Real Estate Investor · Austin, TX · Member since 2015 · 214 posts · 234 votes
I'm haunted by Ben L.'s comment "Don't be a retail investor!" in the podcast on rental properties. This is also common advice in real estate investment books. Always buy at a discount, or, as Warren Buffett says, with a margin of safety.
I've been evaluating some turnkey opportunities and am close to pulling the trigger on one, but Ben's admonition is in the back of my mind, watering the seeds of doubt.
Is it really that big of a sin to pay the asking price if the cash flow makes sense? I am also trying to buy in an area that I believe will appreciate over the next few years.
It's hard for me to conceive of how I can "buy below market" value in this market. If a property is below "market value", why is it even available at that price? Common sense dictates that those kinds of opportunities are ephemeral and elusive by their very nature.
This probably works with properties that need some kind of repair, or where there is value to be unlocked by some kind of zoning change, etc... I don't see how this applies to what I'm doing.
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
10y
@Russell Brazil and @Jacob Sampson both hit on an important point which is what defines market/retail. This is where @Nate R. has asked a flawed question in my opinion. There is a difference between asking price and market / retail price. It is common for a property to be priced above or below the going market price. The true market value is the average cost that properties in similar condition, specification and location have recently sold for. That doesn't mean asking price. You can ask anything you want, it is selling price that matters. It can also be hard to determine market price because no two properties are identical.
I have a strange situation right now where for the first time I have a property under contract and I am paying $1000 over asking price. It was the first day on the market with a multiple bid situation (not a foreclosure). Even at $1000 over asking, I believe I am paying under market value. I estimate around $5000 worth of rehab and it will be comparable to properties that have recently sold in the area for over $160K. That gives me $19K of instant equity. That is why my offer is under market value.
We all want to get a good deal, so people believe if they can get someone down from asking price that we have gotten a good deal. That thinking can be flawed because it assumes the original price was fair to begin with.
Another problem can be buying a distressed property below market and not taking into account the true cost to bring it up to market value. For example, if a house needs a furnace, roof, carpet and paint, that could be $15-20K worth of updates. You may buy a house at a $15K discount to market, but over the next 5 years you may need to put $20K worth of work into it. I would argue that you may not have gotten a good deal.
The final thing to consider is hidden value. In present condition you may pay retail for the property, but there could be opportunities to increase value. For example, I purchased a three bedroom house and added a bedroom in the basement to make it four bedroom. I increased the value and rental income. It could also be something as simple as raising rents to market value. It could be an area this depressed today, but you know future development will increase property values.
The point is that buying under market value doesn't mean under asking price. There are many ways to increase value.
I believe the idea of buying below market is a misnomer. If a property is distressed, and sells at a discount to the properties around it...it is not bought below market value. It is purchased for it's market value. Two people agreeing on a price is a market. All of the things that create that cheaper price affect the market value of a property.
Exactly! You are never buying "below market" What you are doing is buying at market, putting in some time/energy/effort and raising the value to a different market value. I would argue that if you have to go to a property and swing a hammer thats not really "investing" anyway. Its a business where you create value by labor.
I believe the idea of buying below market is a misnomer. If a property is distressed, and sells at a discount to the properties around it...it is not bought below market value. It is purchased for it's market value. Two people agreeing on a price is a market. All of the things that create that cheaper price affect the market value of a property.
Well said! This is exactly what I was thinking, and when I hear statements like "buy below market" it creates a lot of cognitive dissonance for me.
Good discussion here ... My take is that there are multiple markets, based on which pool of buyers is involved. A distressed property, that does not qualify for conventional financing for example, is likely selling at a wholesale price, which is market value for the investor market. The investor that buys it wholesale then repairs the things that make the property distressed (at wholesale material and contractor prices) and sells or rents it retail price, again at market value but for a different market of retail buyers or renters. Different markets, different prices, but all at market value.
To further stir the pot, nobody has mentioned intrinsic value vs. market value. In a perfectly efficient market, they are the same, but is the RE market always efficient? On a related topic, Warren Buffet seeks to acquire stocks and businesses under their intrinsic value, and that is what creates his margin of safety ... market price is rarely mentioned.
Real Estate Investor · Desoto, TX · Member since 2013 · 560 posts · 528 votes
10y
If the financing terms are right, the property is right, and the cash flow is still right, you can pay full value and more. I would go even further and say if the financing terms are right, the property is right, and there is no cash flow, you can still pay full value and come out a winner.
There is no misnomer in my world. I buy properties off-market and at the courthouse steps. I don't do anything to them, and I can make a net 12%-20% net profit if I put them on the market the next day. If I didn't buy them below FMV, then what was it by your definition?
To me, the biggest advantage to buying below FMV is scalability. If you have $50k to work with, you have no money left after you bought two properties at $100k with 25% down each. How long does it take you to save $50k to buy two more properties?
If you are able to buy those $100k properties for $75k consistently, you should be able to do a cash-out refinance after 6 months, have your equity back, and put it into two more properties. Rinse and repeat. If you can do 4 deals/year using the same $50k, your net worth has increased by $100k/year. How many people do you know that can increase their net worth by $100k/year?
People will never truly understand something until it happens to them. It always seems impossible until it's done. It's hard to describe the experience to others. You will have to experience it yourself to believe it.
I'm haunted by Ben L.'s comment "Don't be a retail investor!" in the podcast on rental properties. This is also common advice in real estate investment books. Always buy at a discount, or, as Warren Buffett says, with a margin of safety.
I've been evaluating some turnkey opportunities and am close to pulling the trigger on one, but Ben's admonition is in the back of my mind, watering the seeds of doubt.
Is it really that big of a sin to pay the asking price if the cash flow makes sense? I am also trying to buy in an area that I believe will appreciate over the next few years.
It's hard for me to conceive of how I can "buy below market" value in this market. If a property is below "market value", why is it even available at that price? Common sense dictates that those kinds of opportunities are ephemeral and elusive by their very nature.
This probably works with properties that need some kind of repair, or where there is value to be unlocked by some kind of zoning change, etc... I don't see how this applies to what I'm doing.
Don't get me wrong when I say real estate is nothing but numbers. I don't care if property is full price , have price , when I'm buying. To me this business is real more math then any thing. Secondly knowing the numbers , in the areas I am looking.
When you start talking changing zoning and things of that nature. There are a lot more variables that come into play.
If you are buying turnkey, and the Numbers make sense. Go for it , don't let doubt hold you back. At the same time be very analytical of your numbers.
There is no misnomer in my world. I buy properties off-market and at the courthouse steps. I don't do anything to them, and I can make a net 12%-20% net profit if I put them on the market the next day. If I didn't buy them below FMV, then what was it by your definition?
I'd be interested in learning how this works. Seems like an active strategy suited for someone with a lot of capital and time.
You didn't talk about this risks either. Surely there are risks.
Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes
10y
I agree with @Account Closed
When my company buys at the courthouse, 98% of the otherwise qualified retail buyers are eliminated because they don't have cash (or quick access to cash) for the full bid amount, let alone the 5% cash on the spot. Of the 2% remaining qualified retail buyers, 90% will balk at not being allowed into the house and having no idea what the property condition is. Courthouse purchases are distress sales. It is not a 'market sale' involving ready, willing, and able buyers and sellers involved in a transaction at a mutually agreeable price without undue influence or duress.
This concept of 'just buy at retail' reminds me of the logic in 2005-7. 'Get in before you get left behind' mentality. If down the road a few years you, for whatever reason, need to sell... just realize you may be needing to bring money to closing. Lots of money if the market changes to a buyer's market.
Lender · Raleigh, NC · Member since 2012 · 955 posts · 639 votes
10y
I love the different perspectives on this post. Here are a few other thoughts:
1. The market determines the price. If it's selling for a "discount", there's a reason for that. Keep that in mind.
2. Different investors have different goals, which impacts the valuation of properties--yours may be different than mine.
3. Different investors have different cost structures.
4. Value of time. How much time are you spending in the search process to find the "deal" that's discounted? If it takes you 6 months to find a deal that saves you $2500, maybe you should have just paid the extra $2500, earned that back, learned lessons earlier if you are a newbee...
5. Consider the risk factor. The risk factor for most of the SFR/Duplex rental properties considered isn't that much for the majority of people. When we buy a $100K house, we aren't risking losing $100K if things don't work out.
So, in general, I would recommend pulling the trigger if you are having trouble finding inventory and the cash flow numbers work despite not having immediate equity. HOWEVER, your cash flow numbers need to be ACTUAL. Where you'll run into trouble is if you don't protect yourself by purchasing at a "discount", AND your cash flow pro forma goes out the window....now you could look at a negative cash flow AND upside down on the equity. That's no fun.
Know who you are. I know I'm not a very good landlord in terms of running a really tight operations -- so I need to buy deep. If you are a very good landlord-operator, then you don't need to buy as deep as I do.
When my company buys at the courthouse, 98% of the otherwise qualified retail buyers are eliminated because they don't have cash (or quick access to cash) for the full bid amount, let alone the 5% cash on the spot. Of the 2% remaining qualified retail buyers, 90% will balk at not being allowed into the house and having no idea what the property condition is. Courthouse purchases are distress sales. It is not a 'market sale' involving ready, willing, and able buyers and sellers involved in a transaction at a mutually agreeable price without undue influence or duress.
This concept of 'just buy at retail' reminds me of the logic in 2005-7. 'Get in before you get left behind' mentality. If down the road a few years you, for whatever reason, need to sell... just realize you may be needing to bring money to closing. Lots of money if the market changes to a buyer's market.
See this here is the only reason i see buying at a discount. So you have an exit strategy if you need to dump and you can make your money. Which i think this is a great strategy but i also feel this is why most investors only do 1 or 2 deals a year. They make a good buy rehab rent do it again. If you buy retail you basically have to keep buying
Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes
10y
@Nate R. let me play devil's advocate a bit. First it is always better to get property for below market price if you can. If you can buy a $100K house for $50K of course do it. If you can buy it for it $99K most folks here would say do not do it. The problem is that their situation is not necessarily your situation. I do not make anywhere near the money in real estate that most of the posters make. When I moved to this town I had very little money to my name. What I needed was the ability to buy houses without a lot of money down. I bought my first house with less than $3,000 down from a bank who financed the balance for me. My next house was bought with about $1,200 down by me and a partner. I have in the last 5 or 6 years purchased properties at market value, but with no money down because the seller financed the 20% down with a second mortgage at 2% interest for 5 years. At the end of 5 years I can refinance and pay off the 20% the seller carried for me.
When you have a business you have to have a set of parameters that tells you when a property will be able to meet your business needs. If you make candy and you decide you will only buy sugar at 30% below market rate you might only make candy 2 times a year. If your model allows you to make money by buying sugar at market rates you can sell candy all year. If you find a deal on sugar and buy it for 30% below market great, then can make even more money from selling candy. To think you can enter this business and emulate the tactics of guys with 20 years experience and $300K sitting in the bank and bankers who will loan them a million is nuts.
Ben L. is truly a very smart guy. He will tell you there is only one way to play a violin, start at age 3 keep practicing. The truth is if you are 30 years old and want to play the violin you can learn, but it will never be to Ben's standards. The same is true for investing in rental houses. Ben's model will work for 1 in a million investors, it is the elite high math intrinsic rate of return method. If you can do that great, but you won't be working a full time job while doing that kind of investing. Ben's model is for large scale apartment buildings that you can increase value on by increasing profits and selling on cap rates for the increased income. You must find a model where a purchase price will yield a certain amount of rent back, that will enable you make money for your needs. It needs safety factors like location, condition, and rental demand, but if you add 30% below market value you may only buy 2 of them in the next 10 years.
In my area I cannot make $200 per door per month on houses I purchase. If I waited for those deals I would not own any real estate period. For me, I use 15 year loans not 30 year loans so I am even more restricted on cash flow. My model requires that the property must be able to be rented for at least 10% below market rates and still pay the mortgage, taxes, insurance, and about 8% for vacancy and 15% for repairs and cap ex. If I can buy a property like this with no or little money out of my pocket I try to buy it. It still must have a decent location and reasonable condition of course, but in a town of 3,000 people there is not a lot of opportunities. I try to value add when I can. I paint and clean, and replace furnaces and floors when I can, but that is like a 2nd job for me. I can only compete with the guys who have $500K in their bank account because I manage myself and do some maintenance myself. Ben L. might make a fortune in my town, or he might be selling hot dogs on the corner for lack of serious value adds. You have to make your model apply to your needs and your situation. I have at least 2 houses that would not meet 90% of the criteria listed here on BP. I bought each one for full market price, and had the owner carry the 20% down payment with a second mortgage. I negative cash flowed on these things to the tune of $100 and $140$ per month respectively. They are easily my 2 nicest rentals, and will rent in less than a week if they become vacant. One I only owe $40K on now and I could refinance it and easily make $200 per month in net income. The only way I was able to buy it was by losing $100 per month, and making that money up out of my own pocket. So for $18K total, I have a $100K house that rents for $750 per month after managing it for 15 years. That model has danger. You could lose your job, you could have a $7K sewer line repair, etc. However it fit my model since I don't need the rental income to live off of, and I could handle a large cash outlay if needed. I do have rentals in a different corporation that make money. I add money to it every year to keep fixing properties up or add new properties. Most of those properties were value add in some way so I could at least break even on my formula listed above on a 15 year loan. Find a model that fits your particular situation. I have the 2 negative cash flow houses, but they are B+ properties that will be great retirement income with the least work of any of my houses. I will sale a lot of my rentals before I part with them. I have apartments that I will not be keeping when I retire. They are a lot of money but a lot of work.
Find what your needs and goals are. Set a parameter on things like location, condition, cost of mortgage versus rental income and use that to get your first house or 2. If you get them cheaper great, if not you will still be OK. Keep some money back to be able to buy that great deal if you find one. I have bought acceptable deals then missed out a great deal due to lack of funds. The important thing is to get started with a formula that will work for you. Good luck. Sorry this was so long.
Investor · Boston, MA · Member since 2016 · 245 posts · 436 votes
10y
To echo what @Russell Brazil said in an earlier post, if the numbers make sense and you plan on holding the property for an extended period of time than why worry? The point of buying a rental property is to receive cash flow and to provide an acceptable return on your cash. If you find through your analysis that at 'retail price' you would receive an acceptable return, then it seems like you have found a good deal. Although it is true that buying under market provides a safety net should something go wrong, that fact alone shouldn't stop you from making deals that make financial sense.
Granted, everyone's approach is different and dependent on their market. In markets where there is no potential for appreciation, I can fully understand the need to buy under market value. However in my market, multi unit properties simply don't sell for under $150-200k. I am currently under contract for a triplex that I am paying $199k for. I would say market value is around $210k, so I am paying close to retail (just ~5% under). However, the property cash flows nicely and meets my investing criteria. If it makes sense for what your goals are, then why pass?
Here's the thing, there are a million adages in this business and a million "rules." Everyone has a strategy and a plan that works for them. But all real estate is local and something that works in one area might not work in others. Be wary of people using terms like "always" and "never" when describing their strategies. This usually indicates something tailored to local conditions.
Don't buy retail is another way of saying make your money going in. It's a great idea if you can do it.
Real estate makes money in 3 ways and 3 ways only. Cash flow, appreciation and mortgage pay down. You have to come up with a plan for your area that uses one or more of those factors to make money. In Phoenix, in 2005 you could pay above retail and make good money on appreciation alone. People with rules like "never pay retail" had to sit out the party. Lots of people made a ton of money on that party, and yes, when the music stopped there were some who couldn't find a chair. Risk is real.
Remember how real estate makes money and come up with a plan that will work for your area.
One last adage that I like regarding risk. Always think about risk and make managing it part of your plan because as Mike Tyson said, "Everyone has a plan until they get punched in the mouth."
There is no misnomer in my world. I buy properties off-market and at the courthouse steps. I don't do anything to them, and I can make a net 12%-20% net profit if I put them on the market the next day. If I didn't buy them below FMV, then what was it by your definition?
I'd be interested in learning how this works. Seems like an active strategy suited for someone with a lot of capital and time.
You didn't talk about this risks either. Surely there are risks.
Nate,
It's a very in-depth subject that I can't explain how it works in a few pages. There are quite a few of us on BP doing this including Chris Martin. Active strategy or not is just an excuse IMO. As Warren Buffett said "It's human nature to put obstacles in front of us." I hope you realize that we can either be our worst enemy or our best ally. Fortunately, we get to choose which.
When people tell me they are busy, I tell them it's just an excuse for laziness. I know we will do it for the right cause. What is our WHY? Here is a perfect example. My partner used this strategy while he was holding down a full-time job making $160k/year. He was making anywhere between $150k - $220k/year flipping real estate. Did I mention he had to commute one hour each way to work and home without traffic? That means leaving the house at 4:30am in the morning and coming home after 8pm. It's a short-term sacrifice for long-term gain.
Capital....does it have to be yours? If you want more capital without borrowing, consider taking a second or third job. Everything in life comes at a price. How bad do you want the life you deserve? Are you willing to pay for it?
Risks.........To me, investing is about probability. Knowing your history and your market takes a lot of risks out of the equation. Going out of state puts you at a disadvantage as you don't know the market as well as the local investors. Let me leave you with this "The grass is likely not greener on the other side." I can ALMOST guarantee it. :>)