An unfortunate characteristic of the investment industry is that there are many unethical operators. The standard tactic for these people is to make “guarantees” of high returns. This appeals to people’s sense of greed, and sends them headlong into great disappointment.
Because of this, it is important for investors to have a reality check. When a deal sounds too good to be true, it usually is. Astute investors must understand that contracts and pro-forma projections can be used to hide real problems from investors who have been blinded by their desire for big returns.
Consider the “rent guarantee” scenario where a developer sells you an investment property with a rent guarantee that is underwritten by a property management company, and “locks-in” great rates of cash flow. What could possibly go wrong with this situation? The cash flow has been contractually guaranteed, so all you should have to do is sit back and collect rent checks.
Unfortunately, what frequently happens is that the “property management” company goes bankrupt when the developer sells all of the houses, and the property owners come to learn that the “guaranteed” rent rates were significantly above the market rate.
At this point, the owner sees that they can only rent out the property for a negative cash flow, and if they sell, it will require taking a loss. Meanwhile, the property management company is bankrupt, so that contractual guarantee is completely unenforceable.
All of this could have been avoided by having a reality check at the very beginning. Whenever you are purchasing an investment, make sure to understand what you are buying. The more you understand, the more you will be able to smell when something is wrong with a deal. This will allow you avoid severely costly mistakes by allowing your desire for gains to render you blind to dangers that are hidden from sight.
