High net worth individuals comprise a core of McLane Middleton’s clientele, including a number of professional athletes. As has been well reported, many professional athletes have made questionable investments, including rock n’ roll themed restaurants, nation-wide phone-card dispensers, a company that manufactured inflatable rafts that allowed sofas to float during floods, and even lottery tickets. Athletes also invest heavily in real estate, but not always with profitable results. In addition to buying expensive residences they often sell at a loss, athletes frequently purchase investment properties that overexpose them to the real estate market and/or are poor investments. There are a number of things I wish every pro athlete and high net worth investor knew before exploring real estate as an investment. This is the first in a series of pieces addressing those things and it addresses due diligence.
First, though, a word of caution for pro athletes investing in real estate. “Chronic over allocation into real estate… is the Number 1 problem [for athletes] in terms of a financial meltdown,” Ed Butowsky noted to Sports Illustrated (SI) in a famous 2009 article, “How (and Why) Athletes Go Broke.” Butowsky is managing partner of Chapwod Investments, LLC, and has been holding “financial boot camps” for pro athletes since 2005. Although professional athletes have become more financially sophisticated in the last decade through efforts like Butowsky’s, as well as league-organized programs, they are still in danger of losing their high salaries quickly due to poor investments and money management. More recent data from the Global Financial Literacy Excellence Center shows that 16% of NFL players declare bankruptcy within 2 years of retirement.
In the 2009 SI article, Butowsky recommended that a risk adverse investor – such as an athlete who could earn the majority of their lifetime income by the time they are in their late 20s or early 30s – maintain a portfolio in which 7-12% of the assets are real estate based. That can take many forms (commercial properties, residential properties, REITs, etc.) and we advise pro athletes and all our high net worth clients to work with a qualified financial adviser they trust to make decisions about their total investment in real estate and the form of that investment.
The SI article quotes Magic Johnson – a very successful pro athlete who became a very successful investor – as saying that he will cut off current athletes that approach him for financial advice if they propose relying on friends or family. “That’s the killer,” he says. As an example of this, the article goes on to describe the due diligence former NBA guard Erick Strickland performed before making a $1.8 million investment in Georgia real estate. His father helped him look into it, but “he didn’t go that extra length.” As it turned out, the land wasn’t worth anywhere close to the purchase price. Strickland wishes that he hadn’t put his father in that position: “He just didn’t have the knowledge.”
When I work with clients looking to purchase an investment property, I advise them to retain a team of advisers, which will frequently include the following:
Real Estate Broker: You want a broker who is familiar with the market where you are looking to invest. A good broker will be one who frequently advises clients in your market who are purchasing properties similar to what you want. He or she will know the properties that are available, the properties have recently sold, other comparable properties, and key information about properties on the market, including cash flow, tenants, and property management. Depending on the broker, they might be able to help you manage the property after closing.
Title Abstractor: A title abstractor performs a title search to find any recorded encumbrances in the property’s chain of title. It is likely that your real estate counsel either will do this or has a relationship with a third party abstractor. The encumbrances may include easements that give rights to third parties to use the property, deed restrictions that prevent certain uses at the property, undischarged mortgages that could prevent you from using the property as collateral with a lender or result in a foreclosure action if not addressed properly, and other documents.
Surveyor: A surveyor will frequently visit the property once you have signed a purchase and sale agreement to prepare a survey. This step is particularly important if you are working with a lender, which will likely require a survey in order to remove the survey exception from the lender’s title insurance policy. The survey will show the exact size and shape of the property, map any recorded title documents that have metes and bounds descriptions, and identify encroachments on or from the subject property. When you are making a major investment in real estate, a survey helps you understand what you are buying.
Environmental Consultant: The environmental consultant will perform a Phase I study at the property before closing to determine if there is any hazardous waste or potential discharges that could require remediation expenses. If properly performed, a Phase I can (a) identify environmental issues that might cause you to back out of the deal or give you leverage to force the seller to reduce the purchase price, and/or (b) help you avoid certain types of liability for historic contamination if it is discovered later.
With this team in place, in addition to a trusted financial advisor and attorney, any real estate investor, including professional athletes, will be in a much better position to make a profitable real estate purchase.