Exclusive: Jody Tallal explains significance of knowing ‘science’ of risk vs. return
In my next several columns, I am going to be discussing real estate as a potential investment vehicle. More specifically, how to invest in raw land.
Back in the early 1970s, I began analyzing my clients’ investment portfolios, and it readily became apparent to me that no matter what size income a particular client might have, or where they choose to invest it, prior to my assistance, most of the time they ended up losing a significant amount of what they invested. It did not seem to matter much whether they invested in stocks, gold, oil, cattle, or genetic research in Brazil – they all seemed to fail the vast majority of the time over the long haul.
Occasionally, however, I would see a client whose investments were worth several millions of dollars. It was not until after several years of additional research I realized that all of those clients had one thing in common. Each of these clients had made principally all of their money in real estate investments – more specifically, Raw Predevelopment Land.
Many times, it seemed to occur quite by accident. I remember one case where a client had bought a couple hundred acres of farmland north of town to get away on the weekends. Then several years later, a country club bought the land adjoining his. His land immediately jumped from $1,000 an acre to $25,000 an acre, and he was an instant multi-millionaire. In other cases, it was apparent my clients had a predetermined plan to buy property in the line of future growth. Regardless, I felt it more than coincidental that this pattern was present.
It was at this point I decided to start studying different actual land investments, in an attempt to differentiate the good transactions from the bad. It was my objective to identify potential areas of risks and try to develop methods to remove those risks, without affecting the industry-wide chance for return.
I began my own investments in real estate in 1973. My first couple of investments did not work out as well I had thought they would; but I studied them and learn what I did wrong. By 1975, things were working out much better. In fact, by 1985, I had produced 46 programs for me and my clients. By 1985, 33 of these properties had sold. The average rate of return received by my clients was 63.8 percent per year, and this was net of my fees. These properties were acquired for $25 million and were held an average of 3.5 years. They were later sold in excess of $50,000,000, and all 33 of the programs were profitable.
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One thing I learned in the process of successfully investing in land was that to maximize profits you need to adopt a contrarian philosophy. The reason is because real estate runs in well-defined cycles of booms to busts to booms again. The difference in real estate cycles when compared to, say, stock market cycles is that they are elongated and take years to develop. I will cover more real estate cycles and how to read them in later columns.
What I want to demonstrate in this series of columns is a strategy that proves that land investing is a science and by understanding that science, you can substantially reduce the risk while maintaining extremely high returns. This is done primarily through using a negotiation matrix I developed which will be share throughout this series.
Experience gives the 20/20 hindsight needed to see the irrational, invisible side of the investment world; or to put it another way, experience allows us to ask the irrational question that are invisible to the purely intellectual mind.
Real knowledge is the key that makes the wealthy land investors wealthier and over the long run keeps transferring the assets of the average novice investor to them. I found this lesson very important to recognize as I entered the land-investment maze.
I learned that there is one important thing that must always be done first before the negotiations start. That is to set out your bottom-line criteria in advance of your first offer. Now, most people feel that their bottom-line investment criteria are simply to make as much money as possible. Maybe that is right and maybe not.
What are your true objectives? How much risk are you willing to take? Are you a speculator, land banker, or developer? What is the bottom-line value you are willing to assign to the dirt, and what is the probable upside potential?
These questions have to be answered before you should make you first offer. I learned after my first real estate crash, which was in 1975, that dirt was basically worthless. You could not eat it, build out of it, or create anything else in value from it; and, in an illiquid depressed market, you cannot sell it.
Therefore, how do you determine its future value? We will cover that in my next column.