Book of Wise Investors

Benjamin Graham value investing principles pay handsome dividends to those who follow it, the most famous example of which is Warren Buffet. Given the large similarities between businesses and physical properties, it is clear that some principles can be ported when one is going to buy properties.

No one places 100% cash down when buying properties for investments, other than primary residence. Although the price of a physical property seldom drop to zero, unlike that of stocks where even for a well know blue chip like Enron and Lehman Brothers can fall, its price can still dropped in the short run. In addition, using some leverage for buying properties increases return on owner equity.

Real estate investors can safely use leverage, that is using debt to finance the purchase of physical properties when the following conditions are fulfilled,

1. Maintain sufficient cash reserves

As I mentioned before, the price of houses can fall in the short run. Default on mortgages for more than a few months will result in foreclosures on the property, if the market is not good for properties when it occurs, then investors will be liable for any outstanding sums owed to the finance companies or banks involved in selling you the mortgages.

Even the best properties in the best districts can suffer from unexpected lack of tenants due to economic downturns. As a result, either got cash reserves or steady income from jobs or elsewhere for at least three months of mortgages payments, just in case got three months without rent from tenants.

But when your rental units get more and more, there is diversification of cash flow from different rental apartments, hence you can reduce the cash reserves.

2. Try to avoid negative cash flows

As what Warren Buffet tells us, there is no need to switch at every pitch like most professional fund managers. Value investing tells us to wait for the near perfect pitch. Just because you have $100 000 to invest in properties does not mean that you should invest that $100 000 by buying a property in the next 10 months.

Negative cash flows are when rental income cannot cover mortgage and other expenses. It is like owning a business with negative cash flows for quite a long time, retained earnings cannot pile up and increase shareholder value.

When there are negative cash flows,

a. Place more down payments

b. Try to restructure or negotiate the deal

c. Look for other properties to invest

3. Beware of pro fomas thinking

Do not have the idea that you can increase rent so that rental income exceeds mortgage and other expenses in future. This will most probably lead to unable to find tenants and high turnover of tenants. At the end of the day, this can attract a lower quality of tenants.

4. Avoid over financing

Beginner investors in real estate will be likely to over leverage, do not burrow more than what the property is really worth.

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3. Look beyond market prices for realty investments
4. Why investing in structured products is like being screwed