At the beginning of the 19th Century, the French scientist, Marquis de Laplace decided that since scientific laws enabled us to accurately predict the movements of the sun, stars and planets, we should also be able to predict everything in the universe, human behavior included. Some people still believe that. Albert Einstein, took a different approach when he wrote, “The universe is not only queerer than we suppose. It’s queerer than we can suppose.”
Put ten MBAs in a room (they still believe Laplace) and tell them to predict the future of the economy and especially rental property in America, and they will come up not with ten different answers, but twenty. Why? Each of them will hedge his or her bets by predicting a variant of his or her first prediction. Just look at what experts have done to us so far.
Their methods provide us a glimpse into the gross unpredictability of human behavior and what happens when we rely on experts’ advice to do our real estate investment planning. Five years ago, the experts were predicting, and using other people’s money to back up their prediction, that the economy would continue to boom sometime through the year 3257, that the Dow would hit 13 billion, and that we would have trouble filling all the jobs that would open up. That worked, didn’t it?
Instead, the economy boomed until sometime in the year 2006, the Dow dropped to 6627 from a high of 14,067 (down 53 percent) and unemployment jumped to around 15 percent counting those who are out of work and have quit looking. Plus, the housing market collapsed and foreclosures rose to the worst since the Great Depression. Not only did the bubble burst, it got its gelatinous goo all over everything.
This column is about planning. And it’s also a warning. If you don’t plan, your real estate investments are at risk. If you listen to and believe the experts, your real estate investments may be more at risk.
Considering that both of those statements seem contradictory, how do real estate investors plan and expect to come out ahead? One of the surest ways to plan is to first know your market. There is an “irrational exuberance” among some would-be investors today because housing prices are so low. But what is low and what is low enough?
If you know your market, you will know what is low enough. You will know at what point you can make a reasonable profit on an investment property. I see people writing and hear people talking even now about how they just bought five rental properties. Well, good. So what? The question we always need to ask about rental properties is if they actually make any money.
The idea behind owning investment real estate is that we earn a net profit on it. If we don’t, why own it? Just because something is cheap doesn’t mean it will turn a profit. But if we know the market where we are thinking about investing, we will know if the “cheap” property is actually “cheap” or a hole to throw money into.
The first step for success in planning for real estate investing is to know the market we invest in. We need to know neighborhoods, communities and properties. We need to know where things are going to happen in the market, both good and bad. Once we know that, we can plan what makes sense to invest in. We have solid information that will help us make informed decisions ourselves, not relying on experts who always hedge their bets.
Will a complete knowledge of our markets ensure success? No it won’t, because first, we can never have complete knowledge because we can’t know everything, and second because nothing can ensure success; but you can pay attention. And if you do that, you will have about a seven-eighths-mile edge in the one-mile race for real estate success. A client of mine predicted the real estate crash four years ago. He paid attention to any number of factors that would affect the real estate market including questionable loans by lenders. To back up his belief, he sold his million dollar home and moved into a rental house. In addition to his saving 75 percent in housing costs, he is waiting for the market to crash so he can buy another home just like the one he sold for half of what it would have sold for in 2005.
He spread his message of doom and gloom to the real estate investment club he belonged to and was roundly scorned. Two years later the scorners were crying that they were about to file bankruptcy and were in such desperate straits that some couldn’t even buy food. Those investors had listened to the experts who said that real estate would go up forever. They bought properties using hot air, hokum money and hope, and ended up losing everything including their leased Mercedes.
Too many people are like the Marquis de Laplace and expect that some expert can accurately predict human and market behavior. No, there is no expert who can do that. All experts can do is collect consulting fees for statistics that can predict nothing accurately. You can predict better than the “experts” in your own market and actually make money in any market if you pay attention, study carefully and plan for multiple contingencies.
The multiple contingencies are what you need to plan for. What do I do if X happens? And how about if Y happens? Then there’s Z; hmm, don’t forget about that. Never count on a plan working just the way you thought it would or should. Too many unforeseen variables will rear their ugly torsos and plant themselves in the way of everything working out as you planned. As Einstein wrote, “The universe is not only queerer than we suppose. It’s queerer than we can suppose.” Plan for unpredictable occurrences, but know your market.