I’m sure many of us have watched the Leonardo DiCaprio film, “The Wolf of Wall Street”. DiCaprio stars as Jordan Belfort, the penny stock promoter who cons investors into buying worthless stocks through his pump and dump schemes. The stocks are shares in worthless companies at an incredibly low entry price. Belfort convinces people to purchase the penny stocks claiming that what he has is an unbelievable opportunity for investors to get rich. The problem is, Belfort makes his money on commissions from the sale of these stocks and has no vested interest in the companies themselves. The fervor created by the purchasing of these stocks by Belfort’s customers and other naive investors sends the stock prices skyrocketing. A short time later the market realizes the companies behind the stocks are worthless and a sell-off ensues causing the share prices to crash. With the crash in share prices go the savings of the people suckered in by Belfort’s sales pitch. Hence the term: “pump and dump”.
I entitled this article the “Wolves of Baltic Ave” after the game space on the board in the classic board game, Monopoly. Baltic Avenue is the cheapest property you can buy when playing the game. The attraction to Baltic is its low entry price point. I have viewed a similar phenomena in real estate to the “pump and dump” schemes of penny stock hustlers like Jordan Belfort. So called “real estate gurus”, often individuals with their real estate broker’s licenses, are using the same tactics to convince uneducated property investors to buy poor quality real estate investment properties by touting the numbers. Like Belfort, the guru broker makes his money on the commission of the sale and has no real interest in the value of the investment. The numbers look amazing at first. It seems unbelievable that you should be able to buy, in 2018, a duplex for $120 000 and rent it out for $2000 a month plus utilities. A $90 000 mortgage (75% LTV) at 3.5% interest is a $450 payment, insurance is $100 a month, and taxes are $150 a month. That’s a cash flow of $1300 a month! That’s the pump.
So what’s the dump? The part that the gurus are not explaining to the purchasers is that they have now purchased a property that is almost impossible to manage and they will likely never be able to sell without incurring a loss. These properties are in areas known for their high crime and poverty rates. Tenants rarely stay for as long as a year, and when there is a change in tenancy the landlord has to spend thousands of dollars in repairs to make the property rentable again. Reputable management companies will often refuse to take on these properties because they know that the work required to manage them well will not be worth it for the commissions they can charge. As a result, management options will likely be low quality and / or unlicensed and the investor will be left with a property that has been dumped on them and is quickly progressing towards the label of a “dump”.
Real estate rental properties are a path to long term wealth building. They are not a get rich quick scheme. The best way to ensure that you have properties in your portfolio that are going to perform well and contribute to your wealth is to only purchase high quality property investments. In stocks, these are known as “blue-chip” stocks. According to Investopedia, a blue-chip stock is the stock of a large, well-established and financially sound company that has operated for many years. In the real estate investing world, a blue-chip property would be one in a neighborhood with low unemployment, a high percentage of home ownership, steady conservative cash flow, and high liquidity (meaning you could sell it easily without it sitting on the market for months or having to sell it at a deep discount).
Don’t listen to the wolves. If it sounds too good to be true, it probably is.