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Greed can cost you your shirt! by: Willard Michin
The proper action when things are going well is to pay off debt and consolidate your position. Then you will be financially strong and can go for further expansion without fear of loosing what gains you already have. When you are not deep in debt you do not have to worry about your creditors getting paid. Since the usual history of a business is cyclic (boom and then every 7 years (plus or minus) bust) you can predict when it is time to consolidate.
When the prices are “too good to be true, they are.” In the two years just before the top of the market is reached, prices are going up at very incredible rate. I have seen real estate go up 25%, per year, right at the top. This is incredible and I guarantee you it cannot sustain itself, at that rate. As hard as it is to give up a profit, it is harder still to sell an investment when it is going straight up. But, understand this is when you need to sell. If that is not what you want to do then you need to go to plan B: pay off your debt and get ready for the market drop.
If you are debt free you can survive the drop and then be solvent and financially secure when the recovery comes. I would like to tell you a story of the largest apartment owner in Hollywood.
It was 1980 when I met Nick. He owned 11 buildings at that time. He bought the worse buildings in town. These had the best cash flow. He owned mostly brick buildings. This was because they cost less money than stucco and wood buildings. This lower price allowed Nick to generate higher profits. Nick would buy a building. He then did a market study, and figured out what size apartments and what numbers of bedrooms were generating the highest rent, per square foot. Then he remodeled his building to get the highest price per square foot he could. He spent over $100,000 per building to do this. He also had to earthquake proof all of his buildings.
One of the reasons that brick buildings sold so cheaply was that they needed to be earthquake reinforced. When Nick finished remodeling a building, it was producing a very nice cash flow. Nick would use that cash flow to buy and remodel the next building. This was very smart thinking. Where did Nick fall off the rails? First he would find a great deal, while he was still in the middle of a remodeling job. He just couldn’t pass it by. He borrowed on one of his finished buildings to get the down payment to buy the building.
Then he would borrow on a second building to get the money to remodel the new building. Now he was remodeling two buildings at the same time. By borrowing on two of his successful buildings, he now had to pay the loan payments on the two new loans. The rents from the older buildings now went to the lenders instead of to Nick’s remodeling project. The new building, just bought, didn’t produce enough income to cover the new loan on it because half the building was empty due to the remodeling. Nick now needed to keep borrowing money to fix the buildings and pay the loan payments on the buildings that didn’t generate enough income. When a building was completed it then supported itself very nicely.
Was Nick happy with that? No, he wanted more and more buildings. If at any time Nick had stopped borrowing to buy new buildings, and just finished all his buildings in remodeling, he would have been able to catch up with himself and started expansion from a new level of security. That was, using the buildings profits after paying all of his loan payments to buy and remodel more buildings. Nick just couldn’t wait and consolidate his position. He had every building he owned loaned up to the maximum value that he was able to. The rents were more than enough to cover the payments on each individual building. So what happened?
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