Real Estate Investing, with Tony John

I previously explained how the quality of your tenant can affect your property value. This happens when a valuer (and presumably, the market), can see that you have a better, more secure, more reliable tenant, and decides that the property is worth paying more for. People will pay more to get a lower risk. That’s why we have a different capitalization rates in different areas.

Why do we care about this? Because a higher valuation gives you greater equity, which makes it easier to buy your next property. I keep drumming that in, because it’s so important to keep remembering why we care about this.

But you know what? Tenant quality is even more important than that. There are intangible benefits to having a good tenant. These benefits may not be reflected in a valuation report. They may not affect the value of your property to the outside world. But they sure make a difference to your life.

I’ve had two commercial properties with struggling tenants. Both of them fell behind in their rent payments.

On a human level, these stories are very sad. Nobody wants to fall behind in their payments. These tenants are not bums, they are trying to be responsible members of the business community. They bought the business with high hopes of making good money. But now they are making a loss, for whatever reason. When you meet them, you can see the signs of stress and shame in their face.

At a business level, the situation is a disaster that can not be allowed to continue. I rely on their rents to pay interest to the bank. If they don’t pay, I risk becoming the same as them, unable to meet my financial obligations to the bank.

Both times, I found myself worrying. Worrying whether they would pay rent. Worrying whether I could pay my interest bill. Worrying if I would need to find a new tenant, and whether I could afford an empty building. A struggling tenant affected my peace-of-mind.

In the end, both tenants ended up selling their businesses, and moving on in life. One paid me back completely what he owed, the other paid me back 30 cents in the dollar.

Luckily, the new owners of both businesses are thriving. The new tenants have never missed a rent payment, are profitable, and are happy.

The benefit to me is that I know that I will be paid each month. I don’t lie awake, wondering what will happen if they don’t pay rent. This is a huge benefit to me. Having a tenant that you worry about is a real drain, mentally. Replacing a struggling tenant with a good operator, who you can rely on, makes a big difference to the quality of your life.

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I was looking through one of my Valuation Reports the other day, and found a nice quote which demonstrates how valuers evaluate commercial real estate.

“Well located suburban properties, securely leased to national tenants, with modern building improvements, represent prime property investments and sell on yields of between 6.5% and 8.0%. These properties are in very strong demand with an oversupply of buyers and an undersupply of stock for sale.

Properties that do not possess all of these attributes but have reasonable lease covenants of say 5 years, are selling on returns of 8.5% to 9.5%, depending upon location and building quality. There has been generally good demand for these investment properties.”

Now, your mileage will vary - the numbers themselves will change from region to region. But the key is this: a better quality tenant will give you a more valuable property.

You see, it’s all about risk.

With a big, national company, your tenant has a strong financial backing, which means you can have a lot of confidence in your income.

With a smaller tenant, no matter how well-intentioned or business-smart they are, there is inherently more risk. One big lawsuit, one marital split, one fraudulent employee, or some unexpected occurrence, and their business (consequently, your income) is under threat.

People are willing to pay more for a lower risk.

Back to my valuation report. The valuer went on to value my property using a capitalization rate of 8.75%. This reflected the fact that my property had a single, independent operator.

Now, I’ve got a chance to re-lease the building, and I’m going after a national tenant.

Here’s the math, assuming the valuer chooses the mid-point of the respective ranges:

Let’s say my property brings in $50,000 per year in rent.

With a lower-quality tenant, my property gets valued with a capitalization rate of 9%, giving it a value of $556,000.

With a national tenant, my property gets valued with a capitalization rate of 7.25%, giving it a value of $690,000.

So, switching from a standard, independent tenant, to a strong national tenant will make me $134,000. Even if the rent doesn’t change at all. That’s a massive difference! Makes it worth acquiring a good tenant, doesn’t it?

Some people are surprised by this. It’s the same land. It’s the same building. Surely the value can’t just change like that? What you have to remember is that a buyer doesn’t just buy the land and building. They also acquire the tenant and the lease. That’s why the value of a commercial property can change so significantly overnight.

Tenant Quality Affects Property Value!

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I flew across to one of my properties this week, and met the new tenant for the first time. The new tenant struck me as a delightful person: enthusiastic, motivated, smart, and respectful. It made me think about tenant quality. But before I start this topic, I’m going to repost a relevant article from my old site…

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I had a phone call today from a man representing a sports arbitrage company. His company had sent me a brochure a week earlier, and this was a follow-up.

What is sports arbitrage, you might be asking? I certainly had no idea. Arbitrage is where you take advantage of pricing differences in different markets, buying in one and selling in another, to make a profit. Ideally, the transactions happen at the same time, making a risk-free profit. Sports arbitrage is doing it by placing bets on sporting events.

It was interesting to talk to him. He asked me which sport I followed. After I named a few sports which were out-of-season or for some other reason unsuitable, he steered me towards the Australian Open Tennis, which is on as I write this. I was surprised by this; surely he needn’t have bothered finding a sport I cared about - the whole point is that you don’t have to understand the sport or the contestants, you simply look for suitable odds. He could have picked a cock-fight in some remote Vietnamese village, for all I cared.

Anyway, he found a tennis match in progress, found two suitable sets of odds in different parts of the world, and showed how he could take $1000, place a bet in each market, then end up with either $1067 or $1064, depending on the outcome (a 6.7% or 6.4% return)

Easy money, hey? Only it’s not completely straight-forward. You need access to hundreds of online betting agencies, to find the mismatching odds. You can be sure that there will be other people or companies searching for exactly the same thing. because there’s a profit to be made. Then there are technical issues with losing some money on exchange rate conversions, making sure the bets are accepted at the same time, before odds change, not to mention the upper limits to how much bookkeepers will take before changing their odds, or refusing to take more bets. Plus his company took the first 5% profit for each transaction, so the actual returns promised were pretty small.

At the end of his explanation, he invited me to hand over $8000 and start an account with them. They would take care of everything else. This is where I said no, and we ended our call.

At least arbitrage is in theory risk-free. Some investment systems I find comical. One company was trying to sell me horse-gambling software. If I diligently typed in horse data - results, odds, and so on, from all the different venues, for weeks on end, it would tell me what bets to place. I remember explaining to the sales person: “I like commercial property, because I like the safety of a legally-enforceable lease”. She countered with “but this is as safe as commercial property”. I wondered what my bank would say if I tried put up my house as a 30% deposit, and borrow 70% to bet on horse-racing, explaining that it was just as safe as commercial property, and should therefore attract the same LVR.

I know someone investing in rare artwork. He expects to make a good capital gain, and thought I might be interested. I told him that he may well be right, but that I need cashflow in the meantime. I’m not investing to get some lump some at the end. I’m investing to get cashflow now. My lifestyle depends on my investments paying me money now.

I also know people who honestly believe their best chance of getting rich is to win the lottery.

I don’t know if I attract these people, or everyone gets this: I had a consultant come around to offer me a crop of trees. I wouldn’t get to own any land, just a certain number of trees, which would be cut down in about 10 years time. I was amazed at the low return. Yes, you would double your money over 10 years, but that worked out to be a pretty low rate of return. After his presentation about trees, he moved onto a questionaire, including the question “what rate of return would you like to receive?”

I thought about this. I’ve talked about how I like to make a rapid capital gaid soon after purchasing. I like to make my deposit back in the first year, equating to a 100% return of the money I put in. I thought that sounded a bit high, so I scaled it down and said “Probably 50%”.

“OK, 15%,” he said, writing earnestly into his questionaire. “No, 50%” I said. I wasn’t trying to be boastful, but he stopped writing, and looked at me to check if I was serious. When he realized that I was, he was gone within five minutes, and never did the follow-up call that he promised.

As long as it doesn’t take up too much of my time, I enjoy hearing about opportunities. Even if I’m going to say no, I like to understand it first, so I know what I’m saying no to. When people or companies offer me ways to make money, I generally listen, because it’s interesting to hear different approaches. I see what I can learn from them, evaluate them critically, looking for flaws in systems. For example, when I asked Tree-man what happened if a storm or fire destroyed my trees, he said I would get my money back. Get my money back! I would be devastated if after 10 years I got back what I put in! Talk about going backwards.

There are so many opportunities to put your money into different things. Thus far, I’ve always come away concluding: “I prefer real estate.” To be fair, I’ve only been talking about the more unusual types of investment here. What about the stock market?

This past year, I’ve been bombarded by the media, telling me again and again how much money everyone is making in the stock market (at least until the sub-prime issue dented prices somewhat).This is OK. I would need to undergo a massive education process to do well in stocks. I don’t have the expertise. If I went in without the expertise, I would be gambling. Fundamentally, I don’t like gambling.

When you hear all these different things, it’s tempting to move around, from one investment type to another, looking for that big return. The grass does often look greener elsewhere. Alternatively, you might try to put your money into everything at the same time, trying to cash in on all market sectors,. Instead you spread your money too thin and dilute your profits.

At this point in time, and for the foreseeable future, I’m very happy with my choice to stay with real estate. If the media tells me that others are making fortunes elsewhere, good luck to them. When I worry about what other people are doing, that’s when life becomes less peaceful for me.

If you don’t have one already, the sooner you can develop a very clear strategy for wealth creation, one that you can stick with, the better.

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I’ve got a property which is eating me alive at the moment.

Last year, I sold my only residential investment property. I didn’t want any more properties which cost me money each month. From now on, I told myself, I only want properties which make me money each month. This is one of the reasons I decided to focus on commercial property.

Yet soon afterwards, I broke my own rule.

I bought a commercial property (a child-care centre) for $885 000.
I borrowed 70%, that is $619 500.
I pay approximately 8.5% interest on it, that is around $53 000 per year, to cover the mortgage.
The child-care business is leased out for $31 000 per year.

This property costs me $22 000 per year to own. Ouch! Why did I do that?

I confess that each month, when I have to cough up the interest, I ask myself the same question. It’s not comfortable, owning this property.

But I’ll tell you the reason I did it. The property sits on a big block of land, zoned as ‘Town Center’, in a bustling coastal town. The child care centre occupies around 10-15% of the block. The rest of the block is vacant, and can be turned into at least 8 residential blocks. Blocks are selling for around $170 000 each at the moment.

This means that the 8 blocks should fetch 1.3-1.4 million. It might cost a few hundred thousand to do the subdivision, so all up I should end up with at least 1 million for the blocks. That will put more than $100 000 of profit into my pocket, and leave me with a ‘free’ commercial property paying me more than $30 000 per year for the rest of my life. That will be a good outcome.

It’s a great theory. The only catch is, it’s killing me until I am able to sell those blocks. Sometimes things in property happen slower than you want, and this is one of those cases. It’s almost a year that I’ve been holding this block, and the subdivision process is moving very slowly.

So, should I have bought this property, or was it a mistake? I’m not sure. It’s a learning experience. I don’t enjoy paying out money each month. But if things go as I expect, eventually I will be very glad that I did buy it.

As I’ve said before, even mistakes can make you money, as well as give you invaluable experience. Right now, it’s hurting me. I may not buy a property like this in future, because I don’t like paying so much interest (I prefer to have a tenant who pays it for me). But I don’t regret buying it. It has been worth it for the experience alone.

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Last time, I was writing about techniques to rapidly increase your real estate equity.

One favorite approach to real estate investing, if you want to rapidly gain equity, is to buy in an area which is about to go up. People go to great lengths, studying data, analyzing demographics, watching trends and weighing up all sorts of factors, to work out the areas which they think are about to explode. For convenience, I’ll label this approach ‘buy smart and hope’.

I call it smart because it acknowledges that a rapid increase in equity is A Good Thing, and it tries to maximize your chances to get it. I use the word ‘hope’ because there is no guarantee.

I want to suggest that this strategy is a poor-man’s version of what I spoke about last time: ‘buy below market value’. I’m not saying it’s a bad strategy. It’s far better than having no strategy. I’m saying buy smart and hope is clearly inferior to buy below market value. Why?

• you don’t get your equity immediately. You have to wait.
• you don’t get guaranteed equity. You hope that the market moves like you thought.

So, it’s slower, and it’s more risky. Therefore, it’s inferior, if your goal is rapid equity growth.

Think of it this way. If you had a choice between these two methods of making $100,000 equity:
(a) buy at property for fair market price of $400,000. Wait for value to increase to $500,000.
(b) Find a property worth $500,000. Buy it for $400,000.
Which would you choose? Where possible, I would choose (b). It’s faster, and safer.

I assert that we only buy smart and hope because we can’t see how to buy below market value. Because we can’t achieve the one, we settle for the next best thing.

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Not every real estate investor increases their wealth at the same speed. There are faster ways, and there are slower ways.

When it comes to increasing our wealth, we would all prefer fast growth over slow growth, so long as it doesn’t involve any extra risk. The faster the growth, the faster our equity increases, which means the sooner we can buy that next property, which in turn builds our wealth even faster.

If you just want average growth, you can buy at market price, and wait. Your property value will move with the market, and over time, you’ll (usually) see an increase. If you are lucky or smart and you buy in a better market, you’ll get faster growth, but you’re still fundamentally limited by that market.

For truly extraordinary growth, you need a property which increases in value faster than the market grows. There are two ways to do this:

1. Take action which increases the value of the property
For example, renovating a ‘fixer-upper’, subdividing a block, refurbishing, re-zoning, re-leasing, or redeveloping a property. These things can make the property more valuable than it was when you bought it, without relying on any shift in the market itself. If you increase the value by more than you spend doing it, you increase your equity.

2. Buy a property below market value
This creates instant equity the moment you purchase it.

Of course, there is no reason you can’t do both! But in this article, I want to concentrate on the second method: buying below market value. Buying property below market value is an extremely effective way to build rapid equity.

OK, so far, so obvious. Everyone knows that it is good to get stuff below market value. Even the guy who breaks into your house for your high-definition plasma TV knows this.

If you have any skeptical bone in your body (and if you’re investing in real estate, I hope you do), you’ll be saying: “of course buying below market value is desirable, but it’s easier said than done.”

That’s very true. So the question is, ‘how do I buy real estate below market value?’

A second question, which I think is important, but the guy who breaks into your house does not, is ‘how do I do it ethically?’

Don’t be alarmed, I’m not about to spend time talking about ethics. You’ve got your own standards, and I’m not going to preach mine to you.

But I will point out that I see a lot of stories in the media presenting real estate investors as ’sharks’, interested only in their own profit than at the expense of other people. And you might think this is the only way to buy real estate below market value. You’re probably thinking of things like:

• buying foreclosures
• making lowball offers to flush out the desperate seller, or the seller who is grossly out-of-touch with current market value.
• finding senile old ladies and tricking them,
• and so on.

Before you call the station to lodge a complaint, I know, I know - if you buy from a desperate seller, you’re actually helping them out of a tight spot. Furthermore, I’m definitely not saying that buying a foreclosure is the same as tricking a senile person.

I list these scenarios together because for you to make a rapid gain, someone else has to lose (or has already lost) in some way. If you look for this type of property, good luck to you. I’m saying that personally, I do not look for these types of property, and I know that there are other investors who do not want to deal with this segment of the market, but who are still interested in buying below market value.

What I look for is a piece of real estate where the asking price is well below market value. I don’t need to make a lowball offer if the price is very good already - the seller is delighted because they’ve got what they were asking for, and everyone ends up happy. To me, that is a great deal. Sounds too much like a Disney cartoon? Well, it happens!

I’m not just talking about 5% below market value, either. I’m talking 20% or more below market value. And I repeat, I’m not insulting anyone with lowball offers - I’m paying full asking price!

But why, you ask, would anyone be happy to sell below market value? How would you find such a property?

Well, my advice is to stop looking at residential real estate, and turn your eyes to commercial real estate. I’ve found deals like this on multiple occasions. Once is a fluke, twice is a pattern. In other words, these deals are out there, and will continue to be out there. It takes finding them.

Example 1
I’ve written elsewhere about the first commercial property I purchased, so I won’t go into great detail here. To summarize: the sale had fallen through, and the seller was disappointed, wanting to sell it quickly. They were set to retire to their dream house on the coast. They had already sold their businesses for a good price. Now they were just selling the building which housed those businesses. They already had enough money. What they needed was a quick sale, so they could start their retirement. Speed was more important than getting top dollar. The agent told me “They previously contracted to sell it for $400,000. They’ll sell it to you for the same price. It’s worth more than that.” Yes, he didn’t serve the seller very well by telling us that. Sure enough, straight after we bought it, we had it officially (and conservatively) valued at $500,000. That’s $100,000 of equity on day one.
Why was it undervalued? We had a keen seller who already had enough money, and a slack agent who wanted a quick commission.

Example 2
Then there was the oil company who were offloading all their ’second-tier’ service stations. Mine was the last of their inventory, and by the time I came along, they just wanted it gone. They had already reached their sales target. Paid $400,000 and immediately had it valued at $480,000.
Why was it undervalued? The company wanted a quick, easy sale more than it wanted to achieve a top price.

Example 3
Then there was the government department which was selling one of its offices for less than $100,000. I passed up the deal, because there was some uncertainty about the lease. When the extra information came through, I realised the property was worth more than $200,000, but by then, some bolder soul had already bought it.
Why was it undervalued? A policy change meant that a government department suddenly sold all its offices, preferring to rent in future. I suspect that because the department was selling so many properties simultaneously, it did not have its full attention on this particular (and minor) office. I also suspect the government department lacked the in-house expertise to price the property correctly.

Example 4
Another example: my latest commercial property purchase was a floor in a nine-story city office building. Several years ago, a company had bought the entire building for $8 million. They had then fully refurbished the building, were now selling it at a healthy profit. I bought my floor for $1.4 million. Overall, they sold the entire building for around $16 million.

Less than an hour after I bought the property, the agent who sold it to me said “$1.4 was a good price. If you like, I could sell it for you immediately for $1.6 million.” That was two months ago. I’ve since spoken to a valuer who believes it is more likely worth around 2.0 million, but that’s also because I’ve since re-tenanted my floor.

Why was it undervalued? The seller had contracted to buy a much larger office building for over $30 million, which would be very profitable for it. But they needed to sell this current building fast, to ensure they had finance for the next deal. By the time I came along, they were very keen to offload this floor to me. I suspect we had a secondary factor of a minor real estate company who were out of their depth, and who underestimated market value.

I could list more examples than this, but you take my point. It’s as though people are giving me hundreds of thousands of dollars. Yet they’re happy to sell. There are two main factors at work here:

1. Sellers require a quick, easy sale.
These sellers are not financially distressed, desperate, sad, or mentally unsound. For their own reasons, they place more importance on a quick, easy sale, than on maximizing their sale price.

2. Bad Selling Agents.
They may be agents who, to secure their commission, are deliberately, willfully bad. Alternatively, they may be well-intentioned agents who, for whatever reason, have set a price which I believe is under market value. It takes good knowledge of a market to spot an incorrectly priced property. Incidentally, it also takes a lot of courage to proceed to purchase an undervalued property, without talking yourself out of the deal.

Maybe I’m not looking in the right places, but I don’t find deals anywhere near this good in residential real estate. There’s a different selling mindset. I’ve found that the residential seller will haggle over every dollar. Their house is a big asset, and they’re sure going to make damn sure they achieve top dollar. See the grumpy old man who has been so carefully manicuring his lawn and pruning his roses for the last 60 years. If I offer him 75% of his asking price, he’ll stab me in the chest with his secateurs, and rightly so; this is his retirement nest-egg!

However, I’ve seen these bargains a number of times in commercial real estate, and I hear again and again from other commercial investors who find exactly the same thing. This is one of the many things I like about commercial real estate. So bear in mind if you’re looking to build equity quickly: there are bargains out there in commercial real estate.

Finally, some comments, which I need to add for completeness, and to hose you down if you’ve become too excited.

I don’t want to leave you with the impression that every commercial property is a bargain, with every seller throwing away money. It still takes something to find these properties. I spent months looking for that last property, and made at least twenty enquiries, after dismissing hundreds of properties through browsing the internet.

Secondly, I’m saying nothing about the long-term prospects for the property. After ten or twenty years, the top-quality property in the great location will have done much better than the shabby mediocre one in a run-down area. It won’t matter which one you purchased below market value.

The reason I look for under-valued properties at this early stage of my career is that they give me fast equity, so I can grow my portfolio relatively quickly, without waiting for market growth. At the moment I place more emphasis on this than on long-term growth prospects.

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Some people wonder what I do all day, as a real estate investor. Heck, even my own dear mother has trouble understanding what I do. I think it was easier for her when I had a simple job which everyone understands, so she could just say “my son is an engineer“, rather than “my son spends most of his time at home either looking after his daughter or doing real estate investing stuff.”

So what do I do each day? I find that with real estate, once you have a few properties, they each generate some ongoing work. The amount of work is usually fairly small and steady, but occasionally there will be a spike of work if a particular property has ‘issues’.

Let’s take yesterday.

I had to deal briefly with five properties.

1. I had a tenant whose airconditioner got fried by a recent power strike. He wanted me to authorise a repair. For most properties, I use a property manager for this stuff. But as an experiment, I’ve been managing this property myself, so I can weigh up the benefits of a property manager.

2. I arranged to meet with a business partner about a block we want to subdivide. This subdivision is proving to be difficult, and we need to get a plan for hurrying it up.

3. There’s another property we’re getting a new lease drawn up for. I had to check the progress with my lawyer.

4. Another property hadn’t paid as much rent as I expected. I had to call the manager and find out why.

5. I met with another business partner about a block of sheds we are planning to build.

Some of this work is planned in advance, and other pieces are not planned, but are instead a reaction to some event such as a phone call. The first four pieces of work were generated by existing properties. The final piece was working on my next real estate investment. I like to have something in the pipeline.

This is a reasonably typical day for me. All up, it was about half a day’s work. This is about as much as I like to work, because I like having time to do other stuff, including this blog.

None of the work is hard, complicated, or breathtakingly exciting. It’s not rocket science or brain surgery. It’s not even glamorous - people don’t crowd around me at parties when they discover what I do. But each activity is necessary to keep the portfolio ticking along, and growing. It’s not the minute-to-minute actions which are exciting - there’s nothing exciting about any particular letter, fax, email, or phone call. Some people even suggest that what I’m doing must be pretty boring.

But it’s the overall game which is exciting. I love building a portfolio, and I love the lifestyle that goes with it. This is what makes each phone call worthwhile. I love looking at spreadsheets, showing me how much my properties are worth, and how much money they give me each month. Growing these numbers over time is a game I love to play.

Then tomorrow, in the middle of the week, when most people I know are going to work, I’m taking the morning off with my business partner. We’ll go flying my plane, then talk about life, the universe, and future deals. Real Estate Investing has given me this flexibility. It would be extremely difficult to go back to a regular job now.

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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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