What if we lived in a world in which having specialized knowledge and expertise didn’t matter? Who would go to a barber or a dentist when people could get the same results doing it themselves at home? Universities would go out of business, as would physicians.? Why pay a surgeon to remove your gallbladder when your neighbor will do just fine?
While it may sound silly, this is the world in which mutual fund investors live. Seasoned mutual fund investors know that passive investments in index funds generally garner better returns than investing with the so-called “experts” and their actively managed funds. In this world, not only is your neighbor capable of removing your gallbladder, he is also more likely to get a better result than any board certified surgeon.
In this alternative universe in which up is down and down is up, who can blame mutual fund investors for focusing so much on fees? After all, why would anybody pay more money for less results? This is why index mutual funds are so popular. They are a low-cost passive investment in which the individual can buy the market. Study after study has shown that over the long-run and in the vast majority of cases, index funds beat actively managed funds after fees. For this reason, disciples of index mutual funds rightfully feel that it is better to buy the market than try to beat it.
I sometimes get questions from these index mutual fund investors about the fees associated with private real estate investment companies. While, I understand their concern, real estate investing exists in the regular world : the world in which expertise and experience matters.
I learned this lesson the hard way. Some of my first real estate investments had no management fees. I found the properties, negotiated the deal, inspected them, and managed them myself. After all, I read a couple of books on the subject and figured I was good to go. Unfortunately, I paid for my lack of expertise and lost money. Despite that, I didn’t give up. I learned valuable lessons and over time gained the knowledge necessary to make money in residential real estate.
After I stumbled into commercial multifamily investing and discovered the heightened financial benefits of economies of scale that come with larger properties, I was hooked. I certainly looked at fees and made sure they were in line with industry standards. However, what was more important to me than fees were the after-fee and after-tax returns : also known as net returns.
In exchange for their fees, an experienced asset manager should have expertise in things like:
- Market Selection
- Submarket Analysis
- Business Entity Formation
- Due Diligence
- Capital Improvements
- Business Planning and Budgeting
Most physicians do not have the time, energy, or inclination to obtain expertise in these areas. Most physicians are not interested in a second career in property management. If this sounds like you, you may want to consider passive commercial multifamily real estate investing utilizing a private real estate investment company.
I’d like to offer just a few words of advice before you invest. Look for a private investment company with at least five years of experience. They should have several properties under management and you should verify their returns across their portfolio. Personally, I would stay away from any company without a track record of obtaining double-digit annual NET returns from the combination of cash-flow, appreciation, and principal pay down.
Remember that real estate investing is very different from index mutual funds. In real estate, like most things in life, experience and expertise matter. Lack of expertise can be very costly. There is a reason why I don’t prepare my own taxes or negotiate my own contracts. I believe that you get what you pay for and for that reason I’m happy to pay my CPA and attorney for their expertise. Similarly a proven asset manager with a quality track record whose business plan is in-line with your financial goals can really accelerate your returns. However, just like physicians, these managers don’t work for free. Nevertheless, if their benefit in the form of net returns is substantial and outweighs their cost, then who really cares about fees anyway?
P.S. In the world of mutual funds, passive ownership in index funds makes a lot of sense. In the world of real estate investing, expertise matters. Whether you possess that expertise or you hire someone who does, it is critical to invest in the right markets, the right properties, with the right strategies, and to operate well. Doing so will be handsomely rewarded, while failing to do so is often punished.
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