I think that this is very important because as investors, we often get offers or hear about investment opportunities that sound very attractive, but are not where you want to be putting your money. And in this persistently low yield climate, I understand that people are looking for better, more traditional level yields than the average 1% they’re getting at the bank. But quite often, despite the lousy yields, the decision not to invest can be the smartest business decision you make.
As you might imagine, I get a lot of calls and questions regarding what’s trending in the markets, in real estate as well as other opportunities. Most of them do not pass my test.
For example, one of the areas which was very sound for a long time before the Financial Crisis of 2008, were Mortgage Backed Securities (MBSs). As you probably are aware, these investments performed well for a reasonably long period of time. But, the real estate bubble and the drop in quality of the borrowers due to junk lending led MBS investors into disaster.
Now, no one I know is investing in MBSs anymore, and I’m not suggesting you do so, either. I’m not even certain very many even exist anymore. But, lately I have seen another kind of MBS on the radar: Commercial Mortgage Backed Securities. Relative to current interest rates, the returns look pretty good; but there is more to the story that you need to know.
In 2007, at the height of the real estate market, $150 billion in commercial mortgages were put in place with typical 5 year terms and interest-only payments, with a balloon payment due at the end of the term. Now of course, those commercial loans are coming due this year. This represents a huge potential problem for the mortgage holders—that is, the banks—because on average commercial property values have dropped as much as 40% from their 2007 highs.
Will the banks foreclose on the commercial loans on the massive scale the way that they did with residential mortgage holders? I seriously doubt it. The last thing banks want or could handle would be more bad debt on their balance sheets. Their most rational choice would be to extend the terms on the mortgages out for another 5 years and lower the interest rates rather than take back the properties. But even this option will not solve all their problems; undoubtedly, some commercial mortgage holders will walk away from the debt.
One of the arguments for holding CMBSs today is that the values have already dropped and the economy is now on the rebound, so they should be safer investments with a more desirable yield than what your bank is giving you. That may sound great and you may be tempted to bite, but you can’t be sure what’s going to be bundled in any given commercial mortgage pool. And the economy is a long way away from full recovery, too. Also, you need to remember that ratings agencies aren’t the reliable gate keepers we once thought they were and that the goal of the issuer is to sell their product; whatever it takes. Hopefully we have learned those lessons. I would avoid Commercial Mortgage Backed Securities for the foreseeable future.
Don’t Cry In Argentina or Brazil
Another tempting investment to avoid is the many attractive land, winery, and farm deals in South America. A couple of months ago I spent some time in Argentina and Brazil, and although both are beautiful countries and Argentina makes wonderful wines, you ought to be very slow to put your money all the way down there. I certainly wouldn’t put any of mine there. The fact is, too many risks abound with these kinds of investments. Besides being a continent away from your investment, which effectively prevents you from really knowing what’s going on with your investment, your property is also subject to historically high legal and political risks in those countries.
Another big problem is that chances are good that you are not familiar with the legal system in either of those places. And even if you are, laws can certainly change quickly due to political instability. Foreign assets are often the first to be seized in the event of financial collapse, civil unrest, war, or other unpleasant events that tend to happen down there from time to time.
Furthermore, in the event that something does happen, how much time and money are you going to spend traveling back and forth to defend your investment over the course of a long and drawn out legal battle? I realize that many investors are looking for the best deals, and that some have in fact purchased real estate such as buildings and wineries in those countries, but I think for most investors, they would literally be overextending themselves in doing so. The disruption in most people’s lives would just be too great. Granted, it could be the case that you may not be able to successfully defend every one of your investments in the US from a legal challenge either, but you at least have resources here that are familiar with the law and are able to defend your interests without you having to take a 20 hour plane flight each way.
Relationships Build Trust and Wealth
The third area of investments that I would be very careful with involve real estate right here in the US. This may surprise some of you, because I’m a big fan of real estate investing and syndicates to leverage your investment dollar, but I would tread very carefully when considering putting money into a real estate venture group that you do not know.
Why do I say this?
Because in today’s economic climate, there are real estate deals everywhere; but at the same time, the number of real estate scams has ballooned. This, of course, is a huge threat to your investment dollars. That is why I always have recommended that you develop relationships with people, know who they are, who they’ve done business with before, and who they are doing business with now. And make sure that they who you are, too, before even thinking about putting you money with them. I usually like to have some degree of control in a deal, UNLESS I know and trust who I’m putting my money with. Does that level of trust takes time to build and establish? Sure; but it’s worth it if it saves you from losing big.
The bottom line is that don’t look at the yield of an investment first, look at it last. First ask yourself why you would put your money in any given investment, why you should not do so, and assess the risks involved. Don’t let your quest for higher yields lead you into much bigger problems.
All the best,