Investing Outside of Wall Street – Investment lessons from Hurricane Katrina

Late August 2017, David and I were in San Antonio, Texas, when Hurricane Harvey was starting to wreak havoc.  All scheduled events, away from the hotel, were cancelled.  Thankfully, we headed back up north, staying at the edge of the storm, before any of the highways were at the risk of being closed off due to potential flooding.

With Harvey, followed by Irma just two weeks later, memories of our disastrous investments after the 2005 Hurricane Katrina came flooding back, no pun intended.  Unless some miracles happen, we are likely to be paying for the financial mistakes we made for a long time.  But this was a choice we made instead of filing for bankruptcy, which was an option.

The details of what I’m about to share with you will be in my book #2, which will be published when I will have met my current investment goals.  For this blog, I will focus on the mistakes we made with an opportunity that was presented to us.  As with anything else in life, things are crystal clear in retrospect.  Hopefully, this will help you avoid making the same mistakes that we made.

Gulf Opportunity Zone Act of 2005:

After Hurricane Katrina, to encourage investors to help revitalize the disaster-struck areas around the Gulf Coast, Congress passed the Gulf Opportunity Zone Act of 2005, otherwise known as the GO Zone Act.

Because of the enormity of the aftermath of Harvey and Irma, especially in view of our existing national debt, which recently surpassed $20 trillion, I would not be surprised if the federal government decides to institute a similar act once again.  Therein lies my warning to those who are considering to invest in those areas, especially if you are relatively inexperienced, as I was.

Mistakes made – If I knew then what I know now:

  1. I would not have been so eager to meet my stated goals.
    • As an MBA, I was all about numerical goals by a specific date.
    • I left Chrysler in 2004 with a five-year business plan. It was to accumulate 24 cash-flowing rental properties by December 2009, fully capable of replacing Social Security and pension income.
    • In terms of the number of units and timing, I did indeed meet the targets.
    • To be focused on the numerical goals without a solid foundation to make wise investment choices, however, turned out to be a recipe for disaster.
  2. I would not have been so eager to invest out of state without having gained sufficient experience locally.
    • At the time, I was relatively new to real-estate investing.
    • For any additional units except for those already purchased, I “escaped” the Michigan market because I got scared of plunging property prices – seemingly with no end in sight.
  3. I would not have paid retail prices for rental properties.
    • Every guru tells you NOT to pay retail prices for rental properties. So, of course, I should have heeded their advice.  But I did not.
    • I was blinded by the huge tax incentives.
  4. I would have tried to better understand the tax incentives.
    • This meant figuring out the worst-case scenario of these investments and its implications.
    • In retrospect, my mind was so focused on meeting the five-year goals such that I convinced myself we could not possibly lose money on the deal. Well, I was wrong.
  5. I would have figured that when the federal government creates a huge tax incentive to encourage investments for revitalization of disaster-struck areas, investors of all skill levels flock to it.
    • This means, an over-investment in the targeted areas is bound to happen.
    • Shortages of materials and labor ensue, followed by price increases. As a result, property prices become inflated to far above the pre-disaster level.  Cetris paribus (everything else being equal), such artificially-inflated property prices are unsustainable.  In other words, as an inexperienced investor, I bought them at the highest prices.  (Yes, I was an idiot!)
    • No amount of tax incentives can justify paying for over-heated prices.
  6. I would not have paid retail prices just because I could.
    • Stupidity can be magnified by the amount of money you can “afford” to spend.
    • Take baby steps if you’re new to real-estate investing no matter how irresistibly wonderful you think the deal is.
  7. I would not have trusted those so called, “experts.”
    • Especially when you’re new to real-estate investing, just because those who bring you deals are known in the national-speakers circuit and appear to be experienced, do not assume that they know what they’re doing, or that they have your best interest at heart.
    • As it turned out, in the end, to get out of the mess in which we all found ourselves, those who brought the deals to us chose the foreclosure route whereas we chose short sale.
  8. I would not have chosen to work with a property-management company that was opening shop in a new area for the first time.
    • The organizers of the buying tour brought with them a group of “experts” to sell us these GO-Zone deals. These experts from Michigan included an attorney; mortgage brokers; and a property-management company, which decided to open a branch in Mississippi.  After all, they had captive investors whom they could service.
    • We, the student investors, became guinea pigs for this property-management company’s learning curve and paid dearly for it.  After we fired them, and no doubt so did other investors, the company eventually pulled out of the market as well.
    • This is also where we learned about the fallacies of the Section 8 program.
  9. David and I would not have kept paying good money after a bad deal for as long as we did.
    • This was our attorney’s advice when we kept on making mortgage payments out of our retirement funds until we no longer could without literally bankrupting ourselves.
    • As more and more investors continued to enter this disaster-struck market, it became overbuilt and too few tenants were available for too many units, thereby depressing rents. As you may recall, after Katrina, not all former residents came back to the disaster-struck areas. The situation became even worse as early investors’ properties began to be sold at huge discounts through foreclosures and short sales, depressing rents even further.
    • Over time, our losses due to insufficient rental revenues became unsustainable.
  10. I would have listened to my gut feel.
    • When your gut tells you something is amiss about a deal, STOP and listen!  Cut the loss and get out.
    • While we did our own due diligence to the best of our knowledge at the time, as a student investor, I asked the individual who promoted the GO-Zone deals if the company’s due-diligence results could be shared with the group. The answer was, “No.”  Instantly, I felt that this was a red flag.  Yet, did I listen to my own gut feel?  No.  “Why not?” you might ask.  Again, working toward meeting my five-year goals by the end of 2009 was very important to me.
    • Another example.  I kept telling the mortgage broker that accompanied the buying-tour group that we were not going to agree to an adjustable-rate-mortgage loan. When pointing this out multiple times, they kept saying, “We’ll fix that.”  Yet, every time, they sent back the same document without any corrections until we finally said, “Look, we’re not closing on the deal until and unless it is a fixed-rate mortgage.”  Then and only then, did they make the corrections.  It is my contention that some unscrupulous mortgage brokers rely on inexperienced investors to sign documents without having read the lengthy documents.

The real post-disaster opportunity:

Lastly, the real opportunity for investors are likely to come several years AFTER natural disasters on the scale of Katrina, Harvey, or Irma.  That is when inexperienced investors will already have been wiped out in terms of their investments.  I say this because, after Katrina, experienced investors did buy the foreclosed and short-sale properties in the complex at which we owned multiple duplexes. In 2014, these smart investors paid a fraction of what we had paid for them seven years prior.  In fact, our short-sale properties sold at what we had paid as down payment, which was 20% of the purchase price.  Ouch!

 

Happy investing!

 

 

 

 

 

 

 

 

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