I was out of town last week and had an opportunity to meet a number of different investors on my trip. One conversation in particular stuck with me because I believe the scenario is common to a lot of people. Many investors that are in the market today for investment properties were the same ones that were buying properties either during the real estate frenzy of the mid-2000’s or on the front end of the recession (before prices had truly bottomed out). Many of these investors have either lost houses due to the tremendous drop in value or are hanging on to one or more properties that simply aren’t performing.
The investor I spoke with had purchased three properties in the same market back in 2007 and has done everything in her power since then to try to make them “work.” I stood there and listened as she explained how she had refinanced this house and that house and moved money here and there … all in an effort to get these properties to a place where they at least break even. When she got finished telling me about all the shenanigans she had pulled to get to this point, I simply asked her, “Why?” Why go through all of those motions just to try to feel good about properties that she had no business owning.
Now I’m not saying somebody with a bad investment needs to let it go into foreclosure, but I do think it makes sense to take a hard look at underperforming houses. This is especially true when the bad investments are preventing someone from making new investments . . . as could be the case if you’ve got money tied up or have maxed out your conventional financing ability.
Are Your Underperforming Properties Holding You Back?
As was the case with the investor I spoke with, she wanted to invest in properties right now, but the 3 she had purchased were holding her back. Amazingly, while the houses were essentially break even in terms of cash flow, she was only slightly upside down on them. Being that she was in a market with little upside potential, I couldn’t help but wonder why she hadn’t dumped them yet in favor of better opportunities? I suppose when you’ve put enough time and energy into something to make it “work,” it’s not easy to let go – especially if letting go feels like defeat because you might need to come to the closing table with more money out of pocket.
The question I posed to her and that I would pose to other investors in similar situations is, “What is the real cost of holding that underperforming property?” While it didn’t feel like it was costing her anything, in actuality it was costing her a lot of missed opportunity. While she sits idly by, other investors are scooping up properties at tremendous discounts and locking in at interest rates we may never see again in our lifetime.
So many investors forget to factor opportunity cost into their buying scenarios, but I think it’s a crucial metric to consider. A simple example of this is an investor that chooses property “A,” yielding 10% versus property “B” that could have yielded 12%. In this example the investor actually experiences an opportunity cost of 4%, as the greater yield could have been achieved through the alternative investment.
But what about the opportunity cost of sitting on a non-performing investment property? What could that money (or financing) be doing if it was invested in deeply discounted, high cash flow property with appreciation potential? I would submit that there are a number of investors in a position to sell previously purchased assets at or below what was paid for them, reinvest those funds and end up making much more money in the long run. Why? Because there are unbelievable opportunities to buy properties that produce great yield and have the potential to gain 50%-100% over the next 10 years.
While many investors think the best course of action is to sit tight on subpar investments, maybe it’s time to analyze the true cost of inaction. Perhaps it makes more sense to take a slight loss now in favor of much higher returns from the kinds of deals and interest rates that investors have access to right now.