching that level.
Building a wall around yourself only limits opportunities for you. Your competitors will not subscribe to such limitations. To build a secure investment property portfolio or business you need to cast a net. The larger the net the more fish you will catch. It’s a simple law of physics.
I can see it already. You, my dear readers, will be doing some soul searching today as you review your investments, side gig or business. It’s okay. I was there, too. I cleared a path as I stretched out into the great beyond. I’ll be waiting.
Wednesday 24th of May 2017
I wanted to get into real estate (to broaden my alternative side of my portfolio. I am at 6% but want to be at 10%). After much research I went with an eREIT. I know I have no available attention bandwidth to do anything but select a good provider and have them invest according to a plan. Sometimes you have to go with the experts.
Friday 12th of May 2017
Having had multiple generation of family members that owned rental houses, I cannot see why anyone would want to deal with the hassle of it.
Friday 12th of May 2017
I've often thought about this. It's funny to hear about diversification is vital to returns and then see people throw so much money into one pot. It's counter intuitive at best, more likely counter productive.
And your point about being the capitalist is spot on as well. The whole point is to let the money do your work, and set yourself up so that it provides more income than your manual labor. A rentier, if you will. You almost need to be detached to allow clarity in your decisions so that you are not jaded by the emotion that comes with these things. It's a weird cognitive bias that people have, that makes them want to be able to see and touch everything, otherwise it's not true.
We've started a business that has to be local, as it serves clients in their own homes. But we are looking constantly at ways of diversifying and expanding the reach. Not there yet, but trying and attempting to figure it out.