A combined Oil & Gas and Real Estate Investment – The best of both worlds

Intro:
I get emails and phone calls resulting from reading this Accredited Investor Talk blog. One discussion I had this week was with an oil and gas (O&G) investor who combines these investments with real estate. I thought his strategy would be of interest to both the oil and gas investors and real estate investors who follow this blog.

Concept:
Most of my previous articles on oil and gas investments assume someone else owns the associated land where these wells are drilled, but the partnership funding the drilling projects secures the rights to a lease for drilling on the land. In the case of the investor I talked with, he first buys land near Texas cities with strong suburb growth that are also strong prospects for oil or gas. Once the land is purchased, he drills and puts the associated wells online to generate cash flow from the land. Later, when the value of the land grows from nearby homes being developed in the suburb, this investor starts also developing the land with homes to sell.

My thoughts on a plan for this type of investment:
- Create a detailed business plan and investment strategy before even starting this project: One of the first steps before starting this project must be a detailed business plan and associated investment strategy. The business plan needs to detail what the entry and exit strategies are for the various phases of this project (the O&G phases and real estate phases). It needs to detail all the key stakeholders in the project, their roles and responsibilities, and how they will be compensated. The plan should document the various probabilities of success (and failure) for each phase of the project which links to the level of risk involved. The plan should also discuss what the investment strategy is for this project which should relate to the probabilities and risk levels involved. There are infinite strategies that could be used throughout the project. Will other investors be brought in for various phases of the project or will all funds come from the initial investors only? Having a clear strategy identified and documented in the business plan for each phase of the project helps keep the focus and helps articulate the project to others. I’ve written a past article on an O&G investor’s investment strategy that provides an example of one O&G investment strategy.

- Buying the right land: This investment should include land with a strong probability of containing productive oil and gas deposits. One way to raise the odds of buying potentially productive land is to buy near other productive wells. The logs from these wells should be reviewed to see potential O&G deposits underground in this land. However, purchasing land near current producing O&G wells usually means the price of this land will be high. This must be considered in any revenue model used to support a business plan for this combined real estate and O&G drilling venture. If you over pay for the land, then the revenue from the wells won’t provide enough returns to make the project profitable enough to counter the high risks involved.

- Finding a good developer for the O&G drilling projects: My personal thoughts are a project of this size and cost should use the services of a very capable oil developer to ensure the highest probability of success with hopefully drilling many profitable O&G wells. Unless the investor has a very strong background with the associated experience to develop these wells, due diligence should be conducted to select the best developer for this project. The business plan should state whether outside investors will be used to fund these wells or if funds will come from the initial project’s investors. A good developer will be able to raise outside investor funding for these projects, if that is what the business plan calls for. As a side note, I have written a complete series of articles that covers all the steps needed to drill O&G wells.

- Managing the cash flow: The project needs to clearly document how cash generated from the O&G wells will be used. Will they be used to: 1) pay down debts including purchase of the land, 2) pay back investors, 3) fund additional O&G wells, 4) initiate development of the real estate, 5) paying ongoing expenses, etc. These wells will not provide income forever as the associated limited supply of oil and gas is pumped out. Therefore, a clear strategy must be defined on where the resulting revenues will be directed - leveraged/or not, reinvested, or otherwise spent. Once the revenues start coming in from he real estate development side of the project, this too must be defined and planned. In all situations, the resulting tax issues must be known and dealt with in the cash flow strategy.

- Finding a good developer of the real estate projects: Again, unless the creators of this project have the necessary experience developing successful real estate projects, a successful real estate developer should be used. This may cost more, but their ability to develop successful projects should reduce the risks involved.

- Define what real estate revenue strategy will be used: Will the land be sub-divided and sold off as homes/commercial sites are developed? This would provide large funds to the investors while also giving them an exit strategy as the real estate is sold off. Alternatively, will apartments and/or commercial buildings be built and leased or rented for ongoing revenues to the investors? This would generate ongoing income to the investors while also hopefully providing capital gains as these property values increase. Perhaps a hybrid strategy will be used that considers selling off some of the land while keeping other portions for ongoing rental revenues. That solution provides both large upfront revenues from sales and ongoing revenues from the remaining rental properties.

- Exit strategy: An exit strategy must be defined on how the investors will be able to sell out their interest in the project. Will the project be taken public (if it is large enough) where investors could sell out their shares on the market? Will other investors have the right to buy out an investor’s interest in some other way? An exit strategy needs to be defined and agreed to by all associated investors before the project is started. There should also be agreement between involved investors on what happens in special situations such as the death of an investor, divorce, law suit, etc. All of these things could severely impact the project without an agreed upon plan for each situation that ensures the remaining investors are able to continue moving forward with the project. To cover all of these issues, I highly recommend using a lawyer to draw up documents before investors put in a cent.

Summary:
This is an interesting way of getting the best from real estate and O&G investments, including all of the unique tax benefits provided to O&G investors and other tax benefits provided to real estate investors. However, there are many issues that must be understood and addressed before starting such a project. I don’t pretend to have all of those issues covered in this short article. Any project of this size should employ the best talented people available to ensure success in all phases. If that happens, any included investor would be very richly rewarded.

Your feedback is wanted:
Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers. Happy investing to you.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.

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Stocks: Understanding stock shorting – making money when a stock price goes down

Stock shorting is big in the news these days:
There are many news articles being printed these days about stock shorting. Also, Congress and others are looking at stock shorting and considering various new regulations on this investment tool. Many sophisticated and accredited investors use this means of investing to make a lot of money when the price of stocks move down. I hope to help better explain what stock shorting is, how it works, how it can work against you, and what the benefits and issues are with it.

What is stock shorting?
Most investors are familiar with investing “long” by holding a stock while it hopefully increases in value over time. The goal is for the stock price to continue increasing so there will eventually be a good profit (capital gains) when the stock is sold. However, sophisticated investors make money when the price of a stock goes down. This type of investing can be done by shorting the stock.

How can you make money when the stock price goes down?
As mentioned above - in the case of “going long” a stock, the investor purchases a stock and sells it on a future date hopefully at a higher price. The difference between the purchase and sales price (if sold at a higher price) is then the profit. In the case of “shorting a stock”, the investor borrows stock from someone else and immediately sells it on the market. Eventually the investor buys back the stock from the market - hopefully at a lower price than when it was previously sold by the investor - to give it back to whoever lent the original stock to sell. This is the opposite of going long. The investor first sells the stock at a high price and later buys back the stock at a lower price. The investor keeps the difference.

An ideal example showing how shorting works:
For this example, I’ll assume my broker does not charge to buy or sell stocks so those costs will not be included. Also, I am not going to talk about the broker’s margin requirement. This is a simplified example (as will be the other examples in this article).

On Monday September 15, 2008 I tell my broker to short 100 shares of Morgan Stanley stock (symbol MS). The broker finds 100 shares from someone to let me borrow and then sells them on the market. Assume all the stock shares sold at $34.00 for a total income to me of $34 x 100 = $3,400. Further assume I am a genius investor and happen to know the bottom of the price would be Thursday September 18 at $11.92 and tell my broker to buy back the 100 shares of MS. If I was lucky enough to get all 100 shares for $11.92 then I spent $11.92 x 100 shares or $1,192. The shares are given back to whoever lent me the original 100 shares and I pocket the difference of what I sold the stock for ($3,400) and what I paid to get them back ($1.192). In this case, I would make a profit of $2,208 ($3,400 - $1.192 = $2,208) in only four days without even owning the stock. Furthermore, I didn’t need money to buy the stock since the money was received when I initially sold the borrowed shares.

Where shorting can work against you:
First consider how you lose money when going long a stock. When going long, you lose if the price of the stock goes down. The stock was first bought at a higher price than when you eventually sell the stock with the difference being your loss. In the case of shorting a stock, you lose money if the price of the stock goes up. The stock was first sold at a lower price than when you eventually buy the stock back with the difference being your loss.

An example of how shorting can work against you:
Lets assume the opposite situation for MS than the above example. On Thursday September 19 I think MS is going to continue going lower and tell my broker to short 100 shares. Assuming the broker finds 100 available shares and sells them at the low $11.92 per share, I receive $1,192 at that time ($11.92 x 100 = $1,192). However, instead of continuing lower, the news announcement comes out that the government is working on creating an entity that will take all of the bad assets off of the financial institution books. The stock starts climbing very rapidly. On Friday I panic and tell my broker to buy back the 100 shares. At the time I am forced to buy the shares at a high price of $33.25 since many other short sellers are also quickly buying back shares of stocks to “cover their short”. I then pay $3,325 for these 100 shares ($33.25 x 100 = $3,325). The net result is that I lose the difference or $2,133 in less than 24 hours!

What is a naked short?
You hear a lot about naked shorts these days. In this case, the investor does not first make sure there are 100 shares of stocks available to sell or to buy back and sells the stock anyway. This can be hard to understand, so I refer you to a article on Wikipedia that goes into more detail.

Why is shorting allowed?
Shorting can be beneficial to a stock by helping curtail over-buying of a stock to the point of ridiculous prices above what the underlying company should be valued at. By shorting stocks that have run up in price, these investors can help bring the price back down to more reasonable levels. Therefore, shorting does play a beneficial role of helping to regulate the price of stocks that may otherwise reach very high levels and fall precipitously when the buyers dry up. The “long” investors would then be hurt very quickly as the price drops. By allowing shorting of the stock, hopefully it does not reach such a high level where the risk of dramatic fall is high. If the shorts bring the price too low, then eventually the “long” buyers start coming in to bring the price back up to a reasonable level. The cycle then repeats if the price again goes up too high to where the short sellers get the upper hand to bring the price back down.

How the current freeze on shorting financial stocks might hurt investors:
Currently there is a freeze on shorting many of the financial stocks due to the major financial crisis in our country. This is good in one way since it stops the runaway shorting of a stock where the price goes down and more shorts join in. As they join in the price drops even more attracting additional short sellers. The result is a compounding of shorts that overpower any attempts by the “long” investors to bring the prices back up. Also, many of these financial companies are good. The price drops are not in line with the actual strength of the underlying company, but are the result of these compounding shorts. So, the freeze allows this short upon short upon short to stop, hopefully letting the stock have a chance to rise back in a range reasonable for financial strength of the underlying company.

The danger here is that the price of these stocks could go the other way and be much higher than what is reasonable for the underlying company. Without short sellers to help regulate and bring the prices back down to reasonable levels, these stocks could be in for a dramatic fall at some future point when the “long” investors have all bought what they want. At that time, they start to sell in panic if the price drops. They want to get out at the high and not be caught in a rapidly declining price again. So, we will have to see if the prices of these stocks stop at reasonable levels on their own as they recover from this period of extremely heavy shorting or if they will get too high and be in for another round of rapid decline, even without short sellers. When the ban on shorting is eventually lifted, the short sellers will hit companies where the prices of the stocks have gone way too high. The drops could start a panic sale again as “longs” get out.

Summary:
Stock shorting is a legitimate means of investing and plays an important role in helping keep stock prices regulated. Many times, it helps prevent “bubbles” where prices go way to high and fall precipitously as the “long” investors panic out. Stock shorting is not well understood, but is definitely a tool used by some accredited investors, sophisticated investors, and other seasoned investors.

Your feedback is wanted:
Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers. Happy investing to you.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

Almost everything you need to know about oil and gas drilling investments

Recap of past oil and gas investing related articles.
I though it might be good to recap on the various articles I’ve posted this year related to investing in oil and gas. Below is a list of the various topic areas discussed with links to the associated articles of interest.

Defining an accredited investor:
Accredited investor
You may be accredited and not know it

Tax advantage related:
Tax free income
Reducing up to 40% of AMT income
100% deduction against all income types
Eliminate/reduce 1031 capital gain tax burden

Learn about the oil and gas business:
Why do oil companies need investors?
Who makes money from selling a barrel of oil?
What to watch for when investing in oil and gas
Understanding oil and gas speculators – Why do we need them?

Steps involved in a typical oil and gas drilling venture:
Part 1: Finding the best drilling location
Part 2: Structuring and funding the partnership
Part 3: Preparing and drilling the well
Part 4: Putting the well into production

Examples of actual oil and gas investments:
A single well oil/gas project
A multi-well oil/gas project
Funding the purchase of a oil/gas drilling rig

Choosing a specific oil/gas project to invest in:
Part 1: Know your investment strategy/goals
Part 2: Many ways to invest in oil and gas
Part 3: Choosing a developer and project

Mitigating rising fuel and energy costs for business/owners:
Investing to mitigate the risk of these rising costs

Generating debt free wealth/income:
Using a good oil and gas investment strategy

Real estate vs. oil and gas investments:
Part 1: Time and liability exposure
Part 2: Wealth from cash vs. debt
Part 3: Regulation and liability
Part 4: Considering tax issues
Part 5: Comparison summary and final thoughts

Additional non-oil and gas related articles of possible interest:
The fallacy of buying a home for the interest deduction
Part 1: What differentiates a successful accredited investor
Part 2: What differentiates a successful accredited investor
Part 3: What differentiates a successful accredited investor

A Plug for our sister "Oil and Gas Investor Network" social site:
For those of you who are not aware, we have a sister site for oil and gas investors on Ning. It is the “Oil and Gas Investor Network” Site at http://oilandgasinvestornetwork.ning.com/. This site was originally started to support members of our LinkedIn.com group “Network for Oil and Gas Investors” at http://www.linkedin.com/groups?gid=87188.

Summary:
So there you have it, all of the articles published to date on this blog site. I hope this recap provides a single source of valuable links you can use many times in the future as you either consider investing in oil and gas or continue on your oil and gas investing journey.

Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on how we can help you be a better oil and gas investor or with other oil and gas related questions/topics you have that we can answer in future articles. Happy investing to you all.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles can easily be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

The fallacy of buying a home for the tax deduction

“You need a tax deduction”
Many income earners hear that phrase a lot. It makes good financial sense to find ways of reducing our taxes while still paying our fair share to maintain this wonderful country we are blessed to live in. Some advisors recommend buying a home for the tax deduction of interest on the loan. However, they should have a full understanding of the client’s financial status to make this statement only if it truly fits within his/her financial plan. Unfortunately, many other people hear this advice and feel it is a global statement for everyone.

Understanding the deduction of interest on a home loan:
The ability to deduct the interest paid on a home loan is one of the few deductions used by the ordinary wage earner. A few years back, they were able to deduct interest on credit cards and other expenses. No longer. Therefore, they try to buy the largest home affordable in order to have the most interest to deduct yearly. Once the original loan gets paid down to where most of the monthly payment toes toward principle rather than toward interest, they may get a new refinance loan or a 2nd on their home to have cash for “investing” and higher yearly interest to deduct. They stay in debt on their home to the maximum level possible for this tax deduction.

What does it really cost to deduct the interest on a home?
What these people may not realize is that they are paying out over twice the money than the benefits they are receiving from the deduction of interest. The following example will help illustrate this further.

Very simplified example:
Joe earns a yearly salary that puts him in a 40% combined state and federal tax bracket. Joe buys a house with a total of $25,000 interest the first year. This provides a $25,000 x 40% or $10,000 tax benefit. However, note that Joe spent a total of $25,000 to get this $10,000 benefit, or 1 ½ times more than the benefit.

If Joe was in a lower total bracket of 25%, then the benefit would only be $25,000 x 25% or a $6,250 benefit. In this case it cost Joe $25,000 for a $6,250 benefit or four times as much.

These examples are very simplified and don’t take into account all of the tax issues associated with a real situation. However, they do illustrate the point that Joe is spending much more money than he receives from reduced taxes. In addition, over a 30 year loan, the extra money spent is significant.

Must look at each person’s situation to determine what makes sense.
For some people, renting may actually make more sense financially than owning. For others, owning a home is the best option. However, care must be taken to buy a home that fits within an appropriate financial plan for that person. Don’t try to buy the largest home or get the largest mortgage just to have a big interest deduction. There are many other deductible investments you can make that will reduce taxes while providing income. In this way, the money spent actually generates increased income rather than extra expense. Also, consider the benefits of having your home paid off with the funds that once went toward the mortgage payment now available for investing in additional income generating investments. There are investments such as oil and gas drilling ventures that provide a 100% deduction of all invested funds against all income types while not counting in alternative minimum tax (AMT) income. Other tax advantaged investments include government bonds. In these ways, the investor can reduce taxes while increasing income without adding debt.

Summary:
The main point here is not to buy the largest house or maintain the largest mortgage for the tax deduction alone. Be sure to carefully consider your long term financial plan to determine what level of investment in a home best fits within that strategy. Work with a financial planner as needed during this process.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Past articles can easily be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

Part 3 - What differentiates a successful accredited investor? What makes them successful?

Continuation of previous article:
This the third article in the series describing my thoughts on what makes many accredited investors successful. How do they think and work? What differentiates them from those who have not achieved their goals? In the previous articles - Part 1 covered the first three elements that make them successful: having a dream that forces action, having desire to overcome challenges along the way, and having an end goal for reaching your dream while Part 2 covered the next three: understand change is hard, don’t let fear win, have a plan, and executing the plan. This article covers the final elements: constantly learn, continually improve, never give up, and giving back to others.

Constantly learn:
Successful people are always learning about things. They take advantage of spare time by reading or listening to tapes covering subjects of interest. They love to learn from other successful people how they overcame their fears and eventually succeeded in reaching their initial goals. These people never feel they have fully arrived at the end point. New challenges present themselves. New dreams are beyond their current ability to achieve without learning and moving forward through the required changes.

Continually improve:
When executing your plan, there most certainly will be new changes required as you find out about things not foreseen initially. Look at your plan and make adjustments as needed to keep moving forward with the new information incorporated into the plan. Keep improving the plan and associated actions over time as you get closer to the end goal.

Never give up:
Look at the Olympics - many of the Olympians at one point or another wanted to give up. Think about Great Britton during the World War when Winston Churchill told them never give up – what would have happened had they given up?

There is a difference between giving up out of fear and giving up because your dream was unrealistic (you want to be the first trillionaire). If you give up completely, then that is most likely due to fear. If your dream is unrealistic, then you should down-scope the end goal to something more achievable, but still beyond your current abilities. Remap your plan of action and work toward this readjusted goal. Once achieved, then look for another goal that again is achievable, but beyond your abilities. This process of continually achieving and creating new goals is what many successful accredited investors do over their lifetime. That has lead many to achieve things they would have never dreamed possible when initially starting on their journey of change. By continually growing and moving forward, each smaller achievement built upon another until their current success was achieved.

Give back:
Successful people give back. They want to help others achieve their dreams, if these people are sincere in their desire and show action toward working on the associated changes. They want to help their community and those less fortunate. They want to help the underprivileged learn to become self sufficient by providing tools (education, supplies, scholarships, etc.) these people can use to build a life of success. If you have not seen the recent movie “The Pursuit of Happyness”, I highly recommend it. That is a true story of an overcomer. Watch the bonus material to see how this once homeless man taking care of his son became an extremely successful Wall Street trader eventually owning his own firm. He now travels to Africa and helps many people there.

Summary:
These are my personal thoughts on what differentiates most successful accredited investors. These could also be true for anyone who dreams and works toward achieving their dreams. Be a dreamer and don’t give into fear. Learn from your fears and face them head on. Constantly facing and overcoming your fears will give you new confidence and belief in your ability to make things happen. Understand that you will always face some failures in life. We all do. The difference is how you react to those failures. Will you let them stop you or will you let them teach you? The choice is yours.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. We are not licensed to sell any interest in a project, nor are we registered advisors. Feel free to email us at MarcobeInvestmentsInc@gmail.com with any questions, thoughts, or requests for other topics to cover in future articles.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Past articles can easily be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content