Real Estate Investing, with Tony John

I know this is supposed to be a blog about commercial property, and I’m getting there, I promise. But I’m going to continue about the sale of our residential property (hey, I’m on a roll). It does have general lessons which are relevant to commercial investing.

We bought with the plan of subdividing one block into four. But when we did detailed research, this turned out to be a bad plan. For all the reasons I explained yesterday, the retaining costs were astronomical, and we weren’t able to make money by subdivision. The main reason we bought the property turned out to be a bad one. What a disaster!

Our greatest fear had come true. Actually, it’s a collection of fears: the fear of making a mistake; the fear of doing something stupid; the fear of losing money; the fear that the naysayers, who told us that the sky will fall down, will be right (’I told you so’).

These fears are so powerful that they keep many out of property investment altogether. This is a shame.

Since I’ve been investing, I’ve done some dumb things. Some things I should have known were dumb. Other things, I couldn’t have known were dumb until I did them (Oscar Wilde: ‘Experience is the name every one gives to their mistakes’). I’ve learnt that when things go wrong, it’s not the end of the world. I’m still alive. I still have family and friends. Even when things go terribly wrong (like, when a tenant went broke owing us more than $40,000), it is not fatal.

Making a mistake with a property deal can be painful. But open any newspaper, any day of the week, and you will see that truly, there are worse things that can happen.

As it turned out, while we held our residential property, the market went ballistic, and we made more than ten times our money. Not a bad outcome for this property ‘disaster’.

So, do your research. Do as much as you can. But more importantly, have the courage to act and make mistakes. Otherwise, nothing will happen.

I was given a dictionary of quotations for Christmas, so if you’ll indulge me quoting General David Shoup: ‘The galleries are full of critics. They play no ball, they fight no fights. They make no mistakes because they attempt nothing. Down in the arena are the doers. They make mistakes because they try many things. The man who makes no mistakes lacks boldness and the spirit of adventure. He is the one who never tries anything. His is the brake on the wheel of progress. And yet it cannot be truly said he makes no mistakes, because his biggest mistake is the very fact that he tries nothing, does nothing, except criticize those who do things.’

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I’m reminded of a few other factors in our decision to sell the residential property.

It was an old house, on a rather large block. At the time of purchase, we were looking for a property where we could make a rapid capital growth, through what Dolf de Roos calls a ‘twist’. A twist is where you make some fast, relatively cheap changes to the property, to increase its value. In this way, you increase your value much quicker than if you simply wait for the market to go up. Our twist on this property was that we expected to be able to subdivide the block into three or four smaller blocks. After purchase, we sat on the property for several years. Finally, when we surveyed the block, and began to proceed with subdivision, we found problems.

Firstly, the block was very steep. This meant that a lot of retaining was required, to produce level, buildable blocks.

Secondly, the sewer line was mid-way through the block, in terms of elevation. This meant that one or two of the blocks would be below the sewer line. People don’t like sewerage flowing into their house, so this was a problem. We would have to significantly elevate the lower blocks to put them above the sewer line, which would require much higher retaining walls than anticipated.

Thirdly, the land at the bottom of the block was almost permanently soggy, thanks to a natural spring, so there were serious engineering questions about whether that much retaining was even possible.

In short, where we had done our numbers assuming there would be a $20k earthworks cost per block, our advice indicated it was more likely to be $100k per block! These new numbers forced us to change our plan. We decided not to subdivide. We needed a new plan.

I’ve heard people say that every day, you should be happy to buy each investment in your portfolio again at fair market price. If you wouldn’t be happy to buy it back, why do you own it? That makes sense if the market is perfectly efficient, and there are no selling or buying overheads. When there’s a cost involved with swapping investments, it’s not quite so simple, but the principle still applies: if an investment is not going as well as expected, question whether it’s worth holding on to.

Now, with our new information about retaining wall costs, the investment had changed. We bought with the intention of rapidly increasing its value through subdivision, but now we had learnt that this would not work. Instead, the only growth we got was a general market shift, while we scratched our heads watching. Admittedly it was a significant shift, but we no longer had any plan for how to gain a further (rapid) gain in value, which was one of our aims for each investment.

We felt that for a rapid capital gain, our money would be better elsewhere. Maybe it was time to sell this property.

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Some of you may have followed my earlier website, where I wrote articles about commercial property investment. Well, last year I made some purchases which would make for great articles, but I got so busy with the deals themselves that I neglected to write. So I thought a blog might be a better way to communicate. It will help me to write about property more regularly.

Usually at the start of a new calendar year, I spend some time evaluating my property activities. This is to help me plan for the new year, but also to acknowledge any ground I’ve taken.

To summarize last year: I bought two properties, and sold one.

The house I sold was the only residential property in my portfolio. So now, apart from my own house that I live in, I own purely commercial property. This is not to say that there is anything wrong with residential property - I just prefer commercial, and wanted to focus on it.

The house in question was bought in 2003 for $240k. It sold almost exactly four years later for $680k. Turning $240k into $680k is a nice return, but of course, with property it’s even better than that, because of leverage. Originally, I put in 10%, and borrowed the other 90%. That is, I put in $24k. So I turned $24k into more than $300k, by the time all costs and taxes were paid. That’s well over ten times my money in four years. Incidentally, that was the first property I bought after going on a Dolf de Roos real estate investing course in 2002. Thanks Dolf!

I can’t take much credit for the success of this deal - we have experienced a significant property boom where I live. I guess some credit is due for actually having the courage to buy the property in the first place. I could have been watching TV, instead of running around looking at properties, submitting offers, and finding finance.

Now, those of you who are familiar with Dolf de Roos will have heard how he doesn’t sell properties. It’s one of his rules. In general, I strongly agree with him. There are many good reasons to avoid selling property. So why did we sell this property? Well, a few reasons:

Firstly, this was the only property in the portfolio which was costing me money every month. So, while it had excellent capital growth, it was bad from a cashflow point-of-view.

Secondly, it was the only residential property in the portfolio. It took more management: finding tenants, fixing things, paying bills, worrying about the garden. It took a lot of work - more than the commercial properties. I wanted to make my life easier, and for me this meant focusing on commercial property in future.

Thirdly, I wanted the money to get into another deal. Now that’s not a good enough reason to sell. Why sell when you can refinance? Well, I was having trouble getting banks to value the property properly. When we were having it appraised by agents for $500k, the bank officially valued it at $320k. We couldn’t access all that equity until a bank would agree that the equity existed. By definition, selling actually establishes market value, and a bank, or a valuer, can no longer say “it’s not worth that much”. So selling allowed us to access a whole lot of equity which we were having trouble accessing.

Now, because of the costs involved with selling, it only makes sense to get out of one deal and into another, if you’re sure the second deal is better than the first. In this case, I felt that this was true. I felt that the property had grown incredibly for several years, and was due for a lengthy plateau (so far, this has been true since I sold). I felt that the new deal would give me some rapid growth. So that is the final reason.

All of these reasons, together, were enough for me to break my usual ‘do not sell property’ rule.

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