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What Is A Ponzi Scheme?

I can’t provide all of the details of a Ponzi scheme. I am satisfied that check kiting is much simpler. A Ponzi scheme requires a great deal more energy and imagination, but some of it I understand.

A Ponzi scheme begins with an asset. It is important that the asset have a value which is not easily discernible. For instance, if I could persuade you to invest in an oil well not yet drilled, and convince you that you will have tax write-offs and benefits which the IRS hasn’t yet declared but will soon approve, the investment I hawk may be attractive. It’s important, again, that you don’t quite know what its worth, but to believe benefits are both obvious and impressive.

Next, I have a small group of investors. It is necessary that the number initially be small and that they accept my explanation of potential benefits of the investment. I add to that concentric circles of investors, each somewhat larger than the last, each of which agreed to invest their money in expectation of the expected benefits. As each group grows, I pay “profits” from the most recent investors, making each believe the investment is producing exactly as I predicted. The result is that the first investors are repaid “profits” by later investors on belief that the asset is in fact paying dividends. If investors are paid returns on their investment, which appear to come from the asset, but which instead come only from the contributions of subsequent investors, all of whom believe the asset to be paying those dividends, we have a classic Ponzi scheme.

Those of us in real estate in Northwest Florida do not condone that process. Obviously, investors are misled, and if the asset proves to have less than its predicted value, all we’ve done is churn money and everybody loses but the one counting the money.

But what is the result if we assign a condominium unit yet to be built a future value based not on traditional real estate criteria, like quality of construction, location, view, and ease of parking, but on the promise that others will want the asset more than you and that its value will constantly increase? Whether the asset is an unbuilt condominium unit, a vacant lot to be sold, or a townhouse to be rented, if that which is marketed is not valued as a traditional real estate asset, but on a promise of re-sale, we have in fact departed from the sale of real estate and begun to speculate on a future price that has no connection to value. With all due respect, that is not the sale of real estate. I don’t know exactly what it is, but it is far different from the sale of real estate.

If we add to this item to be sold the reality that subsequent waves of people will pay more than the first wave, we have really created concentric circles of buyers, all heaped upon their predecessor and all jumping in solely because they become convinced that others will follow.

I heard so many times during 2004 and 2005, that “people are paying incredible prices for real estate in California, and that Florida values are just catching up to California”. Now we know that the truth was much more complicated. Those people in many cases were not coming to Florida at all. They were either already here or never intended to be here, but they were investors buying multiple Florida properties. Investors who were, as often as not, intoxicated by the thought that the “value” of these lots (or units) was established by the last flip of similar property.

Professional realtors make the value of real estate their profession; opportunists deal in its price and don’t know the difference (or maybe don’t care). We will return stability to the market when purchasers are made to realize that value arises from cost of production of the item, location, quality, parking and dozens of other considerations that create desirability of property. Even the availability of cheap money, aggressively marketed, can’t change value. It can help people pay the real value to a seller; but we know now that cheap money also distorts value and that a real professional doesn’t invest just because the money is cheap.

My advice: Don’t stay out of the market because of 2005 prices. Forget them. Deal in real estate value. Find a professional who knows the difference between value and price and either take the loss or make the purchase. The traditional concepts of value won’t change.

One thing won’t change. We honor our community and profession by the respect we show for each other. We in the real estate closing business wish you a wonderful and busy new year.

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