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Usually, when I explain that I invest real estate, less than 15 minutes into the conversation, I will get the notorious question:
“How do you know it isn’t a Ponzi scheme?”
To be honest, this is a valid question. After all, whenever you are considering an investment, it is always best to consider every potential way things can go wrong—especially when you are depending on someone else. As with all passive investments, fraud is a risk that needs to be addressed.
How can you mitigate the risk of fraud?
First of all, investing in residential real estate is extremely simple compared to many other types of investments.
- You buy a house.
- You hire a property manager.
- The property manager finds a tenant.
- The tenant pays the rent.
- You receive the cash flow.
There just aren’t many moving parts in this type of turnkey investment. This in itself makes the due diligence process much easier. You are able to limit the amount of exposure you have to fraud, because the steps you need to take to mitigate this risk are much more straightforward than in other investments.
Of course, you shouldn’t just rely on the simple structure of the investment. Here are some steps you should consider taking when conducting your due diligence process, PRIOR to investing:
- Meet the team that is managing your investment and build personal relationships to get a “gut feel” for the way they conduct their business.
- Visit the market you are investing in and get a feel for the neighborhoods; find out the areas you want to avoid.
- Check Rent Fax Pro to get a detailed analysis of the projected risks of the property.
- See, first hand, the type of work your rehab team is completing.
- Run background checks on managing members of the investment.
Of course, this should be just the beginning of the due diligence process for you, prior to even considering a specific property.
However, at this point, if you are paying attention, you start to see the lack of objectivity implied by the question “How do you know it isn’t a Ponzi scheme?”
Why?
Because if you are investing in equities and you are concerned about them being a Ponzi scheme, you can’t do HALF as much due diligence to mitigate your risk of fraud! It would be almost impossible to cover all your angles in a large corporation, compared to a straightforward and simple real estate investment.
Try running a background check on every managing member of Apple. Try personally doing the amount of due diligence that would be required to accurately predict next quarter’s iPod sales. It is almost entirely impossible!
The point is, if you are actually worried about protecting yourself from investing in a Ponzi scheme, the last place in the world you want to invest is in huge multi-national corporations that have thousands of managing members to rely on, and that have global customer bases, which you know nothing about.
If you believe that due diligence is the mother of good luck, then you should be investing in alternative investments where accurate due diligence can actually be conducted, NOT going along with the herd and investing in stocks just because everyone else thinks it’s ok.