By Dr. James M. Dahle, WCI Founder
Usually when I review a book on this site, I like to throw up a bunch of links to the book on Amazon and I make a few cents if readers choose to buy the book through that link. More recently, I've been reading a self-published book that I'd like to review on the site. Unfortunately, you can't buy it on Amazon, Ebay, or Barnes and Noble. The author, John T. Reed, who is most famous for “debunking” Robert Kiyosaki's Rich Dad, Poor Dad enterprise (you'll be very disappointed to learn there probably is no Rich Dad I'm sure), is a long time real estate investing author who sells all of his books only through his website.
I originally sent him an email asking for a discounted copy to review on the site (usually 146,000 page views a month are enough to get a free copy of a book), but after receiving no response after a couple of weeks, I went ahead and ordered a few books anyway since I liked what I read on his website. His books aren't the cheapest at $30-$100, but they're still a solid value. He sells this one for $29.95 plus shipping.
The “Big Picture” Real Estate Book
Best Practices for the Intelligent Real Estate Investor is an obvious play on Benjamin's Graham's “The Intelligent Investor” (also highly recommended by the way) that Reed says took him over 40 years to write. Essentially, he argues, it is easier to write about narrower subjects such as taxes or property management than to write a “big picture” real estate investing book. This is his “big picture” book, and as such, I recommend it to anyone thinking of getting into real estate investing. For those of us who are already real estate investors (whether by choice or by inability to sell our home in the last few years), the book is still recommended, but you may find some of his other titles just as useful or more useful.
Best Practices for the Intelligent Real Estate Investor Is Different from Most Real Estate Books
Frankly, I agree with Reed when he argues that most real estate investing books are crap. According to Reed, in 1980 the real estate investing information business was taken over by a bunch of shucksters such as Robert T. Allen (“Nothing Down”) and now there are so many books written by these guys, usually coupled with expensive seminars and “mentoring” services, that someone just looking for some honest information is severely handicapped. Reed, while definitely opinionated, and far more negative and curmudgeonly than most investing authors, tries for the most part to stick to the facts with solid analysis as he debunks common misconceptions about real estate investing. His books are absolutely packed (205 8 1/2 x 11 single-spaced pages) with high-yield, actionable information. He minimizes fluff and rapidly disabuses you of any “get-rich-quick” ideas you may have brought to the table. In fact, after reading his book, I suspect most physicians will probably decide real estate investing really isn't for them anyway.
John T Reeds Big Ideas
There are four significant themes in the book. The first is that you can't actually hire a property management firm. Not only is it expensive (8%-10% of gross rents in my experience), but the managers have no incentive to maximize your profits. Maximizing the gross rent would increase their pay, but not by enough to act on, and they certainly don't care about your net operating income. Like mutual fund managers, their goal is to increase assets under management. They get paid far more to manage 100 properties poorly than to manage 50 properties well. To make matters worse, you would hope that by hiring an expert property manager that they would be able to get you a great price on the best contractors to work on your place. Instead, they hire those who provide them the biggest kickback. Unfortunately, I have to admit that Reed is spot on in this analysis as I've had the same experience in my limited time as a real estate investor. If you want to be a real estate investor, you're going to have to be a property manager or at least supervise your own employees very closely as they do it.
His second big idea is that real estate investing needs to be actively managed. This is a real bummer to me, since I am mostly a passive investor. Don't get me wrong, I'm well aware that real estate investing is part investment and part second job. For Reed, however, the goal of real estate investing is to make money “on purpose,” not from speculation/pure luck. He defines pure luck as holding on to real estate in hopes that prices will go up, which is honestly how most real estate investors (including me) approach the process. Instead, he says there are really only three ways to make money in real estate “on purpose.” The first is by doing a “bargain purchase.” That means buying something for at least 20% less than it is worth (remember that 10% disappears in transaction costs so you need a 20% discount to make it worth it). The second is by “upgrading.” You basically buy something you can upgrade inexpensively and make it worth much more than the upgrade cost. The final method is by buying a property in a rare moment when it has “double-digit cap rates”, which never persist long. But even after you do one of these three things, he suggests you then sell the property and capture your profits rather than relying on luck for further gains. If you want to be a passive, buy-and-hold, real estate investor he suggests you buy the Vanguard REIT Index Fund (which I also hold) rather than individual properties.
The third theme in the book is that you can no longer buy real estate for cash flow purposes. He notes there was a change in real estate investing starting in about 1970 when investors quit trying to get cash flow for most of their return and started banking on appreciation. After a few decades of that, it is now nearly impossible to buy real estate for cash flow. Despite our ultra-low interest rates or 2013, you simply cannot buy most property with any kind of reasonable down payment and get positive, much less good cash flow. Since most residential property is sold at cap rates of 3%-5%, most properties don't become cash flow positive until the loan to value ratio gets close to 50%.
The math is easy to see. Let's say you have a $300K house with gross rents of $21,818 and a net operating income (NOI = ~ 55% of gross rents) of $12,000, giving you a 4% cap rate. You've got to put 25% down, so your mortgage is $225,000. At 4% for 30 years, annual mortgage payments will be $13,000. You now have negative cash flow. Even if you put 50% down, your annual mortgage payments are $8,674, leaving you only $277 in monthly cash flow on an investment of $150K. That's a yield of 2.2% on your huge downpayment. It's pretty hard to get excited about that. Even with tax benefits and amortization of the loan, you're still hugely reliant on appreciation to get any kind of decent return.
The final theme is that when you calculate your return, you have to include the value of your time. That's no big deal when your other job is working the counter at the 7-11. When you're a physician, however, spending a few hours or days dealing with real estate issues involves an extremely high opportunity cost.
Talked Out of Being a Real Estate Investor?
When you combine his four themes, it essentially eliminates this notion I had of what real estate investing is. I'd prefer to minimize the “second job” part of real estate investing and maximize the investment part. I'm interested in solid returns and low correlation with the rest of my portfolio. My idea of real estate investing is spending a little time looking at properties, buying a few at a decent price, and holding on to them for a few decades as they get paid off and the cash flow situation improves. Then in retirement I can live off the cash flow or sell the properties and annuitize the money. I have little interest in property management, going through the buying and selling process frequently, or in upgrading properties. I have a job where I can trade my time for money at a very high rate. I certainly don't need to trade it (or my free time) for one where I exchange time for money at a lower rate. If the main themes of the book didn't talk me out of that, I think the chapters on litigation and dealing with bad tenants (imagine your worst patients living in your investment) did.
Should You Read Best Practices for the Intelligent Real Estate Investor?
If you always wanted a real estate mentor to pass down the secrets of what he's learned over his career in real estate, this book is for you. It is very different from the typical real estate book. If you couldn't tell that from the first 22 chapters, the last one, on ethics, will reveal it. John T. Reed is one of the “good guys” out there, and you'd do well to read his advice, even if you choose to ignore some of it. I highly recommend you read Best Practices For The Intelligent Real Estate Investor before getting in to real estate investment.
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What do you think? Have you read any of his books? Comment below!