I am afraid to admit this, but I do love some good reality TV. One of the questions I often ask myself is just how real these shows are and how much of it is scripted or rehearsed for entertainment purposes.
When I find myself staying up late at night binge watching reality TV, I try to justify that by convincing myself that I am learning some valuable lessons from these shows.
Million Dollar Listing is one of my favorite “reality” shows. From Los Angeles to New York to San Francisco, I love watching these shows for the beautiful homes they sell and the skillful ways that the brokers negotiate. Believe it or not, in addition to just the fun and games of the millionaire lifestyle and the drama between the brokers, I learned two important lessons from these Million Dollar Listing shows to help me as an investor.
Lesson 1: Remember to Compare Apples to Apples
One of the more interesting sales techniques that I observed on the MDL show was their ability to find buyers willing to pay higher than market value for a property. If a broker knew they were listing a property at above market price, they would simply target buyers from other market areas where prices may be higher in comparison.
For example, on a recent show, there was a property for sale in Malibu, California, and the seller wanted to sell it for a price that was significantly higher than any other sold properties in the neighborhood. To find the perfect buyer, the listing agent targeted buyers from New York to look at this property.
For many of the New York buyers, this Malibu property seemed like a steal. In addition to the property size and ocean views, the price per square foot was significantly lower than any similar properties they looked at in New York. In this transaction, it almost seemed like a no-brainer that the buyers would pull the trigger to buy this home in Malibu. On another episode, the broker had a hard time selling a penthouse for above-market prices so he focused on bringing in foreign investors from Asia and Europe because the penthouse could seem affordable to those foreign investors.
As a real estate investor, the giant flaw that I see in this transaction is that the buyer may not be comparing apples to apples. There are reasons the prices per square foot in NYC are higher than Malibu. New York and Malibu are two completely different real estate markets. So the question that comes up is, why in the world would I use prices in New York to buy a property in Malibu? Just because a 3,000 sq. ft. home in New York costs $1M, it doesn’t mean that a 3,000 sq. ft. home in Ohio costing only $500k is a good deal, right?
Unfortunately, this is a mistake that I often see investors make. For example, I see many investors in California who get excited to buy properties in other states where prices are lower. To be clear, buying properties where the cash flow makes sense can be a great decision. If in California your rental can only generate 4% returns, while going to Ohio you can get 7% returns, it may be a good idea to shift your investment capital to Ohio.
However, it would not be a good idea to shift your investment capital to Ohio just because the same house costs half as much in Ohio as it does in California. As investors, we need to look at all the numbers to make sure the transaction makes sense. If the price per sq. ft. in Ohio is $150, that is the price that I would potentially buy that property for. It would not matter to me that a rental of similar size in similar types of neighborhoods in California cost $300 per sq. ft.
As investors, it is important to make sure we understand that we need to be comparing apples to apples and not comparing apples to oranges.
Lesson 2: Setting Record Prices
Another concept I see quite often on MDL is the broker’s ability to sell a property for “record-setting prices.” What they are generally referring to is the fact that the buyer of this property is paying a higher price than what others have paid in the market area when you look at comparable properties and prices. I understand that for those who are buying a primary home or even a second home, there may be specific items that people love about a particular property that results in their willingness to pay more. However, what shocks me is that sometimes, these buyers who pay the record-setting prices are actually investors who are acquiring the properties.
One of the things that the brokers on the show will sometimes do is to try and convince the investor to buy the property by saying, “Even though you can buy a similar property across the street for $2,600 per square foot, you shouldn’t do that. Instead, you should buy this property today at $3,000 per square foot, and in 5 years, you will be able to sell it for $5,000 per square foot.”
As an investor, there are a few flaws in this thought process.
First, why would I pay more for a property than what it is currently worth on the market when there may be comparable ones that I can buy for less?
Second, I would not buy a property based purely on what the projected appreciation in the market may be in the future. If the seller was so certain that the property would increase significantly, wouldn’t he just keep the property and sell it to me in 5 years after it increases in value? A key lesson for savvy real estate investors is to pay for what the property is currently worth and not what it may be worth in the future.
This is a mistake that I often see in the multifamily space. If the property is only 30% occupied currently, we would buy the property based on what the actual income has been and not pay based on what the projected income would be if it was 100% occupied. If the seller wants to sell it based on what 100% occupancy would be, then they should take steps to get all the units rented out prior to selling it to me.
Also, as a real estate investor, I like to have as much control over my property prices as possible. That means not relying solely on the market to determine what the appreciation may be. As you probably already know, it is quite possible to be in a market with zero appreciation or even significant amounts of depreciation. Alternatively, I prefer to buy investment properties where I can use forced appreciation. By adding value to a property or repurposing a property to its highest and best use, I am able to create forced appreciation rather than passively waiting on the market to determine what the property is worth.
There you have it: Binge watching late night reality TV can be helpful for real estate investors. TV watching may not be helpful in documenting real estate professional time for tax purposes, but some important lessons can be learned if we know where to look.
One of the things we often see on these shows is that the broker meets with a developer who combined several units and built a mansion or tore down an old two-story to build a newer, taller building. Instead of focusing on the sale of these newly built units, wouldn’t it be interesting to watch a show to look at what goes into the investor or developer’s mind in deciding that this was a worthwhile and profitable project? Maybe that is a new reality TV show idea for Josh Dorkin and Brandon Turner at BiggerPockets.
What unexpected real estate lessons have YOU learned lately?
Let me know with a comment!