“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.
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.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.