Deciding If an Opportunity Is Right for You

Although the decision to invest or not is binary, the question really boils down to, “Is this the right investment for me right now?”

This post originally appeared on the Hermit Haus Redevelopment website on 2018-11-27.

Your reason for investing should drive the type(s) of investment(s) you invest in. To oversimplify a bit, there are two investment strategies: building wealth and creating income. In the real world, these two strategies are not mutually exclusive. Where you are in life will influence your strategic choice.

Let’s look at an example rental house that requires no initial out of pocket investment. We’ll assume the debt on this property covers the initial renovation and all the costs of acquisition. We’ll even assume the house provides positive cash flow from the time it’s rentable—$50 each month after allowances for debt service, taxes, insurance, vacancy, maintenance, and capital replacement (big ticket items like HVAC units that can’t be expensed off in one year).

Multiple Perspectives

Here are a few ways to look at this opportunity:

What’s the Difference Between Distress and Motivation?

If you have almost $2-million available, have friends in New Zealand, and love the views as much as I do, this village may be the right investment for you. Check out the listing on OneAgency. They have lots more exciting pix. Photo by: OneAgency

This post originally appeared on the Hermit Haus Redevelopment website on 2018-11-19.

You know we’re always looking for our next redevelopment opportunity. We’ve talked about distressed properties and the opportunities they present if you can look past their challenges. I’ve also talked about how the numbers have to make sense and we buy only a small percentage of the distressed properties we look at.

Why is that?

A distressed property is only one indication of what may be a motivated seller. The level of seller motivation rather than the level of property distress is the real driver of what makes a property we can buy.

Some of the things that may motivate an owner to sell include:

• Physical distress arising from deferred maintenance or the inability to pay for needed repairs
• Lack of interest in an inherited property or a second home the seller just doesn’t want to deal with
• Landlord fatigue that comes from not understanding how to manage rental properties and tenants or when the landlord moves away
• Financial distress arising form health problems, job loss, or financial mismanagement

In any of those cases we can help the seller overcome a (hopefully) temporary problem by buying their property and taking on the headaches they can’t or don’t want to deal with.

One of the challenges in our business is understanding the difference between distress and motivation. This article is one of the best example examples of how to tell the difference between distress and motivation. Here are a few salient facts if you don’t want to read the original article:

• An entire village near Lake Waitaki in New Zealand is for sale with an asking price of $1.8-million.
• Once home to almost 3,000 people, it has been “mostly vacant” for almost 30 years.
• In 1995, the village was awarded historically protected state to prevent its demolition.
• The current owners bought the village in 2011 to use as a corporate retreat center.
• When those plans failed, they put the it back on the market in 2015, but it has not sold as of this writing.
• Recent changes to New Zealand laws prohibit foreign investors from buying homes, limiting the pool of potential buyers for this property.

So far, that sounds like a classic distressed property, even without considering the condition of the homes and the lodge it comprises. I know I would be motivated to sell if I had almost $2-million tied up in an investment that generated no income and had been on the market for three years.

But is the current owner motivated?

“It’s simply a matter of waiting for a person to pay the price we are looking for,” is the definition of an unmotivated seller?

So, no. Even though Suna and I have discussed eventually retiring in New Zealand, we would have to walk away from this property.

I’m Making Them Birds

While you can't just paint over all your mistakes or confusion, you can choose how you let them affect your mindset. Photo by Suna

This post originally appeared on the Hermit Haus Redevelopment website on 2018-10-06 .

Starting with Why: Every day in business, you encounter things that annoy, frustrate, or confuse you. I wanted to talk about how I've chosen to accept some of the things I cannot change.

One of the more frustrating points about running a business is that you can either know what it’s really worth or keep accurate books for taxes. And never the twain shall meet.

Businesses are punished on their balance sheets for being good negotiators. At the same time, they are required to take totally fallacious “expenses” while being forbidden from taking real ones. Here’s a few examples:

• Cost basis
• Depreciation
• Capitalized expenses

Cost Basis

We recently bought an asset from a motivated seller for much less than its appraised value. We got our loan based on the appraised value, but we are required to book the building at the purchase price. As Zacks explains:

Under corporate accounting standards, when a company acquires an asset, it puts that asset on its balance sheet with a value equal to its "historical cost" – what the company paid for it. If it's a fixed asset with a limited lifespan, such as a building or a piece of equipment, the company gradually depreciates that asset over time, which reduces its balance sheet value. Even if the company has good reason to believe that an asset has risen in value, it still cannot increase that asset's "book value," the value reported on the balance sheet.

So we have a $120-thousand building we have to book as an $80-thousand asset. And we have an $85-thousand loan against that asset. So our books show us with $5-thousand of negative equity instead of $15-thousand it positive equity. Our books show us making a stupid purchasing decision instead of a really good one.

Depreciation

Now factor in depreciation. Nobody doubts that assets (be they machines or real estate) eventually wear out. Rather than qualifying that wearing out, businesses are required to take what I like to call “stylized depreciation.” (“Stylized” sounds so much better than “fictional.” Doesn’t it?) I think the real term is “standard depreciation.”

The IRS assumes a 39 year life for commercial buildings and a 27.5 year life for residential rentals. For the asset I mentioned above, we’re required to write down 1/30 (2.654%) of the $74-thousand valuation of the building—not the land—every year until we eventually show no value for the asset except the cost of the raw land at purchase. And remember depreciation affects value. So our building will be worth about $1,900 less every year. It will show negative equity for 10 to 15 years.

We must really suck at business! We don't, but that's the story our books will continue to tell about this building.

The only good thing I have to say about depreciation is that it also reduces my net taxable income. Maybe not as much as my actual expenses would if they were not capitalized, but every little bit helps.

Capitalized Expenses

Capitalized expenses are pretty much what they sound like—expenses businesses are required to show as assets. Sometimes that makes sense. One of the first things we’re going to do with our new building is to spend about $6K on a new HVAC system. That’s money we have to spend (an expense) but it also pays for an asset that should last a few years—probably longer than its depreciation period. That means it increases the value of our building until it doesn’t. (I don’t know how long that is, which is why we pay a good CPA firm lots of money every year. Luckily, I think that counts as an expense.)

But sometimes it doesn’t make sense to capitalize expense. All or the settlement costs, including legal fees, we paid to buy that building are capitalized. We spent the money on a one-time service with no ongoing value, but nope! That’s an asset, not an expense.

All these (and other) factors encourage businesses to churn their holdings. If you hold a building long enough, it looks like you are broke no matter how much the building is actually worth. But if you churn your holdings, you can make it look like your business is growing, even if you pay too much.

As I write this post, I’m wearing a T-shirt with a picture of Bob Ross painting. The caption talks about repainting mistakes to make them into birds. So rather than get all “Back in Black” about these accounting idiosyncrasies that make it so hard to know how well my businesses are doing, I’m making them birds. I like birds. Birds make sense.

Solving Problems

My mom used to say, "When you point at someone else, you have three fingers pointing back at you." That's the best argument for an internal locus of control I've ever heard.

This post originally appeared on the Hermit Haus Redevelopment website on 2018-06-23.

Do you ever feel that the universe is conspiring against you? No matter what happens, something goes wrong so that it doesn't work out the way you want?

Every now and then, we all encounter situations like this. How we react to them is usually based on what psychologists call "locus of control."

People with a strongly internal locus of control:

• Believe they are fully in charge of their destiny
• Take responsibility for their actions and mistakes
• Actively take corrective actions

People with a strongly external locus of control believe that their fate is in the hands of fate (or something else). The events in their lives "just happen to them."

Most of us fall somewhere along the line between these two extremes.

Right now, we have a contractor we are having a lot of trouble getting paid. Our goal is to pay our contractors fairly and quickly on completion of the job. We've sent two checks to this contractor, both of which have gotten lost in the mail. (He's in a distant city, and the work was done on one of our investment properties there.) He did his work promptly and well. We tried to pay quickly, but....

Last night we tried to wire the money to him, but his bank rejected the transfer. We have verified all of the information twice, even three or four times now.

I have a very internal locus of control, but I'm starting to feel that this situation is out of my hands.

What would you do to resolve this problem?

The Waiting Game

When you’re not confident the market will continue to rise, it’s better to be cautious about acquisitions. What do you think the future holds?

This post originally appeared on the Hermit Haus Redevelopment website on 2018-06-18.

I’m back.

I haven’t posted anything for a while, mainly because I haven’t felt like I had anything constructive to say. You see, we’ve been selling off our inventory, as Suna and been talking about. But we haven’t been buying anything. Not since December.

Other people were buying things, but we kept walking away without buying or letting other people out bid us. That made me feel as if it were my fault. I must have been doing something wrong.

But I wasn’t.

You see, the only thing worse than no deal is a bad deal, and bad deals are all we’ve been encountering for the past few months. And I’m not the only one.

According to Sovereignman, Warren Buffet has been going through the same dry spell.

So… here is the most successful investor in modern history who:

1. Didn’t buy anything in 2017;
2. Is stockpiling a mountain of cash;
3. Is now selling an asset that he would typically hold forever, because another company made an absurdly high offer for the business

...[I]t seems pretty clear from Buffett’s actions that it might be a good time to take some money off the table and wait patiently for the compelling opportunities yet to come.

Buffet himself has noted that he walks away from more than 100 “opportunities” for each deal he closes.

That got me thinking about my friend Shenoah Grove who points out that the Austin market is now almost ten years into our five year business cycle. And even though the market doesn’t show any signs of slowing down, you have to worry if it is too hot.

Following Buffet’s lead, I think it’s time to wait for deals that are so compelling that they’ll fund themselves or make money even if the market turns down. We may even have some of those on the horizon.

Stay tuned. Or better yet, help us find a really good deal. We believe in sharing the wealth.

Predicting the Real Estate Market

Economic Base Theory holds that basic industries and support industries are requisite for the population growth that spurs residential and retail development.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-02-12.

When I wasn’t watching the rat race or helping prepare for the educational events at the Dallas conference this week, I was taking notes on what the speakers were saying. My biggest takeaway was to learn about economic base theory (EBT). Economist Robert Murray Haig first put forward the theory in 1928. It essentially says that jobs lead the economy both when it is getting stronger and when it is getting weaker. This is something that we all have intuited, but it was good to have this feeling stated overtly and have the underlying science behind it explained.

I won’t go into all that, but I do want to provide the sequence and define some of the terms used in the theory.

EBT holds that development happens in a specific order for specific reasons.

In Houston, the Medical Center has become a basic industry, providing more hospital services than the local economy consumes. People come from around the world. Photo source: Wikipedia

1. Basic industrial development

A basic industry generates more of a “product” that is required by the local economy. The surplus is exported. Exporting creates more jobs than the local economy would otherwise support. Basic industries create jobs beyond what the local economy would generate without them.

The important thing to remember is that manufacturing is only one type of exportable industry. In Orlando, tourism is a basic industry. In Omaha, it’s insurance. Real estate is not a basic industry because it can’t be exported, but real estate education can be. For most of our history, agriculture was a basic industry.

2. Support industries

Support industries such as accounting and consulting move in once the basic industry grows to the point where it becomes able to outsource these functions more efficiently than it can perform them in-house. Support industries equate to even more job creation.

Industrial development brings in jobs at all pay grades. Some of the new people will demand single-family homes of various prices. Others will drive demand for multifamily development. If you’re going to invest in real estate, you must understand the basic industries that support the real estate market where you work.

3. Residential development

The basic and support industrial job growth create demand for additional housing once they have demonstrated that the jobs are there to stay (whatever that means). Workers like to live near where they work.

4. Retail development

As families move into the area to take advantage of the job growth, they need to buy things. Again, most consumers prefer not to travel very far to buy groceries or clothing.

In rural areas, the school district often is the largest employer. Education is like retail in that it depends on the strength of the local economy to survive. If the basic industry goes away, both retail and education will have to downsize and may eventually become completely unsupportable.

Finally, the advent of internet commerce slows down the demand for retail development and speeds up the deterioration of the retail market if a basic industry moves out without replacement. In fact, you may now see demand for retail space decrease even in a stable economy.

This model can help predict the direction a real estate market will move. It is not 100% predictive because the real estate market is imperfect in that everyone is working with incomplete information, each individual property—single family, multifamily, commercial, or industrial—is unique, and a single seller controls the availability of each property. Nevertheless, we all need to understand the direction our local economies, and therefore our local real estate markets, are moving.

 

Pre Event Report

Illusions on a Double Dimple Photo source: Amazon

Ben, the two of us need look no more

We both found what we’ve been looking for

—Don Black

Weather or Not

I made it to Frisco after taking almost four hours for what should’ve been a 2.5 hour drive, according to The Googles. Waco was probably the most interesting part of the drive. I had to go through a thunderstorm that was like driving through a tropical storm. There were times I couldn’t see the car in front of me, even though the traffic on I-35. It slowed to almost 35 miles an hour.

By the time I made it to the north side of Waco, I had driven out of the rain. The roads were not dry, and the sky looked like it could start to pour again at any second. But it had still been free of the rain long enough for the automatic windshield wipers to stop for a couple of minutes. Then my phone went off in panic mode. “Warning! Warning! Warning! Severe thunderstorm warning for the next 18 minutes. Really helpful, Siri.”

So anyway I managed to get to the event and get checked in to help with the event. My job tonight was to attach badge holders to the end of lanyards, and I did a few hundred of those. Then we broke for the evening and I went to the other hotel because I hadn’t been able to get booked at the Hilton tonight.

I got checked in at the other hotel, which shall remain nameless for reasons you shall see. I went up to the room and found it to be very very nice, if not worth the price that I’m having to pay for it. But that’s what happens when you go to a conference and have to get a hotel in a downtown area.

Rats have their place in nature and science. We don’t have to worry too much about them at the Hermits’ Rest Ranch because we have three dogs and numerous wild raptors who all love rats. Photo source: The Scientist

Ratatouille

By that time, I was hungry for dinner. I went downstairs to the restaurant, and it’s pretty nice and reasonably priced—for a hotel. The waitress was really personable and made me laugh. She took my order and went away. While I was waiting for my food to come out a fairly large gray rat scampered across the restaurant in front of me. I was tired, so I rubed my eyes thinking, “Did I really just see a rat run across the restaurant?”

About the time I convinced myself that I didn’t see what I saw, the rat ran back across the other direction. So when the waitress came by with my drink and to take my order, I told her, “By the way you might want to tell your manager I just saw a rat run across there.” When she realized I was serious, she burst out laughing, “Oh no. Now I have to set traps for it.”

She then left to get my drink refill, and I heard the guys in the bar laughing all the way across the hotel. Mind you, it wasn’t really empty in the restaurant, just slow. Like you expect from a hotel restaurant on a Monday night.

She came back and told me that she told the guys in the bar, and they were having a good time about it. She also told me she poured my second drink so it would be comped. Then she left to check on my order and the rat made the third appearance. I told the waitress about this when she came back, and she told the manager who reiterated that she had to set traps for it now.

Everything was settling down when the waitress went to get my food. She came back and she was laughing so hard she could hardly walk. She said the rat had made it to the kitchen and the three big burly guys in there were all up on the counter yelling that “there’s a bunch of them on the floor and there’s only one.” She says, “Frederico says, ‘He’s been here a long time. He is gray. He’s got lots of gray hair.’ I couldn’t convince him that they’re all gray.”

She and I talked for a long time about how she ended up here and things we have in common. Her husband is a national record producer, and they live in Junction. She came up here to open the hotel and his ended up staying for almost 7 years. I told her that I spent 10 years on a three month contract once. This was a very enjoyable and to what had been a stressful then boring day.

Find your hope and laughter where you can.

Because I was unable to write much this week, Suna adapted this post for republication on the Hermit Haus site on 2018-02-09.

 

Fortune Cookie Humor

A fortune cookie

If your friend wants to learn to drive, don’t stand in the way.

For the first time in a long, long time, I got a funny fortune cookie.

Dream About Missing the Old Office

Zombie image source: Fun Lover What doesn’t kill you
often makes you wish it had.

I am posting this much later than it is dated while going through some old journals. I list the souces as a dream about one of my least favorite parts of the corporate world. Apparently, it left lasting scars.

SELF
I’m going down to the crapateria to grab a bite.

OTHER
That won’t…

SELF
Kill me?

OTHER
No, but it will make you suffer.

SELF
That will have to do.

Happy Birthday, Ralph

We did have another visitor yesterday. Elaine stopped by the ranch on her way from Austin to Houston. Photo by: Suna

Happy birthday to you. You live in a zoo.

You look like a monkey and smell like one, too.

—Childhood parody

Yesterday we celebrated Ralph’s 61st birthday, which actually occurs sometime around Tuesday. When it actually happens depends on how you look at it. Since he was born in Tasmania, he could celebrate more than 12 hours ahead of when he would here in the US, starting the day before. In fact, he says he has a 44 hour birthday.

As usual, he seems to of spent most of the day cooking in preparation for the party. He made what he calls a sweet and sour dish, but you can’t really tell. It didn’t taste like any sweet and sour I’ve ever had, but it was good. Also made curry dish which everyone that we would eat it said was good. While I find his crew dishes more edible than most, I avoid them when possible.

Sue Ann and Canova brought dessert, all of which got eaten.

Also in attendance were Duffy, one of his friends whose name I don’t remember, and Robert Palmer—not the singer; he’s dead, and we don’t really care for zombies showing up at our celebrations.

After dinner, Duffy regaled us with funny stories about the time he owned a rhesus monkey. We drink a lot of wine and went home.