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The Number One Irrational Behavior of Real Estate Investors

by Chris Clothier on September 5, 2012 · 16 comments

  

If you ever get a chance to read my posts on the BiggerPockets forums, you notice that I am a big proponent of education, mentor ship, coaching, whatever you want to call it.  I call it surrounding yourself with people you want to learn from and always learning something new.  One week ago, I had the chance to travel to Boston to attend the Hubspot Inbound ’12 conference and do both!

Before tying this into real estate, I think it’s important that readers understand that there is so much more to building a business that simply identifying something you want to sell and then finding a buyer.  There is so much more to real estate that simply finding some piece of property you want to buy and buying it.  That is what I love about going to conferences like Inbound ’12 and surrounding myself with people that (mostly) know nothing about my business.  Once I am around them and start to tell them about my business, they provide some of the best insight you could ever hope to get.  One of the people I was lucky enough to get to hear speak was Rand Fishkin, CEO of SEO software company, SEOmoz, who gave an entertaining talk about irrational behaviors and beliefs in the SEO world.  His presentation got me thinking about the same irrational behaviors that real estate investors exhibit.  His talk helped me focus in on one irrational behavior that I though stood out above all else – especially in my particular niche of real estate investing.

Irrational Behavior Of Real Estate Investors

Rand opened his presentation with an analytical comparison he had done on a dating website called okcupid.com.  If you’re like me (I was in the audience wondering what it had to do with SEO), you might be wondering what this has to do with real estate investing.  Well, he walked through his analysis and had some very amusing points to make about the differences between men and women on the site, most of which, any of us could guess.  It was a great segway into the rest of his talk on website SEO and marketing.  His main point on his dating site analysis was that men and women both are extremely picky and borderline irrational with the way they approached contacting other users and finding a date.  Both men and women approach the site differently with men being irrationally focused on looks and women being irrationally focused on height.  Both behaviors that could actually lead to  men and women missing out on a great number of possible matches.  Many of those matches  could be based on some solid fundamentals to an online dating site.  That doesn’t mean it’s bad to be picky, it just means that being picky about the wrong things or in the wrong order can hinder the search for a great match.  Stay with me, I’m going to show you how this relates to real estate investing.

His research showed that a majority of women used a completely arbitrary height requirement, 5’9″ to be exact, to filter their possible dating selections and this height requirement comes very early in the process.  For guys like Rand and myself who are challenged to reach 5’9″, this can be a very tricky thing.  Women exclude men who are not at least 5’9″ long before they find out if they are handsome (?), fit and athletic (?), college educated (?), do they read books (?), did they fill out a compete profile (?).  Heck, they even find out how tall a man is before they know if he has a job!  They never see the other analytical data because these criteria come after the height.  For men, it looked even crazier as they focused almost exclusively on looks and a rating system for looks before choosing who to interact with.  I know that comes as a complete shocker, right!  Rand’s point was that to base your decision on whom to date on a completely arbitrary filter was, well, a little irrational.

So as I was thinking about how this relates to real estate investing, I didn’t have to think very hard.  I get phone calls and emails on a weekly basis from interested investors with the same headline “I hear I can buy cheap properties in Memphis”!  They don’t send emails asking about the economy.  Rarely do I get an email asking about a rental analysis for certain areas.  I can’t think of the last time I received an email asking me about property management as it relates to the best zip codes for investing.  I hardly ever get asked for examples of a ‘Scope of Work’ detailing how we show investors the renovations done to a property they are purchasing.  No, I pretty much get contacted like clockwork with the request for cheap houses.

That is not to say that I never get contacted about the real pertinent information.  It just happens a lot less often.

Cheap in relation to what?

I always ask investors who send me requests or even make statements like that about cheap housing stock, “cheap compared to what”?  Cheap compared to where you live?  Maybe.  I started my investing career in Denver and used to find houses there that would cost me $120,000.  I could buy a comparable property in Memphis for $50,000.  So naturally, I thought the Memphis houses were an incredible bargain.  I mean, they were half price right!  Wrong.  I would later find out that what I paid $50,000 for, the smart investor who knew the area had paid $30,000.  I was almost double what other investors had paid and when the housing crisis hit and rents softened, I got hurt the most.

Since 97% of my investors come from outside of Memphis and Dallas, I have to tell all of them that cheap compared to where you live is not a good indicator of a quality investment property.  Cheap even compared to where your investing is not a good indicator of a quality investment property.  You have to dig deeper and get to the meat of the analytics.  Too many investors fixate on price and fixate on price long before they know anything about the city, the neighborhood itself, the economy, the team they will use to help them successfully invest, etc…  They simply decide that since it is cheap compared to where they live it must be a good deal or at the very least a better deal than they can get at home.  The best advice I can give an investor interested in my area (really any area for that matter) is that there is a lot more that goes into your investing decision than price and price needs to come later in the analysis.  Long before you can decide if the price is right, you have to know the area, the economics of the area, the factors that hurt and help an area and, if you are investing out of town, how the people you partner with are going to help you to make your investment a good one.  These are factors that have nothing to do with price, but yet, they have a much greater effect on your investment than the price does.  When you feel like you have the right location and team, then you can focus on pricing and how pricing effects your investment.

Investors who make decisions on investment property simply based on if they think the property is ‘cheap’, completely ignore all of the analytical data that should come first.  Investors have choices today in how, when and where they choose to invest in real estate.  For an investor, man or woman, new or experienced, to focus in on the pricing of an investment and not even consider other properties that do not meet that criteria, leaves them open to missing out on investments that may be perfect for them if not for that one irrational filter.  My advice, on real estate not dating, is to be open to the possibility that your best investment may be the one where you consider price last.

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{ 16 comments… read them below or add one }

Dale Osborn September 5, 2012 at 5:06 pm

It seems that it is a fact of life that people look where they can get the biggest bang for their buck. We left an area of over 500K population for another area with 20K and wondered what we were doing. It was simply price that got us to go where we could get more units for what we had to invest. It worked out okay and after only 4 years we were able to pick up and go back where we started from with more funds in hand to invest back into the old neighborhood. It could have gone the other way and we might still be there. Price is a consideration, but there are other things to also take into consideration.

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Chris Clothier September 5, 2012 at 6:13 pm

Hey Dale –

Great to see you on here and taking time to leave a comment. That really was the main point of the article and I tried to find a fun way to make it. You have to consider so many things and price is important. But, in my humble opinion, too often investors focus on price first and make decisions without considering other factors that are equally if not more important.

Thanks a lot for reading and commenting.

All the best – Chris

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Ziv Magen September 6, 2012 at 3:00 am

Oh, man, truer words were never spoken :)
I get about one email of several hundreds a month that goes beyond the standard “how can I get 15%?”…but when I do get that email, I know it’s a real investor talking. And the most annoying thing is, it doesn’t matter how long-winded and detailed your answer is to those tire kickers, nine times out of ten the reply will be “so you’re saying I can’t get 15%”?

No, I’m saying you’d better understand what those 15% mean before you set it as your criteria. Oh, stuff it, might as well be talking to the neighbors cat.

Meow. Great post, Chris.

Reply

Chris Clothier September 6, 2012 at 8:08 am

Hey Ziv –

You are correct and random percentages are always a focus of novice and even some experienced investors. That is not to say that we all would not want a 15% return on investment, but investors need to understand the risks involved and the likelihood of earning that same 15% return year after year. A lot goes into the planning and execution of an investment strategy and it can be done. Unfortunately, real life is not like ‘The Secret’ and you cannot fixate on a return and suddenly have it. It takes prep.

Thanks for reading and taking time to comment –

All the best – Chris

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Andrew September 6, 2012 at 11:44 am

Chris,

Excellent post. It’s tough as a new investor to stay focused on those metrics that matter, and limit the emotional/feelings quotient of the decision making process. Your article does a great job driving that home.

Your example of ‘cheap’ properties rings true for me also. You can imagine the sticker shock we experienced when we recently moved to the Washington, DC area from our previous home in NC!! Talk about eye opening….

Thanks!

Andrew

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Chris Clothier September 7, 2012 at 6:06 pm

Andrew –

I appreciate you reading the article and leaving a response. I also appreciate the kind words. The reality of the situation is that you can have a budget when investing, but price alone does not tell the story about an investment property and you have to look at other factors first.

All the best – Chris

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Eric Van Kirk September 7, 2012 at 9:58 am

Chris,

I used to manage property before I got into investing and subsequently got my Real Estate license in Fort Myers, FL. I was one of those people who was looking at just price to try to find the good deal. Today I look at everything involved, the area, rental rates, end user vs absentee owner, time on market, all other homes in the neighborhood, and yes, price. Without all of the other factors being taken into consideration there are so many houses that investors miss out on because they think the price is the only factor that matters. Whereas it is important, setting a limit on the amount should merely be a budget factor and not a value deciding factor.

I deal with investors mostly as my buyer clients and focus on conventional listings for my sales side of my business. I have found that most investors have done their homework and understand the many aspects of real estate investing and all of the parameters that must be evaluated in order to find a ‘good deal’. There are many, however, that contact me and say “I have $100k to invest in a flip, find me the cheapest house you can.” When I ask them more in depth questions they are baffled that there are so many other factors that go into real estate investing. One of the biggest ones is how much the rehab will actually cost. They say “How much do you think it will cost to fix up?” Why, am I doing the work? I am not a licensed and insured contractor. Some get discourage and I never hear from them again, others educate themselves and become lasting clients.

Thanks for the article.

Eric Van Kirk

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Chris Clothier September 9, 2012 at 1:58 pm

Hey Eric –

Thanks for leaving the comment. Sounds like you have gone through some of the same frustrations!

All the best – Chris

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Haim September 7, 2012 at 9:31 pm

Chris,

You are absolutely right. It took me more than a year to feel comfortable to invest in another state. The properties price in Memphis is significantly lower than the San Francisco Bay Area but I still had fear to trust someone 2000 mile away to manage the property and take a good care of it.

The price was “cheap” compared to the Bay Area but couldn’t do it without trusting the people I work with such as the sales team, rehab team, property management company and the leaders of the company.

After communicating with your staff and researching your company and what it has accomplished in the last few years I finally decided to pull the trigger.

I have become a Memphisinvest investor and about to close on my first out-of-state deal.

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Chris Clothier September 9, 2012 at 2:02 pm

Haim –

That is great stuff! Thank you so much for you kind words and the trust of our company. I was just in the Bay area this weekend advising investors on how to protect themselves when purchasing out of area. That was one of the big points I made. Just because its cheap compared to where you live, doesn’t mean it’s a good buy. I’m glad to hear you did so much research and due diligence.

Thanks again for reading and leaving your comment. Also thanks for trusting us with your out-of-area investing.

All the best –

Chris

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lynn andris September 9, 2012 at 7:45 pm

Great article! I get a lot of new investors, and sometimes the veterans too, who lose sight of the forest for the trees. especially now when inventory has gone down in the Texas markets and investors are panicking a bit thinking they “missed out”.

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Chris Clothier September 10, 2012 at 7:33 am

Lynn –

Thank for you so much for reading the article! You are correct, both new and experienced investors can lose sight…just ask me! As an experienced investor, I made these same mistakes many years ago.

All the best –

Chris

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Melissa Woycechowsky September 10, 2012 at 6:37 am

I own a property management company, and a large percentage of my clients are people who paid too much for properties because they were so much cheaper than California or NYC. They didn’t understand the type of property they were buying, the types of tenants who would rent it or the maintenance required to keep it operating. They may have blindly trusted a property manager who rented their properties to unscreened tenants, charged for repairs that were never made and cheated them out of collected rent. They would like to sell their properties, but owe more on them than they are worth. For many clients, the best case senario is that they break even every month – and this is with me working hard to get the best tenants and keep repair costs down.

It is possible to make money investing in Syracuse, but you have to buy low and have a realistic plan, and really understand what you are getting into.

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Chris Clothier September 10, 2012 at 7:48 am

Melissa –

Thank you for reading and leaving a comment. The items you ar talking about are certainly the worst case scenarios for investors and I think most of us who have been doing this for a while would agree that there are many more success stories than are ever told. That being said, you are correct that it all starts with mindset and tying back to not buying because it is “cheap”.

Thanks so much for your comments.

All the best – Chris

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Jeffrey Hare September 11, 2012 at 5:39 am

Your presentation on this topic at the Real Estate Investors ExpoSiliconValley in Santa Clara was excellent and an eye-opener. Paying attention to the correct metrics is critical to the success of any venture. A great example of this approach is detailed in Michael Lewis’ book “Moneyball,” in which the Manager of the Oakland Athletics – played by Brad Pitt in the movie – used metrics to build a winning team; studying the statistics carefully to determine precisely which performance factors were contributing to success rather than hype and rumor. He went after players who performed rather than those who just “looked good.” Since many of these players had been overlooked and ignored, he reduced costs and produced wins. That’s success!

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Savitha March 31, 2013 at 1:30 pm

Hi Chris,

I am interested in buying investment properties in Dallas Fortworth area and your article has been an eye opener. I was also stuck on buying it cheap and now feel there are lot more things to consider. What all factors should i be keeping in mind other than price?

Also, pls give share your Property Management company details.

Thanks,
savitha

Reply

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