“You make your money when you buy.”
“The blind man sees things clearest.”
“It’s darkest just before the dawn.”
All of these sound cool, but they are simply not correct in a literal sense. I would even argue they are misleading. The vast majority of the time when purchasing anything, including investment real estate, you do not make money at the time of purchase. Of course, we know the “you make money when you buy” phrase is a way of teaching us to buy right and get a great deal. When we purchase well, the future gains will likely be greater than if we purchase poorly—duh. I think we all know this is the underlying meaning of this phrase. The issue is that phrase and the mindset behind it has us as real estate investors too focused on purchasing the home run deals that are 30%, 40%, or 50% below market value. Because of this, we end up missing the opportunities where we actually can make money. Unlike the popular saying states, you can and do often make your money when you operate and sell. That is where opportunity is—and this is where we should put the equal if not greater focus.
Before I go further, I want to clarify that I am not saying that buying right or trying to get a property below market value is not important. It is, but too often we as investors focus on the price of our purchases to a fault, and as a result, we miss the true opportunities where the real money is made.
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Where is the Money Really Made?
Typically as a real estate investor, if you make money, you will make it two ways: during operation (cash flow) and when you sell (capital gain).
Very often, the capital gains come from realized appreciation. The market, inflation, or other external forces have pushed the value of your property up, or maybe you forced appreciation by adding value one way or another. Market appreciation is speculative and often comes with a bit of luck. Forced appreciation can be controlled, predicted, and executed. Investors can do this through the operations of the investment.
Related: How to Beat the Coming Housing Slowdown With a Value-Add Multifamily
That’s right: The biggest factor determining if you make money is not how you buy but how you operate. Operating well will boost your cash flow as you hold investments and force appreciation to be captured on the sale of the property.
Stepping Over Dollars in Search of a Penny
We’ve all heard another popular saying in business: “Stepping over dollars to pick up pennies.” When we focus so hard on buying a property with X cap rate or X% below ARV that we’re blind to the opportunities that may exist in the operations of the investment. When we do this, we step over dollars in search of a dollar—or worse, we step over dollars in search of a penny.
Good Operations > Good Purchase Price
A good operator can take a mediocre or even bad investment and turn it into a great investment. On the flip side, even the best investment can crash and burn with the wrong operator behind the wheel. The obvious goal, then, is to strive to purchase a great investment AND operate it well. I agree, but the argument of this article is that the first step, the purchase, along with the desire to always get a great deal, is blinding investors to the opportunity that lies within the operations.
This is applicable whether you’re buying single families, multifamilies, or any other type of investment. Brian Burke, a seasoned and successful multifamily investor whom I look up to, has said in many interviews, “I don’t care much about the cap rate. Cap rate really only matters when you are selling.” Brian knows the money is made in the operations and the opportunity that exists within them. So very often we hear people say, “I would never buy below an 8 cap,” or whatever their target may be. Like Mr. Burke and myself say, why does it matter? Good investors who can see an opportunity will gladly pay a 3, 4, 5, or whatever cap on actual financials if there is an opportunity within the operations large enough to make the investment advantageous.
The same goes for flipping houses. Operations are more important than the purchase. Good flippers maximize their profits by operating efficiently. They keep holding costs low, they ensure renovation budgets do not go over, and most importantly, they see an opportunity that others leave on the table. If a property has room to add a bedroom or bathroom to the floor plan, they realize and execute on that opportunity to increase the property’s value.
They Pay More Because They See or Create Opportunity You Don’t
Most markets are competitive right now, and quality investments are harder to come by. There are undoubtedly some poor investments being made. But there are also many skilled investors able to pay more because they can capture opportunity that is found in the operations of the investment.
Related: 5 Sticky Real Estate Situations That Offer Investment Opportunities
Price is part of the puzzle and undoubtedly an important one, but so often real estate investors focus on price to a fault. This prevents them from capturing the real money to be made. By shifting your focus first to the operations of the property, you’ll be able to maximize returns, allowing you to pay the amount needed to get the transaction done while maintaining a satisfactory level of risk.
I wrote this article because I am guilty of this very mistake in thinking. The past two years have been slower than desired on acquisitions. I write this article to self-reflect as well as help others. I know our company has major competitive advantages when it comes to the operations of an investment, and by focusing on the operations more than the price first, I will uncover opportunities that sellers, owners, and competitors will miss. I hope you will do the same.
We’re republishing this article to help out our newer readers.
Do you agree with this assessment? Disagree?
Leave your comments below!
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34 Comments
There’s only one way “you make your money when you buy” doesn’t apply (well, it always does as far as I’m concerned). But that saying is less important if you plan to buy and hold for a long time.
Tons of investors who didn’t follow this mantra – one that I consider to be a hard and fast rule – lost everything during the last downturn. And I’ve seen plenty who thought they could make money along the way end up losing out because they didn’t buy deep enough to begin with.
I understand what you’re trying to say about the lesser deals you’re hoping to make profit on, but it’s a risky way to do business because you’re betting on the future, whether it’s through appreciation or operating your business. Never bet on the future, it’s too big an unknown. If things do end up working out well in the future, hooray! That’s the gravy. Just don’t run a business that way.
Karen, I agree with you. No doubt we can all improve the performance via operations, if possible, and that is independant of purchase price and terms. BOTH aspects are important to me, on every deal. I happen to specialize in forced appreciation opportunities (i.e., real fixer uppers and repurposing/altering the use or bed/bath/unit count situation). And most of the surprises in the fixup costs are all bad for the buyer! So deep discount purchase price is the ONLY safe way to build in a cushion and acceptable risk/margin for a purchase/project. Another thought I had while reading this, is that price is much less important for long term landlord rental investments, as you said. SO, when negotiating purchase terms, price is sometimes a bargaining chip I use will seller financing proposals, to get better Loan to Value/interest rate/amortization/balloon terms which can significantly, and immediately impact cash flow performance from the git-go. For example, if I plan to buy and hold a rental for 20 years, I could agree to a price of $100K, instead of $80K, to get a much better interest rate and CF result, not to mention Cash on Cash return. This is why we always have to use our calculators and analyzing spreadsheets to track all the variables, and how the correlate and covary. Jered is correct though, that being too focused on the “price” can cause us to pass and miss out on deals that might have actually been great for us. Assuming NO natural appreciation (which is ALWAYS my approach and mentality with realty investments) – then Cash Flow is really the key metric. All of the terms, including price, cash down, financing terms and repair costs, as well as the operating expenses, directly affect and impact Cash Flow.
Rob:
I absolutely get what you’re saying. I buy about 60 houses a year. One of our strategies is marketing heavily to free-and-clear properties where we get a lot of seller financed deals. With zero interest and no cost of funds, we are certainly willing to pay more. Tons of room for creativity in real estate.
But, that’s not what most investors here are doing and I worry that most of the readers are newer and will take the above advice dangerously. When holding properties, there are always a lot more options for gaining profits over time.
Exactly Karen. Funny, I just read a new post by Engelo which stated unequivocally, right up front, “make your money when you buy.” LOL. Not making Jered wrong, but your caution is well taken, that it is a universally followed “rule” or principle, and might harm new investors who disregard what it has to offer. Better to PASS on a deal than to make a bad one. That is the difference in mindset we are discussing. Risk management has to come first. Operation improvements are not necessarily any easier to realize or any more assured than natural appreciation.
I guess it is due to my experience level in the game, that I seek out seller-fi opportunities. They seem to coincide with extreme fixer uppers (Old sellers, owned outright, deferred maintenance and lack of funds to do needed capex and repairs). A natural niche for me to focus on. And I LOVE no money down deals and never having to make loan applications or pay fees and appraisals and points…..
Sound advise!. You always set your strategy before going in but playing too close to the margins is always risky business (so yes the numbers matter!) especially if based on uncontrollable factors . Operations focus is great on a buy and hold cash flow standpoint but strategy should not be single pronged for long term unless potential for being in the path of progress is already set.
Interesting comments from everyone so far! New guy here, wanted to throw in an extra few thoughts so I can hopefully learn.
This particular issue is of great concern to me right now. I am trying to find my first deal, and I can’t afford to lose money. So when you make money is a huge question for me! But I also want to play devils advocate to clear up something for my own mind.
One of the many awesome podcasts here on BP that I recently listened to had an investor go through that downturn you mentioned. The guy had bought all his properties at 60% value … and he still lost most of it in the downturn. I don’t know about what deals you find, but if I ever saw something at almost half the value I know it is worth … I would consider that an absolute given. Half price for a cash flowing rental is risk minimization in the highest order! Yet, it still wasn’t enough to protect him from the downturn. And that brings me to one of your next statements.
“it’s a risky way to do business because you’re betting on the future, whether it’s through appreciation or operating your business. Never bet on the future, it’s too big an unknown.”
As a new investor-hopeful, I have been thinking that the entire point of real estate is exactly what you are saying not to do. You invest, take on risk, planning to make money in the future. Putting money down now intending to get a return in the future is ALWAYS betting on the future, is it not? I mean, I’m pretty sure that every investor out there has attempted the due-diligence, and believed that they would see cash returns for their investment through either appreciation or cash flow (operation) after considering purchase price and likely repairs.
What would you say the primary difference is between “betting on the future” and making a wise purchase decision for investments? If you are doing 60 deals a year, I absolutely need a little of your wisdom as I’m trying to get started! 60 a lifetime seems almost impossible, I can’t imagine 60 a year!
Hi Adam:
Great thoughts and questions! And you’re not alone; starting out EVERYONE asks these!
No, I don’t like to bet on the future. In my area, appreciation is very little and I went through the 2008 downturn. No one thought it was coming, even when it was already happening, and no one thought they would be the one to lose out. The market is strong again and investors are confident again and, because history repeats itself, about 80% of them will fail out when the next downturn hits. Best predictor of the future is always the past.
At any rate, I’ve been doing this full time since 2005 so I’ve learned a lot the hard way and I’ve also paid for a lot of excellent coaching. When I say I like to make money the day I close, I mean it. 80% of what we buy we wholesale and, because we have a very strong list of interested investor buyers, about 1/2 of what we buy is sold before we close on our purchase. We choose deals where we can make a lot of money rehabbing and that will resell quickly and those we keep to rehab.
When I find something that needs no rehab and I can buy at 80% or less ARV, if it cashflows, I often add it to our rental portfolio. We just bought a 2 bedroom brick condo that needed nothing for $11,000 (cash). A tenant moved in as soon as we closed on it and she’s paying $600/month. It’s excellent cashflow and ARV is about $50,000, but I still have to maintain the place and it will take a while to gain back the $11,000. Every hold, no matter how valuable, has ongoing costs to own it.
Yes, you can count on appreciation over 20 years for rentals to gain value – but that’s not income for today. You can also add value by adding a bathroom, a bedroom, a garage, etc., but adding value also costs money and is not income for today. Value (equity) is not income. You may look wealthy on paper but not be able to eat because your rentals aren’t providing enough above what they cost.
Best way to learn what to do and how to do it is to hang out with successful investors in your area doing what you want to do. Attend all local investor meetings to learn the language, the vendors, which investors are successful, what to buy and where, etc.
There’s a lot to learn if you want to be truly successful as an investor, but the information is all available and it’s more than worth the time, effort, and cost to learn what you need.
Good luck to you and welcome to real estate investing!
I think his point is not to get locked into some mindset that you will only buy with certain parameters such as I need a 10 cap. You just put yourself in a box and pass up all kinds of deals. All I do is multifamily so can’t speak for houses, and I have found that no one has a clue how to raise rents and what the rents should be which an investor will miss tons of opportunities because they are buying cap rates. We buy properties other people don’t want to buy because the cap rate is 4. However, I do my homework and know that the rents can be raised and that’s where I make my money. Lastly, the other point to the article is you can buy a ten cap and not operate the property correctly and your ten cap is then a 6 cap. Buying low is great if you can make the money on the other end.
I think some good points are made here. I had great luck buying in the 2010 to 2012 time frame. Getting nearly new top shelf CA properties, some at less than 40 percent of their price as newly constructed homes built in the 2006 to 2008 time frame.
However, the last few years have been much harder and the last property I acquired in mid 2016 was at only a 10 to 15 percent discount from market, and that took an immense amount of looking to uncover. I took it for the reasons you indicate, I new I could make a reasonable return on yearly operations (net about 15k a year on a 180k investment) even if I got only very modest appreciation.
It’s certainly not going to make me Buffet money, but it currently Z estimates at about 235 so its actually had some very respectable appreciation that I actually did not anticipate. But even if it had not appreciated I would have kept it for the annual cash flow alone.
Jered,
Thank you for sharing your perspective with us. I fell prey to this mindset myself several years back and did not concentrate on the good management and daily operations. End result I made only a modest profit and sold it later when I should have made it a cash flowing asset. I still tend to look at price and not how soon it can rent or make profit, but I am getting better. I also have 3 units, one I have owned for 3 years that are not fixed up enough to rent yet. I knew I was buying at least 30% or more under market, but did not calculate how long it would take me to fix things up and either resale or rent. I would have saved many thousands if I had thought cash flow first and value second. I have acquired more units for cash flow, and can see the difference. Part of that hindsight euphemism.
Exactly Jerry. Like I said in reply to Karen above. Price, is ALWAYS important, but for long term rentals, other terms and operations are much more important. That said, I have enjoyed some real appreciation rides, as many our age have. One of mine I like to share with fellow investors, I bought for $35K on the courthouse steps, renovated it for $40K more, rented it to the same tenant for 6 years, section 8 at $1,200 a month, then sold it untouched and unlisted, in one day, and settled in 3 days, for $325K ! The good old loose money, no-doc, go-go mortgage scam days that caused the inevitable crash. Would it have mattered much if I paid DOUBLE the price for that one? OR as Jered intimates, what if I passed on buying it because the $75K renovated acquisition cost was just too much based on an analysis scheme? Cash Flow focus keeps us safe and in the money currently and long term, and appreciation can make us look like heros.
The difficulty with much of the advice on BiggerPockets is the vast differences in the types of real estate investors and how that advice may or may not apply to those different segments.
For wholesalers the price you buy at is everything.
For flippers your operations are important but purchase price is still nearly impossible to overcome.
For long term holders price is important only in the sense of how it factors into your cash flow numbers (assuming you know how to accurately assess that market and its numbers and its demographic changes etc. All of this is important, I am certainly not suggesting you can buy at any price, just a price that works even if it is not a price considered way below market).
For long term holders you also have single family investors, 2-4 unit investors, small apartment investors, large multi-family investors, corporate/commercial investors, and any mix of the same. The results of opportunities for forced appreciation, market appreciation, and operational efficiencies and advantages can vary a lot amongst those sub-segments as well.
Those talking about the risk of not focusing on price are usually looking at their exit options and need a means to turn that property over in a shorter time period. Most people who say that (as Engelo just did in his article) are turning dozens or even hundreds of properties a year. For them clearly purchase price is one of the most critical items.
But the longer the holding period the less important purchase price is except for the extent that it affects your ability to carry the property initially and the risk that a turn in the market will make that ability to carry it even worse. But beyond that this article is accurate for a long term investor. The difference in his return over 20 years will not be affected much by getting a property at a 10% cheaper price.
For example, an investor who is so focused on price that he gets all his properties 10 or 20% cheaper than a colleague but ends up with half as many properties early on due to that mindset will come out way behind over 20 years to the person who knows what he can make work and just keeps buying and operating properties and pyramiding his portfolio on the strength of his operations. That person will end up having the strength to build a portfolio that dwarfs the person who will only purchase at the absolute best price on the belief that he is making all his money on the buy. That is really only true for wholesalers and flippers. For long term hold investors, the cash flow and market appreciation over that time will make him worth an order of magnitude more than the person who is too singularly focused on purchase price.
Well said Darin. I would argue with your latter point/paragraph a bit though (because… otherwise what is the point of Blog threads! lol). IF, someone buys a higher number of marginal or at least more risky investments, as you stated, and they lose it ALL due to a reversal of fortunes and economics, etc., then the tortoise will beat the hare for sure. It is a marathon, not a sprint. The longer one is exposed to a market (meaning holding longer term), the more potential risk, and the more potential upside too. We could be made “heroes” by natural inflation (aka, luck) or wiped out by the next financial crisis or recession, etc. BUT, regardless, the only “winners” are those who survive and have a pile of Net worth and net income cash flowing. We all appreciate the potential for using hyper leverage in REI, and the older of us know how that is a double-edged sword. It is not a competitive RACE, but an individual journey for each, and we don’t all have to be a “Grant Cardone” to have succeeded in REI.
Your points about how diversified the whole spectrum of REI investments, investors, and business models is spot on and a good reminder to us all, that we have to filter and consider every piece of advice from our own perspectives and paradigms. Good job Darin!
I agree Rob,
You cannot buy marginal properties just to get more properties and hope to make up for it with operations and appreciation over the years. I tried to state something to that affect in my second paragraph but didn’t restate it in my last paragraph. That paragraph does sound kind of like just pyramiding at any cost to get bigger. That would be a dangerous plan which I would not endorse.
I understand Darin, and was not hacking on you. Good points, all.
This was a very helpful comment to help me get my head around different approaches to investing. Thank you!
Watch this “Monkey Trap” lesson to see what can happen to greedy little piggies, in life and in REI!
https://youtu.be/UTX7Cxq8aGc
Great article, operations is the key to running any business. RI is fairly complex but yet simple. Operate for the lowest possible cash out for the most cash in. The complex part is how much cash out is prudent and what is wasteful. Since I have journey level skills my advantage is doing the correct work at the correct time. So my time is going to make me more money more than someone trying to schedule a contractor and shelling out money that I do not have to. Someone without journey level skills will have to come up with a prudent plan that I do not have to and spend more money. Operation cost continue to rise for someone that does not self manage. I self manage all my rentals, others that do not they have to find a prudent way to operate and pay them. The more people you involve the less transparent your business is. Adding complex issues, travel, lack of building skills, involvement of managers cuts into your bottom line. This also adds complexities and clouds transparency. Complexities cost money, transparency makes you money. Buy low, sell high is the name of the game but how you operate along the way combined with buy low and sell high is the key to success.
John, I like the way you think. I am very similar, 30 years owning a residential remodeling company (Cook Bros.) and still own it though I retired 20 years ago. I am a master plumber, half-assed carpenter and electrician, lawyer, Real Estate Broker and have over 50 rental units ranging from $60K to $1 Million in value, and manage a lot of my own (mainly because there is no manager in the small rural towns in which I own some), and stay very involved personally, with repairs and renovations on them. I LOVE the work, and get a lot of satisfaction from doing it myself, with my wife of 37 years! Put in two basement egress windows this week, cutting 8 inch concrete walls 4 feet below grade, by ourselves! That saved (earned) over $4K right there alone this week alone, had we hired the project out. Hard costs not counting labor were about $1,500 each opening. Labor and markup would have been another $2K each had we paid a pro. And have the plumbing grounds in the slab for a full bath, all done the week before, inspected and poured over, ready to frame! That was another $2K saved (earned) in a few days that week, on the same house. And now the house, which we bought in 2011 for $45K, and have rented for 72 months without a finger lifted on it till now, for $650 a month not including utilities, is a true 4 bed/2 bath home with a huge rec room too, and is already rented for $850 on Dec 1, with 18 month lease. Guess we better get cracking to finish the bath, painting and flooring in the next two weeks. (Lovell, WY location of this one by the way). So I am with you on the DYI modality and business model for buy and hold rentals, it gives us a big edge as you said. (I also bought 9 more units this week which are all rented well and no vacancies or repairs needed at all!). Isn’t’ being “retired” great!
Rob, a man after my own heart. My wife and I of 32 years are the millionaires next door. Best biz partner I could ever ask for plus I sleep with her. Retired and leverages in the millions, what else could a man ever ask for. Keep rocking in the free world!
Cool John!
Well said Jered. 1-4 family investors will have a tougher time agreeing with this concept. Many commercial investors seek under-performing properties and the in-place cap rate (value) is not relevant to how the buyer will operate and position the property. Buying on actuals can equal no buying in this market. You can still be conservative and “over-pay” on actual performance when you can drive the value up shortly after purchase well above what you paid.
Mike, that was a good distinction too. Larger complexes have the cap rate metric which makes driving valuation, based on increasing operating income, and cutting expenses the main motion. Not so much with smaller properties. I think the assumption that rents are more elastic, and can be raised by improvements, or that operating expenses can be significantly reduced thru efficiencies and skills, is one that should be carefully considered. If one “overpays” intentionally, basing that decision on an expectation of being able to increase NOI, she better be “SURE” that can occur, and confident that such improvements are both possible (efficiently) and will have the intended effect. With 1-4 unit properties, that may be akin to betting on inflation (appreciation) to bale you out and confirm your expectations. My largest is a 7-unit apartment building, so I am no expert on the big stuff, where a $50 nuisance rent increase could add $100K to the property value of a big complex, etc. I do focus, more and more, on operation efficiencies though, as Jered suggests. AND I am of the opinion that tenant relations is a HUGE key to improving operations, because turnover is the biggest expense we all have, no matter what size properties! Keep the tenants happy, and they will stay longer. You cannot get more bang for the buck towards improving operating income, than tenant retention – WAY more valuable to reduce turnovers than to increase rents a bit or nibble at operating costs in general.
Thought provoking.. Thanks Jered.
Hi, Jered. I feel I can always get pragmatic and useful information, perspective and knowledge from your article. Thanks.
Great blog post! You always want to get the best deal you can, but sometimes it can be worth it to pay up and create value over the term of ownership & at sale.
“You make your money when you buy” provides good guidance to aim for, but don’t let it deter you from profitable opportunities.
Thanks Jered. Great information as always.
My firm was recently about to walk away from a deal because of a low “going-in” cap rate. But that was based on the last year’s financials, which were based in part on several operational inefficiencies that can be quickly corrected. We took a second look and realized that this deal made a lot of sense, and that we will be able to operate it profitably.
I do, however, agree with the comment that we need to focus on cash flow and make sure that works even in a no-appreciation world. It’s happened before, and most all of us remember it. It could happen again.
Great Post, No Great! Post,
I completely agreed with you!!
I enjoyed reading this and the self reflection. I think the issue arises when there isn’t a clear red light / green light line. I say YES to these days (= rate of return, cap rate, values, etc). If we don’t have these metrics in our buying criteria it’s very difficult to understand (or train on) what we will buy.
For my team, we will buy 150-160 houses this year … and scaling to that level has required us to adjust some of our metrics. BUT, we have been clear on them. Discussed them with my partner and I. Checked them as we bought them, and reviewed them as we sold them or help them.
Know your numbers and make decisions based on facts and data … and be prepared to say YES when its a yes, and NO … when its a no.
Great post and a lot of great discussion. I have been pondering this idea myself over the past 12 months. I see deals go for more than my maximum and wonder what the buyer is thinking or evaluating. It is true that at today’s rates (both rents and interest), I could be buying higher and still cash flow well. You add a few interest rate points to financing or rent stagnation, the could turn quickly.
Definitely thought provoking. Thanks for sharing.
I definitely agree that the quality of your operations are hugely important and overlooked. Great rehab/management can make up for a mediocre deal, but it’s not ideal. I still like the phrase “you make your money when you buy” but I think it needs the accompanying phrase that “you won’t realize that money without good operations.”
Totally agree but you have to balance between the two criterias. Good ? post though.
I think his point is not to get locked into some mindset that you will only buy with certain parameters such as I need a 10 cap. You just put yourself in a box and pass up all kinds of deals. All I do is multifamily so can’t speak for houses, and I have found that no one has a clue how to raise rents and what the rents should be which an investor will miss tons of opportunities because they are buying cap rates. We buy properties other people don’t want to buy because the cap rate is 4. However, I do my homework and know that the rents can be raised and that’s where I make my money. Lastly, the other point to the article is you can buy a ten cap and not operate the property correctly and your ten cap is then a 6 cap. Buying low is great if you can make the money on the other end.
For me, making money when I buy I buying right, but also with a look at the long term. I do not focus on discounts or getting something under market. That’s a myopic strategy and doesn’t mean a thing