Jeff see storm clouds...

Work is still hectic, so this portion of the story may not be as well-edited as the one before, or the ones to come, but still it's here. As promised.

When we last left Jeff, he had purchased (or put under contract) 15 houses in just a few months. These houses ranged all over the country, from Florida to Arizona. At the end of our segment he had just posted the new NAR numbers for the areas that he had invested in. After 6 months of investing, it sure sounded like everything went spectacularly. One of his areas, Cape Coral, FL, appeared to have gone up 45% over the last 12 months! It was so spectacular that he wrote this during the next few days:

August 18th, 2005

>> 45% in Florida, you have got to be kidding!! Nice call on that one Jeff.

>> I give all the credit for identifying Cape Coral to Adiel Gorel. I had hardly

>> even heard of Cape Coral when he (or was it Dani, his assistant) told me about it.

The great thing is that I bought THREE houses there (a lot for me!). Their total value is around 750k. So if they continue to go up at 45% a year (doubtful, but an interesting thought), I could make over 300k in one year! All this on about a ~9k investment. Am I missing something? This seems too good to possibly be true!

If this works out as I am imagining, I am definitely quitting my job. Oh, wait! I can't quit my job, I am unemployed...

Speaking of Adiel, I can't help but think of him telling me about his EIGHTY houses in Phoenix. He estimated their total value at about 16 million. It almost makes me lightheaded to think about it, but since Phoenix went up almost 50% last year, he made ~8 million in one year (in one town, he owns in many towns...).

Wow, are things going beautifully for him or what? We've also learned that he's not working anymore, but with the way real estate is going up, who needs a job! Right?

We don't really hear much from Jeff for a few months, but he comes back in November with more updated numbers.

November 15th, 2005

Albuquerque, NM


Cape Coral-Fort Myers, FL


El Paso, TX


Oklahoma City, OK


Pensacola-Ferry Pass-Brent, FL


Salt Lake City, UT


The continuing saga...

My "worst" investment is no longer SLC (appreciation-wise)--OKC is now lowest at 11%. Of course, I am MAKING $100-$200 a month on fully rented houses in OKC, while my SLC house remains empty on the market at ~$1000 for a 220k house (no takers?).

Holding costs (i.e. vacancies) were WAY higher than I budgeted for (often 5k a month), and I have significantly cut into my cash reserves.

Other than that, I feel that my "cut and paste" strategy has served me well. To the degree that my houses are typical of the areas they are in, and hence these NAR numbers are representative, I could be making a weighted average of a 23% return on ~2.8 million in RE (if current numbers hold). Somehow, I just don't think I will be that lucky--it just seems too good to be true--however, I don't see why I shouldn't make half that...

In fact, if I don't lose these houses to foreclosure due to vacancies...I could eventually make a significant bundle.

Albuquerque is the next Phoenix! El Paso is the next Tuscon!

And the first crack appears in the fascade. Holding costs have continued to get higher and he's not prepared for it. In my last post I mentioned that you can very rarely rent out a 100% financed home high enough to cover payments, and you should always allow for at least 5% vacancies. Jeff told us in the last post that he intended to put away $50k in cash to cover holding costs and emergencies, but those funds are somewhat depleted.

An important lesson in real estate is that if a house is vacant, you still have to pay the mortgage. Since Jeff is nowhere near most of these houses, he's relying on property management companies to find him tenants, and while they don't make money if no one is renting, they don't lose money either. So there's nothing he can really do to speed up the tenant locating process, besides deluge the PM's with calls all day.

However, at the appreciation rates he's experiencing, he could always just sell a couple of houses to cover payments and then keep the rest, right? Everything is going really well. Later the same day he gives a little deeper look into where he sits financially on a cashflow basis:

November 15th, 2007

In El Paso, I had several months of vacancies...I finally rented the third one for about $200? below market (and only a 6 month lease). But in Pensacola (Milton) I rented right away at about $150 below market.

A week ago, I had 4 vacant properties...ow! But just in the last week I rented two of those, so now I am down only about 3k a month...still ow. I hate vacancies...

As described above, I have contracts on 15 houses, but I have technically only closed on 9. I signed the papers on another one in ABQ tonight though, so should "own" 10 by the week's end. Of course, when this one closes I will be back up to 3 vacant, and will be losing about 4k a month. Such is life (MY life anyway). I should have budgeted for more vacancies...good thing my wife stopped me from buying more when she did or I would REALLY be in trouble!

I hope all is well with you...may your days be happy and your vacancies low.

I agree with you Jeff, I hate vacancies. but they are a known risk in real estate investing. Every landlord has them. But things are taking a turn for the worse, aren't they? Back in August he told us that he was positive $250 a month after closing on 5 houses. Now he's closed on 4 more and he's fallen to negative $3,000 a month.

I also noticed that he mentioned that his wife"stopped [him] from buying more". Everyone's marriage is their own business, but remember in the last post when I mentioned that he was a little too eager to buy homes?

Later in the month he gives us even more in-depth data on his current situation (as with most other posts, reformatted for better clarity):

November 21st, 2005
I must admit that my confidence in my numbers is shaken. However, here my numbers are nevertheless. Technically, I have only closed on 9 houses, one is vacant. Including the vacant house, I am losing $2,396 a month (before taxes).

[...] it is impossible to give an accurate prediction of just how much money I will be “losing” next year…it all depends on vacancies (to a large extent at least). So let’s look at a “best case” scenario where all my houses are rented (which they will be, eventually).

When I close on my 15th house, and it rents along with the others, I will be “losing” $3,656 a month or $43,872 a year (before taxes). Now this DOES sound like a lot of money, in fact, it will entirely wipe out my cash reserves in ONE year. But it is a BEFORE taxes estimate. My very conservative estimate of what I will be saving in taxes (depreciation plus loses) is $37,764. So, to the extent that my houses are completely rented, and to the extent that my estimate of taxes is accurate, I will only be “losing” $6,108 a year (a value that my cash reserves can cover for several years). (I am hopeful that, by “compartmentalizing” my houses and using accelerated depreciation schedules a la Albert Aiello, I can get this $6,108 down to around zero, but I am not counting on this.)

Now we start to pierce the veil, look beyond Jeff's shell and into his numbers. Let's start with his cashflow. Before he seemed confident that he'd stay positive before considering taxes, now it appears that taxes will be his salvation. But not so fast.

Let's assume that, for the sake of math, all of Jeff's losses are deductable. They aren't in real life, because some of those expenses go to paying off principal on his homes, which is non-deductable. He wants to claim a loss of $43,872 plus his depreciation. Now if he is considered a real estate investor, then he's limited to claiming $25,000 a year in losses. the other losses aren't gone they are simply rolled forward to next year (and so on until you sell the property).

However, since Jeff has no other job, he can qualify to become a real estate professional (in the eyes of the IRS) by putting at least 750 hours a year into his real estate. From that he can get unlimited paper losses to offset other income. Of course, that's the next kicker, he has to offset other income in order to have tax savings.

He hopes to get a tax savings of $37,764. Using some back-of-the-envelope calculations, his household income will need to be at least $153,800 before he'll be paying enough taxes to claim that entire refund. Considering his personal income is negative, his wife will have to be pulling in over $150,000 to make these loses materialize into cash. (NOTE: Actually she'd need to be earning more, since I was using the single tax brackets numbers, not the married)

In addition, to get a return as large as he is claiming to want, he'd need to offset all of her income. That means claiming $7,328 per house in depreciation on top of his losses. That depreciation number is actually quite reasonable, but the income expectation is high (also bearing in mind that it's not easy to qualify as a real estate professional if you are holding down another job).

So what he's hoping for is probably a bit unreasonable, though he does corerctly point out later that if his losses push his income below zero, those losses aren't lost but are rolled into the next year. And as the month rolls on, Jeff gives a us a deeper look at his long term goals

November 22nd, 2005
My "plan" is to buy these 15, and then each time a house reaches a LTV of ~65%, I will cash out re-fi back to 80%. All re-fied funds will then go to the purchase of MORE homes, never selling the old ones. Eventually I expect to own 50 (or 100? 200?) homes, doubling every ~5 years (or less? depending on appreciation--65% LTV comes pretty quickly at 45% appreciation a year!). So 30 homes total in 5 years, 60 in 10 years, 120 in 15 years, and so on...until I get to the point of "enough."

In case you are unaware, LTV means Loan-to-value. For example, if your house is worth $100,000 and you have a loan for $87,000, then your LTV is 87%. Typically if your LTV is over 80% on a single loan, you will be charged PMI (Private Mortgage Insurance).

I have to admit that most of this plan makes sense. Let the homes build up in equity, then tap some of that out to purchase more homes. So why am I still worried? Because that plan is not the same plan that he's on now. Jeff owns his own home (he mentions it in other posts), and probably could have re-fied to 80% LTV and bought a single home, or maybe two, and began there. Instead he wanted to jump-start his investing by borrowing 100% on 15 homes. So while his long-term plan seemed to be solid, his short term plan was nothing more than a gamble.

Jeff begins to realize this as more and more people point this out:

November 22nd, 2005
>> What if prices start going down 5% a year in Ft. Myers, Pensacola and Albuquerque?

That would be bad...
Do you think that such a thing is possible in the absence of some economic or natural (worse than a hurricane!) disaster? For appreciation to go from 45% to 30% is expected, from 45% to 15% disappointing...but from 45% to NEGATIVE 5%--I really don't see that as a reasonable possibility for Florida. Even Las Vegas, after it "popped" and went down significantly--it is still appreciating at 10%. 10% is still a GREAT return! If I average 10% on my investments I will SKIP all the way to the bank...

Someone points out a possibility of his properties declining and Jeff realizes that such a thing would be disasterous. But he swiftly changes gears and mentions how such a thing would be impossible, quoting his Cape Coral figures. But what he's claiming doesn't quite make sense. Going from 45% to -5% seems far more likely than going from 45% to 30%.

You see, in basic economics you learn that when something is hot (and 45% appreciation is definately hot!), it's unlikely to slow down. Because of the psychology involved, it's far more likely to speed up until it "pops", and sharply reverses itself. But Jeff further explains:

November 22nd, 2005
I have good reason to believe appreciation rates in Cape Coral will remain high including:
a. projected employment highest in nation
b. Foreign investor demand high
c. CC is 20 minutes from Naples, also appreciating at >40% but ALREADY 100k more than CC
d. Projected population increases high
e. Commercial interests high (Home Depot, Publix, etc.)
f. Baby boomers have to retire somewhere and they want a tan

Looking at it from a personal point of view, I can tell you that I'd ignore the foreign investors (investors are investors and while foreign ones, probably European, are more likely to get caught standing up when the music stops, they'll want out just like everyone else). I'm also skeptical about the baby boomers claim. That claim has been made for a very long time, but retirement is changing. People are working later into their lives and sticking closer to family. Still the population numbers, employment numbers and commercial interest are all fairly significant positive indicators.

But worst of all, I think at this point Jeff is starting to lose some faith in himself. His loss of confidence came through when someone pointed out out that what goes up, must come down:

November 23rd, 2005
>> Robert Campbell instructs us that appreciation always eventually reverts back
>> to the mean. Unfortunately, when prices have gone way over average, they have
>> to go below average for a time in order for the mean to re-establish itself again.

Rates do not have to revert back to the mean...all one has to do is wave one's hands and repeat the following...

"things are different this time..."
"things are different this time..."
(don't forget the hand waving...its very important)

The astute amongst you will realize that things don't always have to revert to the mean at a micro level. For example, I'm fairly certain that Redmond, Washington grew signifacntly in value when Microsoft relocated there and is unlikely to depreciate anytime soon. At a micro level there can be any number of reasons why a local market could soar and not crash back down. Some of those are reasons that Jeff pointed out above (such as population growth and commercial interest). But at this point you have to wonder if Jeff really knows anything about these markets besides the numbers that NAR released.

Understanding a local market is not a simple thing, and requires a lot of attention. There is so much information to process and you must stay on top of new developments. There is a reason that professional traders on Wall Street specialize in specific industries or groups of companies. It's hard enough to stay on top of just a few companies, much less stay on top of the entire US economy.

Jeff then gets a series of warnings from other people about the riskiness of his strategy, culminating when a poster named JJ, pleads with him to be cautious:

November 26th, 2005
>> Jeff - I am not stating that your investment style will not work, I am just suggesting
>> that caution needs to be taken with this type of strategy.

Caution...I am in total agreement with your very good point here. Of course, the wisest investor will consider the price of all risks when he invests, including the risk of too much caution. Caution can be risky! Caution can be expensive!

Avoid the risk of too much caution!

Everyone think back over the last 5 years...don't you wish you would of bought MORE houses?

Yes, and 5 years ago you would have been wise to throw caution to the wind. Of course if you bought Amazon stock in December of 1999 at $100 a share because you wished you had bought more 5 months ago when it was trading at $44 a share, you would have lost money in the resulting crash and still would be 20% below your purchase price (excluding the interest from buying on margin).

But at this point it appears as though the fatigue of investing is wearing on Jeff (even when you don't manage the properties yourself, real estate can be a very draining investment), but at the beginning of January, he again updates the numbers that NAR has reported:

Janurary 1st, 2006
For those that are interested, NAR puts the cities I invested in at:

Metropolitan Area


2005 p

2005.III r

2005.IV p








Albuquerque, NM






Cape Coral-Fort Myers, FL






El Paso, TX






Oklahoma City, OK






Pensacola-Ferry Pass-Brent, FL






Salt Lake City, UT






For all of my properties, this works out to a weighted average of 24% using NAR numbers (which are now becoming more and more relevant as I pass the anniversary of my first contract signings). If only my actual houses are anywhere near the NAR numbers...

OFHEO was a little more conservative in their numbers (aren't they always?). They put the cities I invested in at:

Albuquerque, NM


Cape Coral-Fort Myers, FL


El Paso, TX


Oklahoma City, OK


Pensacola-Ferry Pass-Brent, FL


Salt Lake City, UT


St. George, UT


or a weighted average of 22%. Once again, if only my actual houses do half this well...

As for RE investing as a whole...I got into this hoping to catch the last year (2?) of the looks like I have a pretty good chance of doing that. But inventories are going up nationwide (way up in some areas), and prices may already be seeing some drop. I think by investing in the Midwest areas that I did, I maximized the my chances of catching the very last of the nationwide up-cycle--I may see another year or two in the Midwest (cross my fingers). For example, SLC inventories are going down. Funny thing is, prices have not shot way up yet (how to explain that?). Maybe SLC needs something more than restricted supply to get up to 20%-30%, or maybe the buyers in that area are SO used to 4% gains that they psychologically will never pay for a 30% gain in one year?

Cape Coral is my one worry...Inventory is up around 150% in just the last few months!
(Lee existing-home sales, prices drop in January)
(Slowly, prices begin to drop as unsold homes sit longer)
Anyone else have Cape Coral homes? Other Florida homes?

So as we leave our hero, he's beginning to feel the pressure of such a large undertaking. And as his understanding of real estate grow, and the true weight of carrying costs becomes apparent, he begins to fear what even a minor market correction could do to him. Note at the end that his best investment, on paper, would seem to be Cape Coral, which has appreciated somewhere between 36% and 48%. Yet increasing inventory is still enough scare him.

It's been a long journey thus far, but try to visualise these homes as yours. You owe somewhere in the neeighborhood of $2.8 million on the homes and some aren't even built yet. Some months you've had to pay out as much as $5,000 to cover mortgage costs and you spend way too much of your time chasing down property managers, asking about collected rents and chasing them on finding tenants for your homes.

Hopefully 2006 will be good to Jeff and put him in a position to relax a bit more.


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