REIA 109 Paul Moore: The Difference between Investing and Speculating and Why it Matters

Welcome to Real Estate Investing Abundance, the show for busy, fulfilled professionals like you to learn how to develop financial independence built on solid passive real estate investments. Now, here is your host, Dr. Allen Lomax.

Hello, enlightened investors. I'm your host, Dr. Allen. And what a joy it is to be with you today as we explore the difference between investing and speculating and why it matters. Paul Moore has been investing in real estate for over 2 decades since selling his company to a publicly traded firm. He is the author of 3 books on real estate investing, and he is the founder of Wellings Capital, a commercial real estate investment fund manager. Paul, start us off by telling us about an experience From your formative years that helped you to be the person you are today?

Well, it's pretty horrifying, and I'm glad my parents won't be able to hear this because it was my sophomore year in college, and my dad always got these newsletters from these big silver and gold investment brokers. I thought it was investing, but it was flat-out speculation. So I got hold of some kind of an audio recording or something in 1983, of this guy talking about how silver would never see the $20s again. In other words, it was going to skyrocket into the $30 and $40, and then $50 an ounce range. Of course, it had already been at $49 an ounce just a few years before in 1979. And so I got so excited. I believed every word of it. I didn't even take into account that the guy was a total salesman and promoter. Well, I needed $1,000 to get in, and I was going to do it on margin because if I can make 30% return Why not make it into a 120% return? So I did a margin investment. So I had to put $1,000 in. I didn't have $1,000. I had about $500. So I actually went down to the— I can't believe I did this. I went down to the tuition office and said, hey, I'm paid ahead on next year's tuition, right? Next semester's tuition that starts in January. I want to borrow $500 of that out of there. So I took $500 of my future tuition money, which I had worked hard for saving all summer, and I invested $1,000. Within 2 and a half weeks, I got a margin call because silver went down from wherever it was to like 23% below that, which got me close to the 25% margin. Got a margin call, freaked out, sold it and took almost zero back. And that was my first speculation.

Well, if that is your worst, well, I could tell you a whole lot worse stories.

I wish it was.

So let's take us into really investing and what is the difference between speculation and investing?

You know, when I sold my company to a publicly traded firm in 1997, in 1998, I moved from Detroit to the Blue Ridge Mountains of Virginia. And I thought to myself, I'm a full-time investor now. Well, I really wasn't. I was a full-time speculator because that one lesson had not even chipped away at my brain and taught me anything apparently. And so I didn't know the difference between investing and speculating. Now I believe that investing is when your principal is generally safe and you've got a chance to make a return. And speculating is when your principal is not at all safe and you've got a chance to make a return. And so when I flushed, I should say drilled $100,000 into the ground for an oil well that was speculative, I was speculating, hoping that there would be 10 times or 100 times as much oil come out of the ground and zero came out. That was a speculation. And I realized over the years that I believe this fallacy, low risk leads to low return. That's almost universal. So therefore, high risk leads to high return. That's not true. High risk leads to the potential of higher return and also the potential of a significant loss, including all your principal. And so I wasn't aware of the difference and I did a lot of speculating. Like I Invested $100,000 with a currency trader that had this way of getting a 3% return per month, and that was net of his fees. Well, it turned into a pyramid scheme, and I think that lack of due diligence was to blame on that one and greed. Greed is often affiliated with speculating, not always. It's okay to speculate, by the way, as long as you know you are, and as long as you're hopefully Doing it with a small percentage of your assets. But I didn't really know I was. I thought I was investing, as amazing as that sounds to me now. And so I also found out that swinging for the fences was something as an entrepreneur I loved to do. I loved to be like the Elon Musk of whatever I was doing at the time, staffing companies and internet and oil and all that. But really, I found out that that wasn't a good way to invest. It was a fun way to be an entrepreneur, But it wasn't a fun way to invest. I also call speculating entrepreneurial investing. And I think that that was a big mistake. Since then, I've learned to do a lot more due diligence. In fact, that's what my company does. And we also have learned that it's really, really important to not speculate, but to invest, meaning we're looking for cash flow. Warren Buffett said, if you don't learn to make cash, While you sleep, you'll have to work till you die. And that's what I think investing is. I think investing— another point about it is having true wealth is having assets that produce cash flow. Speculative investments in general don't produce cash flow.

Yeah. I wish I'd learned that lesson many, many, many years ago. I did some spec homes once upon a time, And if I had actually spelled out speculative rather than abbreviating it, I may have gotten the message a little earlier and not lost everything I had. But anyway.

Oh my goodness. What year was that?

Not that long ago, 2016. So.

You know, I did learn something about spec homes. I found out when I tried to do it that it's really important to know this. This is a writer-downer. You shouldn't build an expensive ground-up home if you don't know how to change the doorknob on your own home. I'm just saying, Alan.

Yeah, exactly. I mean, I've done a lot of renovation, and so I thought I knew a whole lot about that, but I had a lot more hope than I did sense.

So anyway, well, tell us about the power of a dollar in commercial real estate and how You know, Jeff Bezos went around the Amazon facilities in the US and he removed the light bulbs reportedly from the vending machines. He thought it was a waste of electricity, maintenance person's time, and a bulb to advertise Lance snacks or whatever, because he knows the power of a dollar. Do you know if he can save a dollar a month, that is $12 a year, My mama told me I was good in math. And there's a PE ratio in the stock world, price-to-earnings, that most of us are familiar with. And that is right now about 60 or 60 to 1, if you will, for Amazon stock, although it's averaged over 100 over the years. 60 to 1 means $12 saved per year for Amazon. It translates to $720 in shareholder value. And so, Mr. Bezos knows the value of a dollar. Well, commercial real estate has a similar value formula. You mentioned spec houses. Residential homes are generally valued based on comps or comparable properties. We all know this. But commercial real estate's based on math, thankfully. And that math sounds similar to Jeff Bezos' PE ratio. The math is the value or the change in value is the net operating income divided by the cap rate. So the NOI divided by the rate of return will give you the value of the property. And so in commercial real estate, if you can acquire assets, especially from a mom-and-pop owner who don't have the desire or the knowledge or the resources to increase the income, that numerator, the NOI, to increase the income, and they don't have a real desire based on the fact that their cap rate, the denominator, has already shrunk dramatically, meaning their value has gone way up because the market's taken them up, then these mom-and-pop sellers often leave massive amount of upside on the bone. So if you can acquire from them, you can be pretty sure if you've got experience, a team, a track record, and technology, If you know how to do this, you can likely increase that NOI a lot and therefore force appreciation. And then if the cap rate continues to shrink, the denominator, then you'll continue to ride that tide in and you'll be increasing the numerator, decreasing the denominator, having a massive return. It feels a lot like surfing rather than swimming. But if that cap rate goes in the other direction, it expands, which it eventually will for sure, then you want to have a numerator, the NOI, the net operating income. You want to force enough appreciation that you outrun or outswim that denominator, that cap rate expansion. That's the power of commercial real estate. Allen, I think that's why most of the Forbes 400, the wealthiest Folks in the world, or at least in America, almost all invest in commercial real estate because of that math formula.

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Yeah.

Well, talk to us about the power of the tide. You've just alluded to that just a tad bit here, but the importance of the tide as opposed to essentially the strength of the swimmer.

Yeah. So in our capital, in our value formula, we've got value equals the net operating income Divided by the cap rate. Let's think of the cap rate, which is basically the market. Most of the cap rate is outside of our control. I will say that if— the cap rate, by the way, is the expected rate of return for this type of asset in this condition, at this location, at this time. And so the cap rate typically is set by the market, but the one thing that is sort of in control is— within your control is the possibility of putting together, assembling a portfolio of assets with similar marketing and management and technology, and then selling that under one flag or one portfolio to an institutional buyer. Often you can get a premium, which means a lower cap rate. But aside from that, the tide is going to come in, which in our case would be a lower ever-lowering cap rate, which we've seen since 2009 to now, or the tide will go out, and eventually it will. As Howard Marks reminds us, trees don't grow to the sky. It's eventually going to cycle the other way. Well, the net operating income, the numerator, we can think of as the swimmer. The swimmer's within your control. You can train, you can swim, you can swim real hard, and you can get really good at it, That's within your control. And if you can swim with the tide, great, like I mentioned, or if you swim against the tide, if you can swim faster than the tide, if you're a strong enough swimmer, you force enough appreciation, then you can still win even in a declining market. Buying from mom-and-pop operators and having a great execution team is the key to making that happen.

Teamwork and partnership. Well, let's talk a moment here about the fact that you as a multifamily author are not currently investing in apartments. Why not?

I love apartments. I wrote a book called The Perfect Investment. Very humble title, huh? And the book was about the amazing demographics converging with the low interest rates converging with the low default rates, and the increasing, ever-increasing demand versus supply of apartments, and the fact that you can look down the road at birth rates and immigration rates and kind of estimate where the apartment demand will be in 20 or 30 years. So we love this asset class, but like I said, the book was called The Perfect Investment. This investment is not perfect if you can't get deals that make sense. We found from about 2014 on that multifamily deals were so overpriced relative to their cash flow, going back again to our formula, that it didn't make a lot of sense. So we got frustrated. I'm in my mid-50s, and I didn't know— I didn't think it made sense to take millions of dollars from investors and invest it in assets that were that risky. And so we decided that we wanted to find asset types outside of multifamily that had much more upside. 93% of multifamily, from our understanding, above 50 units, is owned by companies that own multiple assets. That doesn't mean they're run well, but they're often run really well. They often have the value add already squeezed out of them. They've already got new cabinets and countertops and all kinds of nice things. But while 7% are owned by single asset owners, that's not true at all in self-storage. For example, we believe about 50% of the 53,000 or so self-storage facilities in the US are owned by mom-and-pop operators with typically one asset. And about 85% of mobile home parks, there's about 43,000 in the US, are owned by mom-and-pop operators that haven't been able to or cared to squeeze the value out. And so multifamily is a great asset class, but it's so popular right now that we really believe there's a lot more upside in these other asset types. And that's where our Wellings Income Funds focus is on these other asset types.

Well, I have basically come to that same conclusion here over the last several months. Talking with self-storage investors and with mobile home park investors have pretty well convinced me that it's kind of a waste of my time to continue looking in the multifamily or the apartment sector there for the very reasons that you have just shared with us here. Well, Paul, talk to us about Welling's Capital. What is it and how can folks find out more about that?

So when we decided to invest in self-storage and mobile home parks, we kind of fell in love with those arenas, but we also knew that if we were investors, we wouldn't want to invest with somebody who had never done it before. And so we realized, hey, we've got experience in real estate and specifically in commercial real estate, but we don't have the team, the track record, the experience, the connections to buy and operate these assets. And even though we could have— we had over 120 investors at the time. Now we have about 470. We believe that they would've given us millions of dollars to do that, and we probably would've done fine, but we didn't know for sure. And so we decided that it would be best for us to be a due diligence partner for our investors. It would be best for us to go out and find the very best of the best operators, sometimes not that well-known operators who are producing year in and year out the best returns and the lowest risk for investors. And hopefully as a large investor, we would get better terms with them. And that's exactly what we did. We began to find these operators, we began to negotiate and then invest with them. And we have been doing that for a number of years now. We just finished up our 4th fund, the Wellings Income Fund III, and we are now well into the launch of our 5th fund, the Wellings Income Fund IV. And next year we'll be— sometime later this year, actually in 2022, we'll be offering an evergreen fund as well. So our goal with the fund, Alan, is to provide diversification across different asset types, geographies, operators, strategies, and of course, specific assets. Most of our investors come to us because they want cash flow, appreciation, tax benefits, and they want to be hands-off. They love real estate, but they don't want to have to do it themselves because most of them are architects or doctors or attorneys or IT professionals who have a great income, And they don't want a second job. Some of them are retired and they definitely don't want another job.

Well, Paul, I understand that you have a new book coming out here shortly. Tell us about the book.

Yeah. We released in November, we released a new book called Storing Up Profits: Capitalize on America's Obsession with Stuff by Investing in Self-Storage. And that was published by BiggerPockets Publishing, and I'm very grateful to them. You can get that at biggerpockets.com/storage. The book's divided into 3 major sections. The first is why we love self-storage, all the demographics and the math and all the different ways to love and think about self-storage. The middle of the book is 4 different strategies to build a self-storage empire. And then the last third of the book is 7 different paths, 7 chapters on different paths to get into self-storage, whether it's becoming an operator or an employee or an investor.

Well, great. Well, Paul, for our last question today, share with us one of your most difficult setbacks in life and how did you come through that time and what did you learn from that experience?

Yeah.

So we're right up the Blue Ridge Parkway from you in Virginia. And I had $1.5 million in the bank after selling my company in 1997. And then 10 years later in 2007, I had $2.5 million in debt. And I actually had that debt attached to a lot of real estate projects, thankfully, which makes them by nature not quite as speculative as some other things. But we were going into the Great Recession, had no idea we were about to enter this great financial crisis. And so I was trying to figure out what had gone wrong because all of a sudden, we were selling lots at Smith Mountain Lake and they had all dried up. The sales had just dried up. And we knew something was wrong. We didn't know how bad it was about to get. Well, I made a commitment. My family and I gathered together and we said, we're going to give our way out of debt. What does that mean? Well, some of my heroes in history, one specifically George Mueller, actually gave— he just did radical things and he took care of orphans and widows. And I knew that was important to me too. And so I thought, well, I want to do something similar and I think this is what he would do. So we made a commitment to begin giving a set amount, a painful amount every week to charities and nonprofits and our church and things that we cared about. Well, we began doing that January 1st, 2008, not knowing about this black hole we were about to plunge in. And 4 weeks later, I had a light bulb moment in a conversation at a Subway restaurant with a real estate developer. I had a light bulb moment about how to subdivide a 5-acre waterfront parcel into multiple lots, That would bring a significant premium over the 5 acres, as you can imagine. And this had never been done before. I went down to the county planning and zoning department and showed them my plan, and they were shocked. They said, we've had this law on the books prohibiting this for years and years, decades, and you found a loophole in the law that we missed. And yes, you can subdivide it. And anyway, long story short, there was a lot of work left in front of me, Alan, but I was completely debt-free in 13 months in 2009.

Wow. Amazing story. Well, Paul, it has certainly been a delight having you with us today, and thank you so much for being with us.

Absolutely. And I want to mention, if folks want to learn more about commercial real estate, They can go to the link, but it's wellingscapital.com/resources. We have a free course there where people can learn more and figure out if they want to invest in commercial real estate as well.

Excellent. And we'll have that information in the show notes as well. So thanks so much, Paul. It's been a pleasure.

Thank you, Allen. It's been great to be on the show and an honor. Have a great day.

You too, Paul.

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