Our Favorite Way to Build Long-Term Wealth

Dow down 41 on Wednesday. Gold down $3 an ounce. Want something better? Try real estate! 

Yes, dear reader, we don't care much for stocks or bonds. We don't trust them. Because we can never get beyond the threshold question: If these were such good investments, why would they be offered to us?

That question comes from years of experience running a business of our own. As long as the business is doing well, we have no interest in sharing it with perfect strangers. If we ever "go public" – watch out, it will be time to sell! 

But if you don't trust stocks and bonds, what do you do? Bricks and mortar! Terra firma! 

Yes, real estate has its troubles too. Leaky pipes and drafty windows, for example. But at least we understand what they are. We can see them with our own eyes. We saw lots of them last week when we trotted over to an open house two blocks from our office in Baltimore. An apartment building of 13 units is up for auction today. A couple of years ago, there would have been only one or two people at the open house. Last week, there were at least 15, maybe more.

Interestingly, some were people we knew – long-time real estate investors in the Baltimore area. Some were new. One couple was from India. Another man, who spoke English only poorly, was Chinese.  How do quasi-slum tenements in Baltimore attract global investors? We don't know. Maybe the proximity of Johns Hopkins University and the Peabody Conservatory of Music. Maybe investors are just looking for a better deal than they can get in major cities. 


Brand Name Cities

A few years ago, we coined the term "brand name city." The idea was simple… 

There were more and more people who were footloose – especially rich people. Often, they are semi-retired, running their businesses or investments over the phone and the internet. They can live wherever they want.  These people – many of them "nouveaux riches" – drive brand name automobiles… wear brand name clothes and wristwatches. It makes sense that they would also want to live in brand name cities – those that attract the international elite. 

At upmarket cocktail parties and weddings today they then merely say they live in London or New York, and they have something in common with many other guests. If they don't have an apartment there, they know someone who does. Top on the list of brand name cities are London, Hong Kong, Paris, New York and Vancouver… Many others are close behind.

In Paris practically all expensive apartments that change hands are bought by foreigners. In central London the story is much the same. In the most expensive areas few local people can afford to live. Overseas buyers push up property prices and change the character of the neighborhoods. We lived in an apartment in London, for example, where almost all of our neighbors were Russian, Japanese, Chinese or Brazilian. Since most of the owners had other residences, sometimes several of them, the apartment building was as quiet as a library. We rarely saw anyone coming or going.

But Baltimore has yet to find its way into the "brand name cities" category. No one buys real estate in Baltimore for prestige purposes. No one brags that he has a "little pied a terre" in Charm City. And prices reflect it. Here, investors have sharp pencils and short tolerance for spending money.

The building I looked at last week had been "improved" by the previous owners, but in a low-budget way. Woodwork that should have been stripped down and fixed properly was caulked and painted over. Pipes that should have been removed and replaced were left running along walls and across ceilings. A huge, rough-sawn timber kept the staircase from falling down. "Sheet goods" – rolled linoleum made to look like wood – covered the floor.


6-7% Annual Returns?

A real estate pro explained the deal to us:


“Prices have gone up substantially. So, you've got to be careful. There's a lot of money coming into the area. Landlords are going to have to compete for tenants. Margins are going to be squeezed.”


"Does this mean it's no longer a good place to invest," we asked? 


“Well, I don't think we're going to see the kind of returns we saw a few years ago. We were getting 10% to 12% on some projects. We'd invest $1 million and get net annual return of $100,000. Now, prices are up. And mortgage rates are up. So maybe we're only able to get a return of 7%… or 6%. That's not great, but it's not bad. And it beats gambling in the stock market.”


Meanwhile, another real estate pro in Florida (one of the experts we tap into from time to time for real estate recommendations for our Bonner & Partners Family Office advisory) has offered what appears to be an even better deal:


“I'm not able to find good deals in the best markets. But there is still money to be made, if you're willing to go a little further out and work a little harder. I'm looking at an apartment building of 55 units. I think I can get it for about $1.8 million. The total budget including closing costs, improvements and reserves might be about $2.2 million. We fix it up. We get in good tenants. We would eventually seek a Fannie Mae cash out refi and could probably return 60% to 75% of our capital. We're looking at an almost guaranteed return of 7.5%… probably a bit higher.”


Yep. Better than gambling on the stock market.



The above article is from Diary of a Rogue Economist originally written for Bonner & Partners.

Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.





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One Response to “Our Favorite Way to Build Long-Term Wealth”

  • SavvyGuy:

    As mortgage rates have come down over the past few years, investors have rushed into purchasing rental properties with loans. So I sense an “oversupply” of rental units building up. At the same time, median incomes as well as household formation are flat to declining, and I sense an “underdemand” for rental units.

    Let’s do the math:

    Oversupply + Underdemand = Lower rates of return than in the past, and that’s if property taxes and insurance costs don’t go up!

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