Wednesday, March 08, 2006

John Burley's Investment Returns

…or: Why Economists Make Poor Entrepreneurs

John Burley declares, at every opportunity, that he routinely gets investment returns of 40%, 50%, or more on his wrapped properties, and “with little risk.” Specifically, he tells his investor partners that he is aiming for (but of course doesn’t guarantee) a minimum first year return on investment for them of 50%—or that’s what he was telling them when he recorded Blue Print for Success back in the mid-90s. I can’t be sure what he is saying now.

However, given that the average return on investment (ROI) in the stock market has historically been around 11%, I don’t believe Burley’s claims are credible—over the longer term, anyway. An explanation of why requires delving into a little economic theory known as the efficient markets hypothesis—or, as Burley might call it, “Psychobabble.”

Of Grocery Store Lines and Freeways

It’s an early Saturday afternoon, and you—and everyone else, it seems—are at the grocery store. When your basket is full and you’re ready to leave, which line should you pick? The fastest, right? Which one is that? As you take the time to figure it out, you notice that other people keep getting into the lines ahead of you, and they all seem to be roughly the same length.

After you finally make it out of the store and you’re driving home on the multi-lane freeway in stop-and-go traffic, you notice the next lane over seems to be moving faster than yours. As soon as you see an opening, you take it. Your victory is short-lived, though. Soon your new lane comes to a stop. You watch in dismay as the car that was behind you in the other lane now zips past you.

Economics 101

The above over-simplified examples serve as intuitive and familiar illustrations of the concept of the “efficiency” of competitive markets (for a more detailed discussion of the above examples, go here to read their source). Stated less colorfully, but in a way that is more relevant to discussing John Burley, the basic idea is this: In a competitive marketplace, where all economic actors have basically the same goals and roughly the same information, excessive profits will be very unlikely.

That’s a bold statement (pun intended), and also rather abstract. Let’s define some of the terms and hopefully make it clearer.

Competitive Marketplace – In this case, I mean Maricopa County’s residential property market, and specifically the market for home buyers who have a poor credit history. Is this market competitive? I can’t speak for what it was like in the early 1990s, but a quick search through the real estate classifieds at, using keywords such as “low down,” “ez qual,” “no bank qual,” “bad cred,” etc., ought to at least give you pause. If he ever was, Burley is clearly no longer the only game in town.

Economic Actors – By this I mean all the buyers and sellers of single-family homes in Maricopa County—and mostly I mean the Investors.

Same Goals – Investors are interested in getting the highest ROI. Sellers are interested in getting the highest price for their property. Buyers are interested in buying the nicest house that they can afford.

Same Information – All the economic actors know (or should have at least a basic understanding of) what home prices, rents, interest rates, etc., are doing. None of the economic actors can see the future. None has secret knowledge that is unavailable to the rest—at least not on a consistent basis.

Excessive Profits – I am not using the word “excessive” in a normative sense, here. In a free market, high profits serve an extremely useful social function: They are a signal or a guide to entrepreneurs about where there exists unmet consumer demand. Profits attract investment dollars to where they are needed most, as defined by the consuming public. In a very real sense, consumers vote for the best entrepreneurs with the dollars they spend. So here I am defining the word “excessive” as simply “higher than around 11%,” since that has been the long-term historical average ROI of the stock market.

The Hypothesis Expanded

So, now we’re in a better position to explore why it is that John Burley is almost certainly, um, let’s say, “stretching the truth” when he claims he regularly gets 50%, or higher, ROI with his wraps.

Burley would like to buy an investment property for as cheaply as he can get it. Unfortunately for him, the state isn't going to give him a monopoly on the Phoenix housing market, so he can't just name his price and expect all sellers to just roll over and take it. He is competing with all other homebuyers in the market. That includes other investors, out for a bargain purchase, and “retail” homebuyers, who aren’t necessarily looking for a bargain so much as looking for a home that they will enjoy living in. Thus, the retail purchaser will usually be in a position to outbid the investors for a given home, assuming 1) that the home doesn’t have some hidden serious defect, or 2) the investor(s) didn’t find out about the property before the retail buyer even had a chance to bid.

Unless Burley can come up with some ingenious ways around the above problems—ways that he can keep secret from all the other buyers, so that they can’t also use them—he is going to have to deal with buying homes usually at a higher price than he would want, and expend time and money searching for longer than he would want, both of which negatively affect his ROI. On Blue Print for Success, his only advice is to “make lots of lowball offers” until you get lucky and some dumb/desperate seller accepts. Is this a “costless” strategy, do you think?

Once Burley finally gets lucky and buys an investment property he’s up against a different set of problems. He’d like to sell his place for as much as possible, but he can’t ask too much, because then his house will sit vacant as buyers go elsewhere. Other investors are as motivated as he is to attract the finite set of homebuyers, and this process of attraction costs money—either in terms of advertising costs, repair, maintenance, or upgrade costs, or an attractive purchase price or terms—all of which, again, negatively affects Burley’s ROI.

As the number of investors rises in a given market, the competition for the same resources (meaning properties and buyers) increases. John Burley, just like the rest of the investors, then faces a choice: lower your expected ROI, to compete, or suffer losses from properties sitting unsold. Over time, this forces the average ROI of all investors down to a level where they are basically doing something a little better than 11%. Those investors who don’t meet that ROI either go broke or decide (wisely) that their money would serve them better if, instead of using it to wrap houses, they put it in, e.g., an index mutual fund.

Now, admittedly, this analysis is still a bit simplistic, but the burden of proof is on John Burley to show that he really is getting consistently “excessive” returns (and then to show how he’s doing it, since he claims to be providing “the highest quality real estate investment, wealth-building, and debt-free lifestyle information”). Of course the irony is that as soon as he’s revealed it, nothing precludes his competition from adopting his techniques and putting them to use against him. That might go a long way toward explaining why he’s so fond of yelling “Psychobabble!” when people ask him “How?”

As you probably know, I’ve been looking at Burley's public record. I hope, therefore, that I’ll be able, in an upcoming post, to take a close look at one or two of Burley’s investment properties and get at least some rough approximation of their actual ROIs. Stay tuned.

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