The saga of Jeff

Meet Jeff.

Jeff is a night manager at Taco Bell. Married and wanting more out of life. He hears about the magic money in real estate and buys in, hook, line and sinker. He goes crazy and buys 14 houses in three months. What happens next?

Unlike many "people" I tell stories about on this site, Jeff is not a hypothetical person. He really exists. Early 2005, he appeared on a discussion board frequented by real estate investors. What made Jeff so interesting is that not only did he appear to be an ethusiastic and genuinely nice guy (although a bit naieve), but he also was extremely open about his investment strategy and his purchases. He continued to post updates on this board until around April 2007, giving us an opportunity to see the progress of a guru-follower in action.

Jeff's guru of choice is a man named Adiel Gore. For quick look at the guy's "credentials" simply watch the quick film below.

I could spend an entire post talking about how ridiculously over-simplified this man's view of real estate is, but I'll just point out a few problems. To pay off that mortgage early (without using your own money) you will have to be earning considerably more in rent than your mortgage costs, a very difficult proposition with No Money Down single family homes. You also must include allowances for repairs and other costs. Not to mention I despise his ending, where he says "want more money? Just buy TWO houses!" I've ranted enough about irresponsible leaverage.

So Jeff, after reading and listening decides to put all of his chips in. He signs 14 contracts in 14 weeks (most of these aren't actually finished houses). His main metric of measurement is NAR's official list of appreciation rates. Let's take a look at his journey through real estate investing, using his own words (Some formatting has changed to increase readability):

May 12th, 2005
Using last quarter's NAR info, I invested in the following cities (the numbers beside each are number of houses and last quarter's appreciation rates). (A special thanks to Suzanne Goulet, who helped me with many of these.)

Location	# of Homes	YoY Increase
El Paso	2	1.5%
Albuquerue	3	14.8%
SLC	2	6.5%
Oklahoma City	2	10.8%
Fort Meyers	4	26.5%
Pensacola	1	19.2%

and 1 other house in Saint George (not on chart!).

Now the NEW NAR numbers show that there has been little change (with one exception!).

Location	# of Homes	YoY Increase
El Paso	2	15.0%
Albuquerue	3	11.1%
SLC	2	6.1%
Oklahoma City	2	9.3%
Fort Meyers	4	25.6%
Pensacola	1	18.5%

Look at El Paso!? Now I know these numbers can move around a lot and not be meaningful, but c'mon 1.5% to 15% in 3 months! That's either a typo or an incredible change.

El Paso is the new Phoenix! Everyone rush there now before it is too late! (Actually, never mind, wait until I buy one more...)

So far so good, it sounds like his investments are taking off. But look carefully between the lines and you can already see a number of alarming signs. He's basing his investment strategy off of a very general set of statistics that are produced by a biased industry tradegroup, and he's a little to eager to buy more homes. Also take a look at where his houses are, he owns property on opposite coasts, which may be difficult to maintain. How well do you think he understands the local markets?

A short while after posting such exhaustive information, he gladly answered all questions on the state of his portfolio, including this post on the 13th of May, 2005 which ominously foreshadowed his future:

May 13th, 2005

I would LOVE to tell you about how my investments are doing. Sadly, in order to do that I would have to KNOW how my investments are doing. This is next to impossible given the fact that I have only been investing for roughly 3 months and I am a "buy and hold" strategy guy. I have just done the "buying" part and haven't yet done the "holding" part--not by a long shot. In fact, I have only closed on three homes. Many of my homes won't be built until the summer/fall, and at least 5 won't be built for a year.

His number are promising, but that's all that they are right now, numbers on a spreadsheet. It's difficult to get comps, since we're talking about undeveloped neighborhoods. But the problem is potentially a bit more treacherous:

May 13th, 2005

In fact, if I just see a 10% return on average over the next few years my 2.7 million portfolio will return (on paper) 270k a year. Such is the power of leverage. Of course, if "the bubble" bursts and we all see a 10% DECLINE, then I will be LOSING (on paper) 270k a year. This is why I have trouble sleeping at night (did I mention that all these homes were bought with 100% borrowed money? ...even more stress).

But so far I see no bubble, and my goal of a 10% return seems reasonable given the appreciation rates above ( 15.0%, 11.1%, 6.1%, 9.3%, 25.6%, 18.5%--SLC appears to be my "worst" investment right now at 6.1%). That is why I liked this article so much, I look forward to re-checking in 3 months.

Jeff is hoping to continue to see his home appreciate at a rate of 10% a year. That sounds like it may be a bit unreasonable, after all if homes appreciated at that rate historically, an average home worth $44,600 in 1950 (the median home price in 1950), would be worth over $10.2 million today. At those rates no one would be able to buy homes anymore (which of course would cause a crash in home prices... anyone see how this works yet?). There is a very good reason that real estate trends closely mirror inflation over the long term.

Interestingly enough, Jeff has a "hold" strategy, but there's no discussion about how he intends to pay the mortgages on 14 properties that are 100% financed. As I've discussed before, it's very difficult to charge a high enough rent to cover 100% financing. If you can buy a house with no money down at the same price as renting it, why wouldn't you buy? There is most likely going to be a gap, not to mention the property managers taking a 7% cut of rents, but no mention of how he's going to cover that much of his carrying costs.

In August, Jeff admits that he still has very little idea of the real prices of his homes. All he knows is the NAR released numbers. A fellow poster named Taddyangle asked him if he was using comps to get a better understanding of his homes in particular instead of just looking at broad market indicies. Jeff responded:

August 3rd, 2005

Taddy,

As usual, I like your ideas. Recent sales are a good measure, especially if it is the same model by the same builder...I admit that I DO have some data points to use here, but not enough to feel confident about what appreciation is. After I have more data, I will feel more confident. For the most part, the recent sales suggest that appreciation IS positive and is IN the range reported by the NAR. But it is too early for me to give definitive answers...with ONE exception.

I can say with almost absolute confidence that the appreciation reported by the NAR for Cape Coral is TOO LOW. The houses that I bought there are now selling for 30k more, same model/floorplan. This is about 10k a month.

After investing for around 6 months, things seem to be looking up for Jeff. On paper his houses are making money, and one of his latest markets, Cape Coral, seems to be booming. These houses in Cape Coral, by the way, aren't actually built yet. And there is no knowing whether these homes have been picked up by investors or by people actually wanting to live there. But still, $10k a month seems to be incredible. Jeff could be going from night manager to millionaire by the end of the year!

In fact Cape Coral homes seem to be doing so well that only a few days later he says:

August 6th, 2005

[...] I expect to be ~$300-$500 [cash flow negative] on [the Cape Coral homes] each month. I am willing to do this though, as each will probably be going up 10k a month on average (my guess). On paper, is seems as if they can sit empty and still be good investments (like Phoenix a few months ago?).

That same day, he also answers a question from samzell, wondering about where he'll sit when he's a landlord and needs tenants. Jeff gives us a very open look into where he sits from a financial point of view:

August 6th, 2005

These numbers are not "real world" in the sense that I am not accounting for a "repair fund" or a "vacancy fund."

These number ARE "real world" in this sense, however. I HAVE calculated cashflow numbers on my first 5 closed properties (posted elsewhere), and they are VERY encouraging. On my first 5 closed properties, which are fully rented, I am making $250 a month before taxes, $961 a month after taxes (estimated), and >50k a year assuming a 5% appreciation, and nearly 100k a year assuming a 10% appreciation (on paper, of course). These are NOT made up numbers--these are actual numbers on actual properties and actual loans (albeit fully rented--as they are). [...] In SLC, my actual monthly total expenses on my 212k house is about $1500. My L/O lessee pays me about $1600. This actual 100% financing scenario seems much better than your "example."

This answers our earlier question about floating the properties. Jeff has managed to charge enough in rent (actually through using lease options) that he can stay positive.

So Jeff is earning a bit over $50 a property, but has no fund for vacancies or repairs. John T. Reed estimates that about 45% of your rental income will end up going to pay management costs, repairs, vacancies, taxes and everything else. So to discover if you are truely in a positive cash flow, multiply your annual rent by 55% and compare to your mortgage costs. In this case, we can estimate his mortgage costs to be in the neighborhood of about $1250. Using the above formula we can see that, sustainably, he's earning about $880 in cashflow, so he's most likely negative about $400 a month per property in a long-term view.

But Jeff does have a fallback option. In the same post he comes clean on the riskiness of his "plan", and how he will cope with short-term problems:

August 6th, 2005

>> I find it interesting that people buy "sight unseen".
If you mean by "interesting" seemingly insane and unjustified...I agree with you. Still, my hopes are high that my "buy and pray" strategy will pay off...

>> Also, have folks that are doing a lot of out-of-state buying & holding
>> thought about what happens if say 5 of their houses go vacant for at the
>> same time for a few months? In the scenario above that is $9,250 per month!!!

With 15 houses closed or under contract, I have thought about such a scenario a great deal. Still, I don't think such a thing likely to happen--with one year contracts and a 10% vacancy, it simply will NOT happen. But cash reserves ARE important...I am planning on keeping 50k immediately available--with a Heloc of 200k. This should MORE than cover any "vacancy" losses...enabling me to "ride out" any market downturn or other problem...I encourage others to keep a similar cash reserve...

It's encouraging that Jeff has $50k cash on hand (or at least he's "planning" on it? It's unclear). It's also good to know that he can get his hands on more money if there is a short-term disaster. However borrowing money to float your business is very risky. If your business is losing money, then borrowing can only make things worse, UNLESS you have a plan to turn things around. That HELOC that Jeff has available will have to be repaid on a monthly basis if he need to tap it, and I'm not sure that a $250 a month surplus will be enough to cover it.

On the other hand, it's a bit alarming when an investor says "it simply will NOT happen".

So Jeff has entered the scene with a bold strategy and a unique openness about his financial situation. Some tough quetions have been asked, and Jeff has been considering his risk. However, let us leave for now with an update on his original post, where he now re-evaluates his properties 3 months later with the new NAR numbers:

August 15th, 2005
>> ...my goal of a 10% return seems reasonable given the appreciation
>> rates above ( 15.0%, 11.1%, 6.1%, 9.3%, 25.6%, 18.5%--SLC appears to
>> be my "worst" investment right now at 6.1%). That is why I liked this
>> article so much, I look forward to re-checking in 3 months.

Well, 3 months is up...and here are the new numbers.

Metropolitan Area	2002	2003	2004	2004:II	2004:III	2004:IV	2005:I	2005:II	%Change
Albuquerque, NM	133.8	138.4	145.4	145.4	144.5	155.8	149.7	171.7	18.1%
Cape Coral-Fort Myers, FL	133.3	151.9	187.2	183.8	194.8	198.0	226.0	266.8	45.2%
El Paso, TX	88.9	92.9	94.7	96.0	95.1	96.1	104.8	108.9	13.4%
Oklahoma City, OK	100.1	103.0	112.4	107.0	125.8	109.7	110.3	115.7	8.1%
Pensacola-Ferry Pass-Brent, FL	112.2	116.4	131.1	132.7	133.8	139.6	143.8	163.6	23.3%
Salt Lake City, UT	148.8	148.0	158.0	161.5	161.3	159.7	157.0	169.9	5.2%

I can't help but notice quite a few interesting (to me) facts...

Albuquerque is now at 18%!. ZOWEY! Albuquerque is the new Phoenix!

El Paso appreciation is continuing in the double digits! I was VERY suspicious that last quarter's increase from 1.5% to 15% was a fluke (or typo?), but now it seems as if that level of appreciation could be sustainable. El Paso is the new Tucson!

Cape Coral appreciation is insane--I mean, 45% in one year!? I KNEW that 25% was too low. Now I KNOW I should have bought more there...oh well, it's too late now (or IS it...?)

My earlier skepticism about his expectations of 10% annual appreciation seem to have been incorrect, as Jeff's properties are going through the roof (at least according to NAR).

It seems as though our hero Jeff is quickly on his way to a real estate fortune! Tune in Thursday to see how things go over the next few months! Will real estate continue to appreciate at unheard of rates? Will he sell his Cape Coral homes for millions?

Stay tuned...