Why I Don't Like Other People’s Money
“It’s perfect. I’ll take it. How much is it?”
So said the Irish hairdresser to the Montenegrin real estate agent.
The agent was touring the young woman through an apartment for sale in the medieval town of Kotor. The woman didn’t get past the entryway before making her buy decision. Indeed, she had been ready to invest before boarding the plane from Dublin.
She was desperate to take her first step onto the property ladder but didn’t qualify for financing at home in Ireland (the “do you have a pulse” mortgages didn’t become common in this country until a year later).
No bother. Everyone was buying property abroad. She would, too.
The agent who sold the hairdresser that Kotor apartment told me the story when I met him the following week. I, too, was considering an investment in Montenegro.
It was 2004 and that agent (like all real estate agents in the country) was selling properties faster than he could count the commissions. All Europe and a few Americans like me were competing with each other to get into the hottest new property market on the Continent.
Unlike the hairdresser, I didn’t invest. The math didn’t work.
That young woman from Dublin, like too many novice and even many experienced investors, was buying because she was certain the value of what she was buying was going to increase. She didn’t bother to ask about the potential for rental yield or try to project the cash flow she could expect.
She (I assume and would have loved to have had a way to confirm), along with multitudes of other global property investors, learned the hard way and only four years later that, when investing in real estate, rising prices are not guaranteed.
The 2008 crash wiped out values worldwide and, with them, investors who hadn’t run the numbers but had bought for appreciation rather than yield.
Property values move up and down and matter only if you’re selling the property. Cash flow can be reliable and is always bankable. Buying for appreciation is chasing paper profits. Buying for cash flow is putting money in your pocket.
What Frank Lloyd Wright Taught Me About Other People's Money
My first real estate purchase was in Chicago. I was renting in a three-flat when the owner sent a notice to all the tenants telling us he was listing the property for sale. It was a Frank Lloyd Wright building. My apartment was big, the layout comfortable. I didn’t want to move.
It was that stubborn resistance to the idea of giving up something I liked that started me on my real estate investment career.
Rather than considering where I might move, I began figuring out a way to buy the building. Unfortunately, the people living on the top floor had the same idea and approached the owner with a plan to convert the building into condos so they could buy their apartment. That inflated the price in the seller’s mind.
Undaunted, I put together a spreadsheet to see if I could make the numbers work for an outright purchase. I’d continue living in my apartment, paying myself my rent, and rent out the other two. I calculated that I could charge more for those units, as the current rents were below market.
Banks were offering special programs for first-time buyers. I knew I could get a loan. The more important question was whether the cash flow math worked. Would the three apartments generate enough income to support the mortgage?
The theory is that the rent pays back the bank, month by month, and covers your other expenses, hopefully with some cash flow left over. Meanwhile, equity builds up as the mortgage gets paid down… while, in theory, the property’s value appreciates. Investing with other people’s money (OPM) is the first thing you learn at any real estate investment seminar.
I obtained a mortgage with a loan to value (LTV) of 98%. However, it wasn’t for the building where I was living. My neighbor’s condo plan botched that deal. But the seed had been planted and the spreadsheet created. My math showed me what to do.
I found a real estate agent and explained my parameters. Today I make buy decisions based on projected rental yields, gross and net. For this first purchase I didn’t think beyond paying the mortgage.
I spent four months considering dozens of properties and entering the details for each into my spreadsheet. Two-flat buildings never came close to break-even cash flow, though I probably could have made many of the buildings I looked at work for me financially by increasing my own rent. Again, my stubbornness paid off (I like to point this out for Kathleen’s benefit). I kept active in the market, looking daily at new listings, until I found a building that fit my requirements.
A building had come back onto the market after the woman who had signed a purchase contract for it failed to qualify for financing. She was a hairdresser (but not Irish).
The price was good. The location was within the zone I’d targeted. Most important, the math worked. I could keep paying myself the same rent and cover the mortgage without increasing the rent for the other two apartments.
Two-and-a-half years later, I met Kathleen, and we made a plan to move together—me from Chicago, her from Baltimore—to Ireland. The timing was ideal for selling my three-flat. The Chicago market was frothy.
Set the price above the going market rate, and the building still sold quickly. I walked away with 80% more than I’d paid less than three years earlier. The leveraged return on my 2% down payment was 3,000%. I’d turned US$5,000 into US$150,000 after closing costs and commissions. And I’d had positive cash flow from rental income every month I owned the building.
It was an as-good-as-it-gets property investment experience, first because I’d made my buy decision based on cash flow math and second because I was able to leverage the purchase.
Buying with OPM can, as any property investor will tell you, mean an upside, but it comes with risk. It doesn’t matter what your property is worth if the cash flow it generates doesn’t cover the mortgage. I’ve known too many U.S. real estate investors who have lost too many properties when market changes collapsed their highly leveraged portfolios.
Even though I’ve benefited from it, I don’t preach the OPM mantra. Twenty-five years of experience across 25 markets worldwide, including the United States, have taught me to respect the fundamentals.
I don’t buy unless the projected net rental yields translate into cash flow enough to support the investment.