Investing on Your Local Street Instead of Wall Street

David Phelps, DDS

David Phelps, DDS

[Editor’s Note:  This is a guest post from David Phelps, D.D.S., who has freed himself from the “slavery” of his dental practice not once but twice by investing in real estate.  He now teaches seminars on real estate investing.  He subtitles this post Creating Sustainable Income Through Strategic Real Estate Investment In The New Economy.  We have no financial relationship.]

My Story

I began building my investment portfolio in residential real estate in 1980 while a first year student at Baylor College of Dentistry.  During my undergraduate studies, I spent what leisure time I had reading books about the stock market and real estate investment (ok, I admit it, I was a bit on the nerdy side).  I could not understand how I, as an individual investor, could exert any control over stock market investments whereas real estate seemed to be the ideal investment for me.

I convinced my father, an ophthalmologist in Colorado, to be my first joint venture partner, a topic I will discuss later in this article.  I provided the management component and Dad was the passive capital investor.  Fast forward four years later when we sold our property and split a net profit of approximately $50,000.  This was far more than I earned waiting tables at night and on weekends and the management of this property consumed very little time at all (we bought the right house in the right neighborhood – one of the keys to successful residential real estate investment).

After graduation, I began the private practice of dentistry and simultaneously continued to acquire and build my real estate portfolio, later adding note receivables secured by real estate, a mobile home park, and a commercial building.  Fifteen years into practice, I had enough replacement income via my real estate investments to replace my labor-produced dental income…..and then, unfortunately, my marriage failed.  Six years later, my only child, a daughter, age 12, had to undergo a life-saving liver transplant.  Life had thrown me a few unplanned curve balls.

Fortunately, my real estate investments provided me the financial foundation to allow me to leave private practice and eventually sell the practice in order to spend the time that I needed and wanted with my daughter.  I am happy to report that Jenna is 21 years old and doing well today.

Real Estate Investing Gave Me Freedom

My own life is no longer scheduled by appointment.  I work, but I work when I want to work (on real estate investments) and choose what I do and with whom I do it.  This is my definition of “freedom.”  As a side note, I make far more profit and real equity in real estate investing today than I did in just over twenty years of running a top 5% producing dental practice.

The traditional paradigms of investment and financial planning, that is, earning and saving one’s way to retirement, followed by putting one’s full faith and future in the hands of Wall Street (stock market or municipal bonds) are no longer valid….if they ever were.

Like it or not, we live in uncharted waters today, with political and economic dynamics that have to date never been experienced.  Wall Street has not proven to be a good steward of our money.  The outright manipulation and high speed trading functions of these markets is reason enough not to be the place for the prudent individual retail investor to place his hard earned capital.

Historically, more wealth has been created via real estate than any other investment class.  The majority of business owners who are financially free have a significant portion of their assets invested in real estate.  Last year, Warren Buffet stated, “If it were practical to load up on single-family homes, I would.”  Today, Warren Buffet is systematically buying up real estate brokerages throughout the nation, providing him access to all of the single-family properties that he desires.

[Editorial Note:  I disagree with the simplification that investing in stocks and bonds is the equivalent of putting one’s future in the hands of Wall Street.]

Issues with Other Methods of Real Estate Investing


Why not commercial or multi-family, REITS (real estate investment trusts), PPM’s (private placement equity funds), limited partnerships, or TIC’s (tenant-in common) vehicles?  Each of these investment classes allow for ease of investment for the passive investor who wishes to diversify into real estate, but not without some serious downside risk.

The problem with each of these asset classes is that the investor loses control over his investment.  Capital is pooled with other investors and a management entity (which generally takes a handsome fee on the front end plus management fees during the holding period) does all of the management work.  In an ideal world, the investor receives the anticipated return on investment as well as a return of his initial capital invested.

Unfortunately, the loss of investment control simply to be passive often results in a loss of investment capital.  The internet is abundant with lawsuits from unhappy investors who believe that they were misled with false or misleading representations, or the management entity invested in inappropriate investments, or mismanaged the assets and so on.

Myths of Single Family Real Estate Investment

Then what are the options for the individual investor, particularly White Coat Investors, who are busy and focused on running and maintaining a viable professional practice, yet don’t want to lose control over their investments by handing them over to Wall Street or pooling their investment capital with syndications?

Let’s deal with some of the myths of single-family real estate investment before discussing the benefits and how best to be an efficient and prudent passive investor.

Common objections or barriers for the novice single-family real estate investor are:

1)     Inefficient market….it’s not easy! (the stock market being an “efficient”market).

2)     Limited access to opportunities (where and how does one find ‘good deals?”).

3)     No centralized management (the investor’s nightmare).

4)     Lack of liquidity (takes time to liquidate real estate equity)

These very objections to single-family investment are what make this asset class a prime opportunity for those who wish to build wealth in today’s economy.  We are experiencing a massive transfer of wealth (redistribution) today with trillion dollar bailouts of the big banks and Wall Street and the concurrent collapse of the housing bubble in 2007-2008.

Those who have access to and an understanding of local markets are taking advantage and acquiring these assets at well-below replacement cost and with cash flow returns well into double digits.   Strict credit financing and underwriting regulation has reduced the percentage of available homeowners who can qualify for financing which in turn causes rents (cash flow) to increase.

The inefficiencies in the market, the lack of ability for real estate values to be traded on an exchange, is what allows for the real opportunities for the astute investor.  It is because of these inefficiencies that real estate cannot be manipulated by high-speed computer or insider trading and keeps professional or sophisticated traders out of the market.

Finding ‘good deals’ is an art and requires both a local presence or network and the ability to lead generate through various media sources.The passive investor must rely on a co-venture partner who is a ‘boots-on-the-ground’ active investor to gain access to the best opportunities.  It’s all about the connection, or “who you know” (see joint ventures below).

Almost everyone knows someone or has direct experience with a landlord/tenant horror story.  But it is this very management skill that creates real opportunities for those who know how to either systematize or outsource the management component.  Real estate investment is not for the accidental landlord; someone must set up management systems and processes.

The fast track for the ‘passive investor’ for finding the best local opportunities and handling the management issue is through purposely-structured joint ventures with an active co-venture partner.  A joint venture is not a partnership.  Joint ventures provide for severable interests in real estate that are documented, secured and do not require the future division of interests through litigation  (the messy downside to traditional partnerships).

The most successful people in the world are those who learned early that almost any endeavor can be achieved more efficiently by collaborating with others who bring complementary assets, skills or resources to the project or investment.  Going solo limits the efficiency and ability to achieve and produce more.

Avoid Banks To Finance Real Estate


Real estate values have always been dependent on the availability of financing.  When interest rates are low and banks and mortgage institutions are providing relatively easy credit financing, real estate is more liquid and values increase (the driving force in the housing bubble which peaked in 2006).  During times of limited access to credit financing, housing values decrease and real estate is less liquid (the cause of the housing bubble collapse in 2007).

Novice investors consider traditional bank institutions as the main source for investment financing.  This limits the investor to the bank’s lending criteria and requires placing all of one’s personal assets at risk (personal liability .  Experienced investors have long avoided bank financing for acquisition and holding periods and instead utilize both private lenders and seller financing for leveraged acquisitions.

When one has developed access to private funds, no longer are real estate investments illiquid and leverage financing carries much less risk.  Additionally, private funds can be used in both equity and debt financing (the former being the most risk averse form of financing and the subject of a future article).

Additional Real Estate Benefits

Additional benefits of real estate investment include

  • Income – there will always be a need for well-located bread and butter single-family houses.  The occupants, or tenants, go to work every day to earn income in order to pay rent,  the source of income, similar to the dividends paid by some stocks.  Income via real estate carries a natural inflation-index component.
  • Depreciation – real estate provides tax benefits that no other asset class provides, including depreciation, tax-deferred equity appreciation and tax-free exchanging of capital gains profits.
  • Equity – ‘equity capture’ can be created by acquiring distressed assets at discounts to market values and can be ‘forced’ by adding value by way of property renovation.  Equity may also increase by natural appreciation or inflation in the economy.
  • Amortization – the pay down of debt leverage by tenant income (rent) is another form of equity building.
  • Leverage – the ability to control a larger portfolio of equities with relatively nominal percentages of capital investment.

As an aside, my father, my first joint venture partner, continued his own investment into real estate after our first successful project and made a real estate investment a significant portion of his retirement assets.  Today, his investments are almost all invested in notes secured by real estate, providing him monthly cash flow without any management issues….the perfect endgame for him.  He no longer has a need to build his wealth through equity acquisition.

In future articles, I will discuss how joint ventures are created, various yield returns available for single-family properties, the proper use of leverage, equity versus debt investments, and the use of self-directed IRA’s and real estate investment.

What do you think?  Does single family home real estate investing have a place in your portfolio?  What percentage of your portfolio would you allocate to it?  What have you done to avoid being an accidental landlord and to outsource the tasks you can’t or don’t want to do?  Comment below!

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Comments

Investing on Your Local Street Instead of Wall Street — 26 Comments

  1. I think the writer got incredibly lucky many times in his young career. I wish I would have had some of that luck.

    – He just happended to get into real estate during an incredible market for it and was able to build up enough of a stockpile before the crash to weather it (and probably pretty lucky that his renters weathered it as well.
    – He just happended to have some one essentially finance his early investments (I would have bought rental property too if it weren’t my capital)
    – I doubt he had school loans to pay off if he was investing while in Dental school (with his father’s money)
    – He apparently has decent connections to further help him finance some of his earlier properties

    Life through him some curve balls but it through him some juicy fast balls in the first couple innings that let him run up the score….

  2. This seems like terrible advice to post on a website that is focused on helping high-income, low net worth (at least when they start out due to loans and inability to save during school and residency).

    I suppose you can’t have a blog that just gives the same advice over and over (force yourself to save money and put it into several Vanguard Funds or similar low-cost index funds/etfs; don’t check the prices or performance daily; don’t try to “time” the market by predicting highs and lows…)

    The writer makes several snarky remarks about wall street, while ignoring the fact that if you had simply ridden the 2008 lows (or perhaps continued with dollar-cost-averaging during this time) you haven’t lost a single dime and, including dividends over that time, have made money since 2006 (even if you haven’t bought anything since the end of 2006).

    I believe investor behavior is the largest variable that can impact performance, and this type of “get rich quick” article only reinforces the idea that chasing performance and ignoring simple advice (dollar-cost-average, low-cost index funds) is appropriate.

    If you have participated in your 401k, funded your ROTH, have a taxable account with low-cost index funds, and have purchased appropriate term-life insurance; then you can think about dabbling in the real-estate market; but heroin may be a safer hobby.

    • You did lose money if all you did was get back to break even over the time period.

      There are two ways you lost:

      1) Inflation (real inflation not the CPI numbers that the government manipulates) has run between 3-5% a year. So if you are not at least making that you are losing purchasing power.

      2) Opportunity costs – the money could have been generating a forward yield instead it was trying to claw back the losses that occurred.

      Putting your money in the stock market is designed to maintain your principle against inflation, but it will not create wealth, you will be lucky after fees to make 6.5% long term if you are in a Fund structure. You can do better if you invest in individual stocks and can read a balance sheet and an income statement and now about long term sustainable drivers in the industry.

      Otherwise, to really grow your Investment portfolio, you need to invest in alternative asset classes and private partnerships. I have been able to significantly increase my families net worth through real estate investing, (I am the active manager) even though I am only 6 years out of residency and a primary care physician.

      The reason those of us in the know down Wall Street (I went to business school while in medical school and have family who are portfolio managers in NY) is because it exists to enrich the money managers, not the “investors”. Once you figure that out you will begin to look at ways that you can control and understand what you are investing in.

      • What do you prefer to use for “real inflation” instead of CPI? I can find some people who claim “real inflation” is 8, 10, or even 15%! The truth is the only inflation that really counts is your own personal inflation rate, which is nearly impossible to calculate, much less predict.

        Why do you think 6.5% after fees long term in a fund requires so much luck? The Vanguard S&P 500 Fund has an average annual return over the last 38 years of 10.82% per year, and all it does is just buy all the stocks. I see no evidence whatsoever that someone is likely to do better by “reading balance sheets and income statements” and buying individual stocks. There is a great deal of evidence showing you are likely to do worse doing this. Now that I think about it, I think that’s a quote from Robert Kiyosaki.

        Returns from “alternative asset classes” leave much to be desired. If you want to talk about something that exists to “enrich the money managers” I think a great place to start is alternative asset classes with their standard 2 and 20 compensation system.

        Real estate works fine for making money, but so does investing in publicly traded businesses via low cost, low-turnover mutual funds. I see no reason why an investor should shun one and invest in the other. It seems wise to me to invest in both.

  3. Hats off to him. Granted, he may have had some easy pitches along the way as Beau points out, but he put in the work and took the risks that are required to hit the home runs. I’m sure it has been very difficult and full of risk. I have slowly been building up a commercial real estate portfolio over the last several years. I have spent innumerable amount of time on deals that have closed, but also an enormous amont of time on deals that ended up not closing and thus you get nothing out of them other than experience. The amount of time and effort put into acquiring and managing real estate is significantly more than the time and effort needed to put into the stock market. If there is not a significantly higher return, then it is not work it. The author has put in the time and effort and is being rewarded for it. My guess, is he is setting up his articles to climax into offering to be a syndicator as one of the previous posters did. I agree that partnering helps to tap into their experience and work on the deals, but as seen with the previous posts, it comes at a costly price. If you really want the high return, you need to do it yourself or partner in a way that the work/effort/risk is equal as well as the returns.

  4. Although I’m not a physician, I do run a mortgagee practice with 15 employees and frequently put in 60+ hour weeks. On top of that, my wife and I own and manage as partners with my mother, 98 rental units here in Salt Lake City. Yes it’s a lot of work, but we effectively cut our federal income tax rate down by nearly 50% due to depreciation. We have created impressive equity and net worth over the last 12 years – it’s allowed my mother to retire from her law firm and focus what she loves the most, which is building our family net worth. She’s not only working for her, or for us, but for my children and we hope and believe for their children.

    Can a stock/bond account do that? We’ve found not and love our little business of being a landlord.

  5. Some posters are probably a little too negative on real estate. Real estate is a great way to get great returns and like with many things in life, the harder you work the “luckier” you get. The main downside is that it contains many elements of a second job. You can either pay someone else to do that job (lowering your returns) or do it yourself. For Dr. Phelps, it sounds like he prefers doing real estate work (much of which can be done when he wants to do it) to being a dentist.

    As far as real estate being a get rich quick scheme, I don’t think that’s necessarily fair. Many people have gotten very rich in real estate, but they generally do so by combining significant risk (high leverage) with a favorable market. Being highly leveraged in real estate from 2000-2006 made a lot of people a lot of money. Those who got out or deleveraged or were otherwise able to hold on or even buy more in the crash did just fine. Real estate isn’t anywhere near as efficient as the stock market. I don’t think it is as easy as many people who run seminars on it (such as Dr. Phelps) like to make it sound, but it certainly is no scam.

  6. I thought this was a good perspective. I’m interested in hearing more details. However, real estate investing was far more painful for my own family than Dr. Phelps’s seemingly easy experience. While they are doing well now, the time and effort put in has not been worth it in my opinion. It was stressful and took alot of time away from family at night and on the weekends, chasing after deadbeat tenants, fixing destroyed property, contending with town regulations, among other things. And in the end, the laws are always structured to benefit the tenant. “Real estate investment is not for the accidental landlord; someone must set up management systems and processes.” Yes but those management systems are very costly. I’d like to learn how to keep those management costs at bay before jumping into real estate investing ourselves, otherwise it’s not worth it.

    • You just have to get the correct training, I spent more money learning how to correctly manage residential real estate then I did in business school (b-school did not help me with real estate, it did however help me to divest all of my stocks and bonds).

      There is good investment training out there, and I can point you in the right direction (I have no financial ties to any training companies) if you like.
      But you have to remember that this a business, even more so than practicing medicine (self employment vs. passive income a discussion for another post).

      Please remember, by some estimates anywhere from 70-90% of millionaires world wide made or hold the bulk of their wealth in real estate.

  7. I love the post and I think that if you’ve maxed out your tax-advantaged accounts like a lot of us have, then real estate is a great (if not the best) place to put the money that would otherwise go into your taxable account.

    I disagree that passive, commercial multi-family real estate investing through a syndicator necessarily means loss of investment capital. You just have to find the right syndicator with a good track record.

  8. I really hope he addresses the details in future posts, as other commenters plead, especially regarding management and investor/venture connections. Right now, his piece reads like propoganda for Flip This House television.

    • You know, it’s really interesting how hungry readers of this blog are for details on even complicated subjects. There is so much information on the web, but so much of it is fluff and sales pitches. I try to include as much detail as possible and encourage guest posters to do the same.

  9. I would be much more open to investing in real estate if I didn’t move around so much with the military. I have several friends who have done well as absentee landlords buying a house in some places they have lived and turning them into a rental when the leave, but I’m wary of that. Also, statements like “avoid banks to finance real estate” are MUCH easier said than done. Access to private lenders means access to wealthy people, or at least pretty well off people.

  10. As a dentist, I feel this guy. I long for the day when I don’t have to grind it out giving mandibular blocks, listening to 9/10 patients remind me how much they hate going to the dentist, and a whole host of other complaints.

    Having said that, when you’re to the point where you’re selling expensive DVD’s, CD’s, and seminars to talk about plans like this, then the actual real estate investing itself can’t be that good.

    If the real estate investing were that profitable, then wouldn’t the best use of your time be utilizing your time to continue to make additional investments and managing properties rather than the SIGNIFICANT amount of time it takes to develop the training materials to give these courses and then sell them and market them?

    Reminds me of the guys who would run poker training websites, give gambling tips, or run stock picking websites. The holy grail is getting money without risk, which is what this guy is doing now. And it’s a great gig if you can get it.. even if an extremely small % of the people you sell the advice to are going to be able to do it.

    I bet there’s more money selling the advice than in the real estate itself.

    • First, keep in mind it is always possible that someone really does want to help other people and share something with them they’ve found to be very valuable. I find this trait far more commonly among those who wear the white coat. If I added up the hours I spent on The White Coat Investor and divided by the profits I’ve made I bet it would make my hourly rate as a resident look pretty good.

      Second, developing a business can be just as fun and profitable as investing in real estate. Just because someone is doing one doesn’t mean the other didn’t work out well for him.

      Third, I don’t think most people would consider developing a course and marketing it as the equivalent of “making money without risk,” at least not any more than the daily job you and I go to each day. Dr. Phelps seems to enjoy running a course and investing in real estate at least as much practicing dentistry. Shouldn’t we all do something we enjoy for work?

      Last, I agree that marketing generally (and Dr. Phelp’s marketing specifically) contains lots of hype, and the proof is in the pudding. There are many people who have made lots of money in real estate, and plenty that have made enough to leave a job they hate. I have no idea if attending one of these seminars will speed up or slow down the process for someone who wishes to do that, and leave that to the reader to decide. But if I wanted out of medicine as soon as possible, investing in real estate would be a natural direction to go for me. The leverage and the ability to have your labor and your capital working together to increase your net worth can be a powerful combination. But for now, I enjoy medicine more than searching for real estate deals, making real estate deals, and doing property management, so I’ll stick with doing that and investing passively for the most part.

  11. For me, residential real estate is not right due to the lack of economies of scale. Having said that, many health care workers own residential real estate and feel comfortable in that space.

    If residential real estate is your thing, this author does point out a very important concept about traditional bank financing. This type of financing generally comes as full recourse lending and can put your other assets at risk.

    Another point he does not mention about traditional bank financing is that it is capped for residential real estate. The number changes, but I’ve seen the cap as high as 10 properties and as low as 4 properties. This can be problematic. If the goal is to get rich with residential real estate, then you had better buy a lot of properties.

    Without endorsing a program that I am unfamiliar with, I can say that the concept of finding an inexpensive and reliable funding source that doesn’t put your other assets at risk and that won’t be capped is a good idea. That is a great description of commercial lending, but of course you cannot get commercial lending on residential properties.

    • Hey Dennis,

      For single family residential real estate you can have up to 10 1-4 family financed properties on your personal credit.

      After that point, you can turn to local commercial banks for lending, usually at 70-75% of the after repaired value of the property, or total project cost whichever is lower. If you learn how to build a team effectively you can very much get economies of scale in Single Family home investing, it is all about your knowledge base.

      Now, multi-family investing creates much larger economies of scale and allows you to accelerate equity accumulation if you do what is called a “value play” by purchasing a distressed asset and then increasing the operating income thereby increasing the value. But from a pure cash flow standpoint, in our market, on a per unit basis, single family will create larger cash flows in terms of percentage return on investment.

      As for personal assets, many states do not allow banks to come after personal assets, only the property that was used as collateral.

  12. I greatly appreciate all of the comments and feedback on my November WCI article titled “Investing on Your Local Street Instead of Wall Street.” Rather than reply to each individual post, for efficiency of time, I have responded to most of them herein.

    Why do I do what I do? I could live my life in a safe, small environment, simply acquiring and overseeing my own real estate investments. However, I enjoy being around like-minded and entrepreneurial-spirited people who seek answers and solutions to the challenges that we face in our country.

    “Relationship capital” is the greatest asset that I have. Self-reliance and a strong work ethic are qualities that I admire. However, trying to learn and do everything myself (the way I was taught to do) is not the fast track to any goal.

    Because I am free to choose how I live my life, doing what I want to do, when I want to do it, and with whom I want to do it, I have chosen to invest both time and capital to create a community of people like me. This is a community or brain trust of people with different experiences and skillsets who, together, meeting several times per year, strategize and mastermind to develop solutions to the challenges ahead. We all want the same thing; happiness, security and peace of mind.

    Within this community, friendships are forged, information is shared, and financial investments are made. We don’t need brokerage houses or investment advisors. We create our own market for both investment access and capital. We are active and passive investors and invite those with a similar mindset who bring unique and varied experiences to our group.

    In regard to my article it, it appeared that there were four general categories of response:

    1. Those who, as I often am, were highly skeptical of the material and made assumptions or doubted my motives for writing the article. I’m ok with that. I invite questions and skeptics. Hopefully, I can dispel some of those assumptions.

    2. Those who look at real estate investment as a “get rich” or “flip this house” scheme sold to the unwary and naive………..again, I get it. There is a lot of misinformation and “hype” about investing in real estate. It was there when I got started investing in the late 70’s and still exists today. Proper due diligence should always part of one’s investing program.

    3. Those who have had direct experience in the real estate investment markets confirmed what I attempted to do in the article; trying to educate the readers on an alternative investment class that can provide very solid returns with an inflation index in a tax-preferred environment.

    4. Management is too difficult and requires too much time. Paying others reduces return. Absolutely. I do not encourage those whose labor produces high income to trade their time for managing tenants and toilets. I started out with more time than money and over the years, as my portfolio grew, I learned how to joint venture with those who would do and could do the management for me. If I consider the value of my time (and hopefully you do yours), then employing others to do that work allows me to either find more good deals or just take time off. At some point, I don’t need to have high returns and am happy to accept a lower more passive return. If you haven’t built an adequate retirement base, then you have some work to do. There are no shortcuts and I did not intend for my article to imply such.

    While it was not possible for me to encapsulate thirty plus years of my learning curve and experience in one article, I did not intend to mislead anyone into thinking that real estate is get rich quick play. There are many who do market real estate as “the way out,” or easy-to-do if you pay me enough money for my secrets. That is not who I am. On the other hand, real estate has throughout history, created more millionaires than any other asset class. There is no magic. One should put in the time to at least understand the principles before turning his or her money over to someone else to invest or manage. I believe in education and many years ago decided that I would become as proficient and efficient a real estate investor as possible. That decision has provided me the ultimate in return on investment – a freedom lifestyle before age 50.

    I could write multiple articles about deals that did not go as planned, that took time and additional capital to turn around. Over the long term, I have never lost principal in any of my real estate investments (I am not a “house flipper” or speculator). As a long-term investor who understands how to safely leverage to build equity and cash flow, I have weathered four major economic down cycles without any capital loss.

    Below are some of the specific post replies with my response:

    “The writer got incredibly lucky many times in his young career……happened to get into. He just happened to get into real estate during an incredible market for it and was able to build up enough of a stockpile before the crash to weather it (and probably pretty lucky that his renters weathered it as well.
    – He just happened to have some one essentially finance his early investments (I would have bought rental property too if it weren’t my capital)
    – I doubt he had school loans to pay off if he was investing while in Dental school (with his father’s money)
    – He apparently has decent connections to further help him finance some of his earlier properties
    Life through him some curve balls but it through him some juicy fast balls in the first couple innings that let him run up the score….”

    Reply:

    Many assumptions were made in this post. Allow me to correct for the record. I don’t see anything that I have accomplished in my life as “lucky.” If I were magically “lucky,” I suppose I could have done as well or better playing the odds in Vegas. My definition of “luck” is when opportunity meets preparation. I did the work….I did the preparation. I made mistakes, but learned enough from good mentors who showed me very early how to mitigate risk while maximizing and leveraging the opportunities I found….but none of that was “luck.”

    Being an active investor since 1980, I don’t believe, would qualify the statement that “I just happened to get into real estate during an incredible market and stockpile before the crash.” There have been four major down cycles since 1980. Because I use “principled investing” vs. “strategic investing” and I do not speculate, surviving down cycles has never been an issue for me. In fact, even though my portfolio would lose equity value during a down cycle, strangely enough, none of my houses seemed to notice. Renters did not flee or stop paying rent. The cash continued unabated. One of the greatest reasons that I like single-family houses as an investment is that I don’t see a time here we will have an oversupply of houses….unless the federal government interferes and begins creating it’s own subsidized housing and building program. And, I would stay away from democratic blue states with population outgo.

    “I doubt that he had school loans to pay off”

    Reply:

    Actually, I did. I waited tables nights and weekends through college and dental school along with learning to acquire and manage real estate investment. Why would school loan debt (or any debt, for that matter), prohibit me from any entrepreneurial activity or investment? That statement just doesn’t make any sense. It doesn’t take money to make money.

    “He apparently had decent connections to help him further finance acquisitions.”

    Reply:

    Yes, indeed I did. But these relationships were not handed to me on a silver platter. Relationships are the greatest asset that we have. Relationships have been the core of my ability to survive many of the bumps in the road that I had to endure and continue to allow me to live the life that I do today. Too many people, particularly type A personalities (“drivers”), believe that they have to do it all themselves. Big mistake.

    “Life threw him some juicy fastballs…”

    Reply:

    Hmm…… again, not sure where this poster got that idea from my article. One can believe that “success” in life is all about luck, or one can believe that “luck” is in direct correlation with preparation and work. I didn’t nor did I ever seek to hit any “home runs.”

    This seems like terrible advice to post on a website that is focused on helping high-income, low net worth (at least when they start out due to loans and inability to save during school and residency).
    I suppose you can’t have a blog that just gives the same advice over and over (force yourself to save money and put it into several Vanguard Funds or similar low-cost index funds/etfs; don’t check the prices or performance daily; don’t try to “time” the market by predicting highs and lows…)
    The writer makes several snarky remarks about Wall Street, while ignoring the fact that if you had simply ridden the 2008 lows (or perhaps continued with dollar-cost-averaging during this time) you haven’t lost a single dime and, including dividends over that time, have made money since 2006 (even if you haven’t bought anything since the end of 2006).
    then you can think about dabbling in the real-estate market; but heroin may be a safer hobby.

    Reply:

    I’m not sure why this poster felt that this is bad advice for “high-income and low net worth individuals.” I would never suggest that anyone “dabble” in real estate or consider as a hobby unless fixing houses and managing tenants is desired. As far as the stock market, those who rode the down cycle in 2008 and feel that “all is good again” will be in for another big disappointment. That’s the nature of Wall Street manipulation. Individual investors are the “retail buyers” who take it on the chin every time. The problem that I see for most high-income individuals is just that…..high income and no net worth with no passive income and the reason most cannot retire without major downsizing of lifestyle. Real estate investment requires discipline and consistent investment. It created for me a net worth five times the value of my business (dental practice) because of the ability for me to leverage (leverage is not a bad word if it is used properly) to build my wealth. This is something that I could not do with my dental practice unless I was willing to build out multiple dental clinics.

    The reason those of us in the know down Wall Street (I went to business school while in medical school and have family who are portfolio managers in NY) is because it exists to enrich the money managers, not the “investors”. Once you figure that out you will begin to look at ways that you can control and understand what you are investing in.”

    Reply:

    I agree with this post.. The current market is riding a high due to the monetization of our debt by the Fed. Once the money-printing spigot is turned off, the market will crash. No control.

    “He may have had some easy pitches along the way as Beau points out, but he put in the work and took the risks that are required to hit the home runs. I’m sure it has been very difficult and full of risk. I have slowly been building up a commercial real estate portfolio over the last several years. I have spent innumerable amount of time on deals that have closed, but also an enormous amount of time on deals that ended up not closing and thus you get nothing out of them other than experience. The amount of time and effort put into acquiring and managing real estate is significantly more than the time and effort needed to put into the stock market. If there is not a significantly higher return, then it is not work it. The author has put in the time and effort and is being rewarded for it. My guess, is he is setting up his articles to climax into offering to be a syndicator as one of the previous posters did. I agree that partnering helps to tap into their experience and work on the deals, but as seen with the previous posts, it comes at a costly price. If you really want the high return, you need to do it yourself or partner in a way that the work/effort/risk is equal as well as the returns.”

    Reply:

    Again, I’m not sure what the “easy pitches were.” Hard work and study have been the benchmarks of any “success” that I have had in my life. I am not a syndicator. Through my years of experience, I have found that “partnering” with the right people is a form of leverage. I can better use my time and my skills by finding those who complement what I do well.

    “The harder you work the “luckier” you get. The main downside is that it contains many elements of a second job. You can either pay someone else to do that job (lowering your returns) or do it yourself. For Dr. Phelps, it sounds like he prefers doing real estate work (much of which can be done when he wants to do it) to being a dentist.

    “As far as real estate being a get rich quick scheme, I don’t think that’s necessarily fair. Many people have gotten very rich in real estate, but they generally do so by combining significant risk (high leverage) with a favorable market. Being highly leveraged in real estate from 2000-2006 made a lot of people a lot of money. Those who got out or deleveraged or were otherwise able to hold on or even buy more in the crash did just fine. Real estate isn’t anywhere near as efficient as the stock market. I don’t think it is as easy as many people who run seminars on it (such as Dr. Phelps) like to make it sound, but it certainly is However, real estate investing was far more painful for my own family than Dr. Phelps’s seemingly easy experience. While they are doing well now, the time and effort put in has not been worth it in my opinion. It was stressful and took a lot of time away from family at night and on the weekends, chasing after deadbeat tenants, fixing destroyed property, contending with town regulations, among other things. And in the end, the laws are always structured to benefit the tenant. “Real estate investment is not for the accidental landlord; someone must set up management systems and processes.” Yes but those management systems are very costly. I’d like to learn how to keep those management costs at bay before jumping into real estate investing ourselves, otherwise it’s not worth it.”

    Reply:

    If one understands the tenets for long-term real estate investment and how to safely leverage so as not to be caught in a down cycle as many were in 2007-2008, real estate will continue to produce very good cash flow not matter what the economy is doing. One still must be prudent as to the geographical location for investing. Certain markets are known to be more volatile and probably not suitable for the investor who is not actively engaged. Management: Anything worth doing requires some level of management. You either do it yourself (= a “job”) or you build systems and employ others to do the work that you don’t like to do, don’t do as well as others, or would rather have your time. There will always be a price to pay somewhere. I can obtain very high returns if I am actively involved in any particular investment. However, I am a passive investor in about 50% of my investments today because I value my time and did the sacrificial work earlier in my life. There is no escaping some sacrifice somewhere and at some time. But it’s a choice….and I see far too many high-income earners sacrificing their whole life and then wondering what happened at age 50, 60 or 70.

    “But you have to remember that this a business, even more so than practicing medicine (self employment vs. passive income a discussion for another post).”

    Reply:

    Again, one can be passive or one can be active. It’s a choice. If the high-income job is the best use of one’s time, then the investor should be passive and employ others to handle the active management of said portfolio. I transitioned from a relatively high-income profession into active real estate investment. I do work, however, my time is completely flexible. I am able to travel at will and spend time in hobbies and with my family. That is true freedom to me.

    “Right now, his piece reads like propoganda for Flip This House television.”

    Reply:

    I made no reference to flipping houses. Flipping houses is truly a business, one with many moving parts and a great deal more risk. Might be good to go back and re-read the article.

    “Statements like “avoid banks to finance real estate” are MUCH easier said than done. Access to private lenders means access to wealthy people, or at least pretty well off people.”

    Reply:

    That is your mindset and experience. You don’t know what you don’t know. Self-limiting beliefs will hold one hostage. I have more money to invest than I have viable deal flow.

    “When you’re to the point where you’re selling expensive DVD’s, CD’s, and seminars to talk about plans like this, then the actual real estate investing itself can’t be that good.
    If the real estate investing were that profitable, then wouldn’t the best use of your time be utilizing your time to continue to make additional investments and managing properties rather than the SIGNIFICANT amount of time it takes to develop the training materials to give these courses and then sell them and market them?
    Reminds me of the guys who would run poker training websites, give gambling tips, or run stock picking websites. The holy grail is getting money without risk, which is what this guy is doing now. And it’s a great gig if you can get it.. even if an extremely small % of the people you sell the advice to are going to be able to do it.
    I bet there’s more money selling the advice than in the real estate itself.”

    Reply:

    My real estate portfolio is where 100% of my income is derived today. For over 30 years, through disciplined work and investing, I build a platform that allows me to be free.

    I think that this is more a comment based on perspective, perhaps personal experience in losses by other speculative investments or schemes (I’ve been taken, too). If the comment was a comment directed specifically toward me, I don’t believe my article was selling “expensive CD’s and DVD’s. “ However, I am a massive consumer of information, so I personally do invest a great deal of my income in education which includes seminars, events, CD’s and DVD’s. The adjective “expensive” is, of course, based on value received in return. If there is no real or perceived value, then the word “expensive” fits for that individual. Perhaps there is a market segment that would feel the same about your services or product because 1) they didn’t need what you offered or 2) they felt that they could receive the same for a lesser cost to them (whether true or not). But just because you don’t value certain information that you have not taken the time to review, does not mean that it is “expensive” for everyone else. For some, a GM truck might seem expensive while a Chevy seemed to be appropriate (thought they are the same base vehicle)….is that marketing hype when the former sells for $10K more than the latter? How about Toyota vs. Lexus? Am I wrong if I drive a Lexus when I could essentially get the same vehicle by driving a much less expensive Toyota? Value has different meanings to different people. If I can learn something from someone who provides me with what I believe to be good and valuable information that will allow me to in some way better my situation and do so more quickly and with less risk, was that information “expensive.” Depends. Don’t be so quick to judge. Ask intelligent questions instead.

    As a side note, I “sell” very little in products, though I have created several based on the investment models that I teach. My real estate active investment transactions thus far in 2013 have been an average of three per month, averaging an annual return of 14% plus inflation hedges. I am both active and passive in my investing, so 14% is a good number for me. In summary, I do not make a living selling products or events. I created a wealth platform that provided me personal freedom.

    “Marketing generally (and Dr. Phelp’s marketing specifically) contains lots of hype, and the proof is in the pudding.”

    Reply:

    I agree that much of marketing is hype today. I am a very conservative and highly skeptical person. The world is replete with those who do make claims in real estate an other types of investing that I believe are not true and certainly are hype. I find it interesting, however, that anyone would make claims of “hype” without knowing the facts and doing their own due diligence first. That is a statement that would one would typically make out of ignorance and/or lack of real understanding. Here’s another thought – “if it’s been done, then it is probably possible.” What was the attitude of the world in regard to breaking the 4-minute mile? Absurd! Impossible! And then it was done….and not just once, but many times since. A lot of our own (myself included) beliefs come from our own mindset baggage. We believe what our environment has taught us or from our own experience and is not based on fact. Being a skeptic is good….but don’t let that completely cloud your opinion until you base it on fact.

    “Residential real estate is not right due to the lack of economies of scale ….”

    Reply:

    Warren Buffett, in 2012, publicly stated, “If I could, I would be loading up on single-family houses.” And guess what Warren has been doing….buying real estate brokerages across the country. Is Warren “actively managing” those houses? I think not. Is Warren concerned because he is giving up too much in profit by “joint venturing” with others to create value and capture market equity? I think not. Why is it that we think that we are “giving up” when we collaborate, or “partner” or joint venture with others? In my opinion, that is a scarcity mindset. My hat off to you, Dr. Dennis Bethel, because you obviously understand the benefits of real estate and are finding your market niche to be working well. Warren apparently is not worried about lack of “scalability” in single-family house investment.

    “For single-family residential real estate you can have up to 10 1-4 family financed properties on your personal credit.
    After that point, you can turn to local commercial banks for lending, usually at 70-75% of the after repaired value of the property, or total project cost whichever is lower. If you learn how to build a team effectively you can very much get economies of scale in Single Family home investing, it is all about your knowledge base.”

    Reply:

    By far, the most enlightened and intelligent comments regarding my article were from those with some level of experience in real estate investment and showed that they had also studied and prepared before investing. Yes, you can build in economies of scale into single-family investing. It’s the safest real estate investment class. The above post regarding commercial financing is correct, however, I don’t advocate using institutional or bank financing for real estate investment. The banks will own you. The banks are 80% owned by the government. I don’t want that kind of joint venture partnership.

  13. Hey David,

    Thanks for the compliments in your replies to everyone,

    This is Eric Tait (internal medicine from Houston), we met a couple of times at Eddie Speed’s note events.

    The commercial lenders I was referencing are local community banks that were precluded from participating in the government recapitalization schemes during the downturn and they are proud of it.

    They hold their loans in portfolio and with a 5 year term, 20 year amortization, by the time you have interest rate shocks, one would have around a 40+% equity cushion in the property or more. So although they might not be the ideal partner, they have access to capital and are willing to lend at rates (5.5-6.5) that allow for great cash flow and equity build up, so for the beginner without the Rolodex of private lenders its a way to get started while prices are still cheap.

    As the old saw goes “You can lead a horse to water….” and I find that among my physician colleagues who have watched me (even with massive school loans) amass a tidy real estate portfolio since I graduated from residency (2006).

    All one can do is continue to spread the good news, and hope we reach those that want to be reached.

    • Hey Eric! Thanks for identifying yourself. Yes, I do remember visiting with you.
      I understand what you are saying about the local banks. You may be very right.

      My long-standing experience is that those who stayed away from any institutional loans are those who could weather the down cycles, in particular, the most recent. Once people or investors use the banks, it’s difficult for them to be more creative in the ways that private lender joint ventures can be constructed. It’s a handicap in my view.

      I enjoy the conversations on this site – we all have our own experiences and perspective and I find many interesting posts in other financial arenas that are helpful.

      Stay in touch…..let me know if I can ever help you!

      David

  14. I’m not sure I see a 10 mortgage limit as a huge barrier to someone looking merely for financial freedom. If you buy a property a year you have ten years before you have to start buying properties for cash (or you can just pay off the first one and then go get a new loan for property 11.) After 20 years, you ought to have 10 properties paid off and clearing perhaps $1000 a month a piece, providing a reasonable income.

    There’s no doubt that real estate investing is a great way to invest and I think there is a lot of data to recommend its use in diversifying a portfolio. There are two issues with it that many of its proponents tend to gloss over:

    First, its an inefficient market. A talented investor can boost his returns. That also means an investor without the necessary talent is likely to have lower than average returns, perhaps much lower than average given the use of leverage that is typical in the asset class. Since average returns in real estate investing are typical to average returns in stock investing, there are a lot of real estate investors performing below average with no way to easily achieve the market return (as there is in stock investing.)

    Second, as noted above in posts by Dr. Phelps and ET, there is a need to put in a lot of work and become educated on the subject. That is fine for those who want to do that. However, many readers of this blog aren’t particularly interested in a career as a professional investor. One of the primary messages of this block is that a doctor doesn’t HAVE to get into real estate (or anything similar) to be successful. Due to his high income, if he will just save 20% of his income from day one, invest it in a reasonable portfolio of stock and bond index mutual funds, then over time he will achieve financial freedom. This “default” investing method has much to recommend it. There are many roads to Dublin. Taking the “real estate” road may be faster for many investors, but it will be slower for others. Staying on the motorway with the “default method” will get you there quite reliably.

    • Let me add a counter point to what you said –

      “First, its an inefficient market. A talented investor can boost his returns. That also means an investor without the necessary talent is likely to have lower than average returns, perhaps much lower than average given the use of leverage that is typical in the asset class. Since average returns in real estate investing are typical to average returns in stock investing, there are a lot of real estate investors performing below average with no way to easily achieve the market return (as there is in stock investing.)”

      First, the inefficient market is why we LOVE real estate, insider dealing is encouraged and you can actually have an advantage, this will never happen for an individual investor in stocks and bonds.

      As with all things in life, there are average people and above average people, but let’s look at what an average real estate investor can achieve on a modest deal, and you let me know if falling short of this still beats the BEST above average stock picker (as an aside it is way easier to become a millionaire investing in real estate part time then it is in being a part time stock investor with another day job)

      Our last investment project, bought 6 weeks ago.

      Purchase price 72K
      Out of pocket costs to purchase and renovate = 11K
      Mortgage amount = 82K
      Current market value = 120K
      Capital gain – (120K-82K) = 38K
      Return on capital gain (38K/11K) = 345%
      Monthly cash flow after all expenses and vacancy factor = $315
      Cash on Cash return 34%
      Total return year one (345%+34%) = 399%

      This does not even take into account the tax advantages, principle pay down by the tenant, or depreciation.

      So if I stipulate that I am somehow an above average real estate investor then the average real estate investor might get half of this return, I think that they would be happy with it. And just so you realize, this is an OK deal, we have had a few where we had $0 out of pocket and higher cash flows and capital gains.

      “Second, as noted above in posts by Dr. Phelps and ET, there is a need to put in a lot of work and become educated on the subject. That is fine for those who want to do that. However, many readers of this blog aren’t particularly interested in a career as a professional investor. One of the primary messages of this block is that a doctor doesn’t HAVE to get into real estate (or anything similar) to be successful. Due to his high income, if he will just save 20% of his income from day one, invest it in a reasonable portfolio of stock and bond index mutual funds, then over time he will achieve financial freedom.”

      Yes, I spent time studying the subjects of how to invest my own money and then how to help my colleagues invest their money, I actually went to business school as well as medical school (dual degree program). I practice medicine 5 days a week as a primary care physician. Saving 20% of one’s income is unrealistic for many people as the average American spends more than 90% of what they make every month (even white coat wearers), so the model of saving your way to retirement is really broken.

      I define financial freedom as the ability to maintain your current lifestyle WITHOUT TOUCHING YOUR INVESTMENT PRINCIPLE, while not having to work full time (or at all). The scrimp and save method will only get the highest of high income earners to that level.

      I have studied the academic literature on investment returns, and while index funds are a fairly new in terms of wide spread adoption, if you look at buy and hold, the great bull market coincided with the transition from defined benefit plans to defined contribution plans, which coincided with the baby boomers being in their prime/peak earning years. So all of this money was thrown at Wall Street in the early 80’s and you can watch the run up that occurred.

      But there is something called regression to the mean, and the U.S. had 20 years of above average stock returns, and we will then have 20 years of below average returns as well. The Dow Jones index was around 13,600 in 2000, we are just reaching new highs today, almost 13 years later, that is less than a 3% return a year, not counting fees and expenses. The Fed is currently pushing nominal prices up with its money printing, but inflation is also eroding purchasing power, so prices are up on stocks and on things that you would use the money from stocks to buy as well so that is a wash.

      The stock market is a place where someone can attempt to match the inflation rate as a forced savings program and no more, if you are trying to attain financial freedom it will take some effort to go out and learn how true wealth is created.

      • When calculating your real estate returns, be sure to calculate in the value of your time, including the time you spent educating yourself. At $100-300 per hour, that adds up very quickly. I’m glad you’ve got a bunch of homes worth $120K available to buy for $72K. If you are particularly talented at finding those, I’m sure you’ll do very well in real estate investing. But the idea that anyone and everyone can go out and buy homes for $72K, fix them up for $11K, and then turn around and sell them for $120K at any time they please is unrealistic. However, anyone and everyone can save a reasonable chunk of his income, buy index funds, and let them grow over decades.

        The model of “saving your way to retirement” is not broken just because some idiot can’t live on a mere $400K of his $500K income.

        You may define financial freedom any way you please. The “scrimp and save” model can get anyone to that level. I’m not sure you completely understand the concept of “total return investing.” If you don’t want to spend your principal, that’s okay with me. You can leave your principal to your heirs or charity. Some people would rather spend some or all of it. That’s okay.

        There is absolutely no reason that the US somehow HAS to have 20 years of below average returns because they had 20 years of above average returns.

        I suppose index funds are “fairly new”, although 38 years isn’t exactly brand new. At any rate, the investments that index funds invest in certainly aren’t new. Businesses have been around for millenia, just like real estate.

        The stock market has bested inflation by several percentage points over the long run. I’m not sure why you think that something has changed and now it can only match the inflation rate. I’m not arguing that you cannot create “true wealth” with real estate. I’m arguing that it isn’t the only way to do so. You seem to carry some anti-business/stock bias that I don’t quite understand. Owning a profitable business is a great way to make money, whether that business produces products and services people want and are willing to pay for or whether that business provides a place to live that people are willing to pay rent for.

        I disagree it is “way easier to become a millionaire investing in real estate part time then it is in being a part time stock investor with another day job” but I respect your opinion. I think a doctor making $500K a year, saving 20% of it, earning 8% on the money will become a millionaire (not counting anything but the investments) in a little over 7 years, and need spend no more than 2 hours a year on his investments. That seems easier to me than spending a lot of time and effort educating oneself about real estate investing, searching for deals, completing deals, fixing places up, reselling them etc. Sure, if you’re willing to work a second job, you’re going to get rich faster. That seems obvious. Investing in real estate and investing in businesses are both great ways to build wealth. I see no reason to use only one of them and lots of reasons to use both.

        • I actually spend less than 5 hours a month (unless we are in acquisition mode, I bought the last house because I need some more tax write offs before he end of the year) on my real estate portfolio, because I am a buy and hold investor not a flipper, flipping is a job, investing is passive.

          I invest 10% of my income on personal development yearly, just to become a better person, some of that is spent on business, other real estate, some on paper assets. I see that as insurance against the inevitable change that always comes.

          I agree with you wholeheartedly that someone making 500K should be able to save 20% and still live well, but that does not seem to pan out as often as the case would seem.

          Also not touched upon is the fact that the 500K MD will probably not be making this in 5-10 years as we move to alternative payment models. Cardiology and Radiology were cut 20% a few years ago, so your savings premise would have gone out the door with these two specialties. What are these M.D.’s going to do in a non fee for service, bundled payment future?
          Are they going to magically cut there living expenses commensurate with their cut in income? Again, that is trying to divine the future with a crystal ball, all I am advocating is allocating to value and cash flow early in people’s investing careers, it will mitigate the changes afoot in medicine.

          I am a firm believer in investing in businesses, I am an owner in a few myself outside of our real estate holdings, but I find the knowledge and skill level needed to be successful much higher than real estate investing.

          You are correct in picking up my bias against paper assets (specifically assets traded on public markets). I will sell stock all day long, but I am loathe to buy them, the real profits were in the sell, not the buy.

          • Yes, I suggest that if someone’s income decreases that they “magically” cut their living expenses. I call it budgeting. What do you suggest they do?

            I absolutely agree that someone should allocate money to building wealth early (as well as later, but more important earlier) in their career, however one wants to do that. If it is learning about and investing in real estate, that sounds great to me. I generally suggest 20%, but if your returns are high enough or you do it for long enough, 10% would still get you there.

  15. Great points ET and WCI. This is what makes this site so valuable. As you both suggest, to become a savvy investor in RE does require time in education. I did spend the time…a lot of it.

    The advantages to me, however, were numerous. I think we all agree that most of our colleagues are very poorly equipped to run a business or invest for their future. Real estate taught me how to do both and helped me become very adept in a number of disciplines, including business, marketing, negotiation, finance and taxation.

    I have also been able to associate with a brain trust of other like-minded investors and health care professionals who have very similar goals. Those associations have proven to be invaluable to me.

    It is very possible for those who do not want to be active real estate investors to invest passively through joint venture investing and have passive returns cash on cash well into double digits, notwithstanding the additional inflation index. I do it all of the time as I am both active and passive in my real estate investments as a form of diversification, both in asset class and geographically. I could NOT do this without my affiliation with other active investors. Your network is your net worth.

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