Blinded by Numbers: How Fixating on Metrics Can Lead to Bad Investments

by | BiggerPockets.com

“[N]ot everything that can be counted counts, and not everything that counts can be counted.”
—William Bruce Cameron

I was talking to a group of real estate investors at an investor meet-up. A few of them purchased buy and hold properties in the middle of the Great Recession. They focused on the numbers and closed a buy and hold deal with a potential 25 percent cash-on-cash return.

Things were going well for a time, but as soon as the market recovered, vacancies began to rise.

Related: How to Calculate Cash-on-Cash Return

Why did the vacancies increase?

The tenants lived there due to the recession. As soon as their incomes rose, they left ASAP. As a result, the investors dealt with frequent tenant churn, theft, and vacancies. Over time, the properties turned into huge liabilities.

The investors had a golden opportunity to purchase quality properties at a discount, but instead they picked losers. How did this happen?

More than likely, they were relying too heavily on metrics.

financials, metrics, real estate, investing

Why Do We Overemphasize Metrics?

Occasionally I watch the show “American Greed.” I cringe when I see these con men prey on poor investors.

I thought it was the hucksters’ way with words and charm that allowed them to steal people’s money. But actually, that wasn’t it. The cons told the investors what they wanted to hear: “You can make a quick buck by investing in X.” The lure of a fat return quenches our collective thirst for money.

It happens to most of us. We see a property and think to ourselves, “Yes, it’s in a shady neighborhood; yes, it was constructed in 1910; and yes, it looks like crap. But look at the 15 percent cash-on-cash return.”

So, we pull the trigger and then decide which Caribbean Island we will retire on.

Sadly, that’s where most real estate investors fail. They focus only on the numbers and neglect the factors that drive the numbers, which results in the utter failure of their investment.

How Can Metrics Hurt Our Investments?

Donald T. Campbell created numerous works in the field of social science and psychology. Unfortunately, most of his work isn’t known in the investment community, so I took one of his laws and put an investor’s spin on it.

A Campbell-Inspired Real Estate Law:

“If real estate investment metrics (e.g. return on investment, cash-on-cash return, etc.) are used as the primary reason for investment decisions, odds are the investment will fail.”

Numbers are important, but they’re not as important as the investment vehicle generating them.

Metrics are tools. Similar to a compass, they can point you north; however, they won’t warn you about the canyon ahead.

Post-purchase, if we continue to heavily focus only on the numbers, we will make poor decisions in the short term that can potentially cause long-term losses and more substantial costs.

If we make decisions solely on metrics—such as pushing off a major structural repair or cutting corners with cheap, shoddy work in order to keep our numbers in line with our projections—eventually we will decrease the value of the asset and reduce its ability to generate cash flow.

neighborhood, property attribute, real estate assessment

How to Pull Yourself Out of the Metrics Trap

Investors should instead focus on three factors that lend themselves to a healthy real estate investment.

Neighborhood

Consider the following when sizing up a neighborhood:

  • Is the neighborhood where the property is located a place people would want to raise a family?
  • If money wasn’t an issue, would people choose to live in this neighborhood?
  • Is this neighborhood within the path of economic development?
  • Are new businesses being started in the area?
  • How are the schools?
  • Are people forced to live here or are they choosing to live here?

Physical Attributes

The physical attributes of property include the floor plan, square footage, lot size, and so on.

Ask yourself these questions:

  • Which characteristics of this property will allow you to charge above-market rents?
  • Is the floor plan larger than comparable properties in the area?

Tenants

Think about the following with regard to tenants:

  • What type of tenants will be attracted to this property?
  • Will people with steady incomes, great credit, and clean tenant history want to live in this property?

Related: The Real Way to Evaluate a Real Estate Deal… If You’re a Rehabber

So, What’s the Best Way to Use Metrics?

We need to start respecting metrics as tools that can help us make decisions as opposed to being the sole determinant of decisions.

Optimally, metrics should be used as a status report on how things are going. They’re a tool for tracking trends and discovering relationships between factors, which can then be considered as part of the overall decision-making process.

We’re republishing this article to help out our newer readers.

How do you prevent yourself from being blinded by the numbers?

Leave a comment below!

About Author

Jordan Thibodeau

Jordan Thibodeau is a tech employee and real estate investor. While working with his father, Jordan learned the family business of real estate investing and made his first real estate investment in 2013 when he partnered with his dad to purchase a duplex in Sacramento. Jordan went on to form the Silicon Valley Investors Club, which is one of the largest investing clubs for current and former tech employees that has nearly 6,000 members. He wrote a popular BP blog post that has helped numerous full-time employees get started in real estate investing. He writes a monthly investment newsletter called Investors Therapy that helps investors understand their psychology to make better investment decisions. His writings have been seen on Forbes and Thrive Global. Also, Jordan has interviewed or hosted some of America’s top thought leaders and investors such as Ray Dalio, Anne Wojcicki, Tim Ferriss, Ryan Holiday, Annie Duke, Ben Horowitz, and Eric Barker to learn about human psychology and what we can do to make better investment decisions.

15 Comments

  1. Cheryl Vargas

    Great article Jordan!
    Where do you find information on the desirability of a neighborhood?

    Regarding your goal to charge above-market rents, do you buy floor plans with only 3/2 or greater bedroom and bath amounts?
    Thanks!
    Cheryl

    • Jordan Thibodeau

      HI Cheryl,

      Great question.

      Before I invested in Sacramento, I spent 6 months looking at houses in the area. I saw at least 100 homes. After seeing all different times of homes and areas, you begin to get a feel for each neighborhood and you can which neighborhoods are ideal for your investment objectives. I would always talk to the neighbors about a given area to get the inside scoup on what’s happening.
      Anyone close to your RE deal can be biased by their need to close the deal and earn a commission, so I always try to seek out neutral third parties.

      Trulia and Zillow keep records on school districts, I find that the stronger the schools are, the more desirable a location is. Of course it’s not a perfect rule, but it can be an indicator of a decent area.

      Also, you can use nextdoor.com to preview zip codes to see what people are saying about their neighborhood.

      RE Above Market Rents: While I only invest in multi family. Around sacramento I’ve been seeing 2 bedroom houses and apartments with square footage of 650~. My duplex, has 828 square feet. Sometimes comparing houses by the number of rooms isn’t a apples to apples comparison.

      Let me know if you have any other questions.

      • Cheryl Vargas

        Thank you Jordan

        That is a brilliant idea to buy a property with more square feet than other properties nearby with the same amount of bed/ bathrooms. I’m going to keep that criteria in mind when looking for property.
        I’ll look up that website- next door- and I’ll talk to the neighbors to get a feel of what direction the neighborhood is going in.
        Thank you!

      • Katie Rogers

        I do not know about Sacramento specifically, but in many parts of California so-called “market rents” are already too high relative to the typical median tenant wage. And tenants with higher wages are not necessarily more desirable in terms of noise, cleanliness, and promptness. One way to get great tenants is to offer a nice home at below market rents, and screen carefully. Bad landlords love to trap tenants with one-year leases. And bad tenants love one-year leases because it is more difficult to evict them. I always go month-to-month. If you are a good landlord, your tenants will stay for many years.

        • Jordan Thibodeau

          @Katie Rogers: Thanks for the great points.

          I’ve been using year long leases for my duplex in Sacramento. I find that tenants enjoy have the security knowing their rent won’t be raised for at least a year (especially in hot markets).

          The year lease allows me to weed out tenants that are only looking for a temporary residence, because I don’t want to drive to Sacramento for multiple showings each year.

          I find that month to month and year leases are a matter of landlord preference.

        • Katie Rogers

          If you are a good landlord, tenants will not need to worry about sudden increases in rent, especially if you write in your month-to-month agreement. So rent stability is really a non-issue, or does not need to be an issue.

          I try to operate by the Golden Rule. If I were a tenant, and I got a better job in another city, I would not want the hassle of breaking a lease. If I wanted to buy a house, I would not want to be trapped by a lease. So I try to give my tenants what I would want. Temporary tenants are also a non-issue if you are a good landlord. Tenants tend to stay a long, long time with good landlords because they are so rare.

        • Deanna Opgenort

          Ditto. Month-to-month saved my bacon on my first tenants – I could do an “I no longer want to rent to you” letter, vs. having to break a lease. My parents have had some month-to-months stay for better part of a decade.
          People leave good, fairly priced housing only when they need to (job or family issues) and that rarely happens 365 days after they moved in.

  2. Andrew Syrios

    All of these metrics are based on assumptions and if those assumptions are flawed, the metrics are useless. This is absolutely true with things like the 2% rule and buying in warzones. Yes, it looks good on paper. But it will only look good on paper.

  3. Alison Robinson

    I love metrics! Always have always will. Cash on cash return, estimated annual cash flow, %expenses, %occupancy, mean time between tenant turnover, income 3x rent, etc. I track most and continue to look for more. Metrics may not be the whole story but I think my likelihood of success increases when i leverage both metrics with property criteria.

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