In the late 1970s, I made my first investment in rental real estate.
It was a tidy little one-bedroom condominium apartment in a recently refurbished building on Massachusetts Avenue in Washington, DC. The woman selling it was the owner of a townhouse we were renting. She persuaded K and me to look at it by explaining how prices had been escalating in the area, assuring us that they would keep on rising, and by offering us a loan that required no money down.
“No money down! How cool is that!” I thought.
We went to see the apartment. It was small but not cramped. The building was old but had been remodeled recently, with a handsome entry and a gilded elevator. It had central AC, and, as she put it, “good bones.” Plus, the woman noted, it was in the center of an up-and-coming neighborhood.
“It will be easy to rent out,” she said. “You really can’t lose.”
“And there’s no down payment, right?” I said.
She smiled.
K was suspicious, but it seemed like a no-brainer to me – and it was. Alas, the no-brainer was me!
The woman was correct in telling us that property values in that part of DC had been going up. (She was also correct in predicting that they would continue to rise.) And she did, indeed, come through with a no-money-down deal, although it required us to sign some papers that didn’t quite make sense to me.
“Don’t worry about it,” she assured me. “This is what we call creative financing.”
“And the bank’s okay with it?” I asked.
“They drew up the documents,” she said.
A month later, we had a mortgage and the keys to our first investment property. All without coming up with a dollar in cash.
What the woman hadn’t told us was that the value of the apartment we bought – the estimated value that was indicated on the mortgage – was considerably higher than what it was actually worth. And at the end of the three-year term of the mortgage, I discovered, quite disturbingly, that had to file for a new mortgage. The new mortgage had a higher interest rate than what I had been paying. Plus, I had to come up with several thousand additional dollars for bank fees and other “transaction costs.”
But the pièce de résistance was that, at the end of the three-year term for the new mortgage, the balance was higher – by thousands – than it had been on the first mortgage!
I learned the hard way what negative amortization means. It means that the mortgage payments I was making were not sufficient to cover the interest payments on the loan, and not a penny was going towards the principal.
The Bad News Gets Worse
I wish I could say that was the totality of the bad news, but there was more to come.
We had rented the apartment to a nice young woman that presented herself as a college student. As it turned out, she was earning her tuition – if she was actually going to college – by entertaining random men in her apartment at night.
This led to regular complaints from the neighbors (which were transmitted to us by the building’s foul-mouthed superintendent) and fines from the homeowners association.
To add insult to injury, after the second month, our tenant stopped paying rent!
I asked a lawyer friend of mine about how to kick her out. He told me that DC had recently enacted a string of tenant “protection” regulations that would make the eviction process long and difficult. “You’ll be lucky if you can get her gone in a year,” he told me.
I considered changing the locks when she was away, but my friend said that if I did, I’d be arrested and put in jail.
“Well, that’s a nice thought,” I told him. “I’ll be sitting in jail, still paying the mortgage, still losing money every month on the negatively amortizing loan, still paying fines to the HOA, and she’ll still be comfortably entertaining.”
I had fallen into real estate hell with no prospect of getting out.
When I finally saved enough money to pay off the overpriced mortgage and sell the damn whorehouse of an apartment, I took a hit of nearly $40,000, which was about $40,000 more than my net worth at the time.
The Silver Lining to the Story
I made a Master’s Degree of mistakes in making that one investment – most of which I would never make again.
Ten Edifying Facts About Investing
1. Fact: Since 1916, the Dow Jones has made new all-time highs less than 5% of all days, but over that time, it is up almost 300,000%, including dividends.
Takeaway: 95% of the time you are underwater. The less you look, the better off you will be.
2. Fact: The Dow has compounded at less than 4 basis points a day since 1970. Since then, it is up more than 30,000%, including dividends.
Takeaway: Compounding really is magic. CHF 1,000 became CHF 300,000.
3. Fact: The Dow has only been positive 52% of all days. The average daily return is 0.73% when it is up and -0.76% when it is down.
Takeaway: See #2.
4. Fact: The Dow has spent more time 40% or more below the highs than within 2% of the highs (20.6% of days vs. 18.4% of days).
Takeaway: No pain no gain.
5. Fact: The Dow lost 17% in 1929, 34% in 1930, 53% in 1931, and 23% in 1932.
Takeaway: Be grateful.
6. Fact: At the low in 2009, US stocks were back to where they were in 1996.
Takeaway: Most people think long-term means 5 to 10 years. Sometimes it can be longer.
7. Fact: At the low in 2009, Japanese stocks were back to where they were in 1980.
Takeaway: Different stock markets have different cycles.
8. Fact: Gold and the Dow were both 800 in 1980. Today, gold is $5,000/ounce, the Dow is at 49,000.
Takeaway: Cash flows > commodities.
9. Fact: Since the dot-com peak, gold is up 1,400%. Stocks are up 500%, including dividends.
Takeaway: You can support any argument by changing the start and end dates.
10. Fact: Warren Buffett is one of the greatest investors of all time. In the 20 months leading up to the dot-com peak, Berkshire Hathaway lost 45% of its value. The NASDAQ 100 gained 290% over the same time.
Takeaway: No pain, no premium.