Business Focus With Constrained Resources
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
Business Focus With Constrained Resources
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Real Estate Investor · Alpharetta, GA · Member since 2010 · 415 posts · 484 votes
15yI think, "to each his own." Let the flippers flip, let the buy-and-holders buy and hold. Everyone has different goals, risk tolerances, time commitments, credit, access to capital, etc.
I think you can run those strategies in parallel, too. Sometime a great flip would make a lousy rental because the cap rate is just too low. If I buy a house for $140,000, put $20,000 into it, then sell it for $215,000, I might clear $30,000 pre-tax when all is said and done. That same house, however, might only rent for $1,200 a month, which is terrible.
I agree with Bryan, too, that flipping and renting is apples and oranges. Sure, in absolute dollars, the calculated ROI on a flip might be magnitudes higher than the current ROI on a rental. BUT, that is not at all taking into account the huge time commitment to a well managed flip. If you assign any sort of value to the time it takes to locate, negotiate, close on, renovate, market, and sell a flip, the numbers get a whole lot different.
I know in some cases flippers flip because they have no choice. They need chunks of cash to survive; a $100 or $200 cash flow each month isn't going to do them any good, even assuming that they had access to long term credit, which many of them probably do not.
I did a series of flips a few years back, and at the time I thought it was the greatest thing in the world. My very first deal, I net $25,000 plus at settlement, and I didn't put one cent of equity into the deal.
Thing is, it became harder and harder for me to find deals with that much fat in them, and when I started assigning a dollar value to my time (and paying the IRS their cut), I realized that the money wasn't as good as it looked.
Now I see the value in long term holds, and that is my new goal. However, if I encounter a potential flip that is too good to pass up, I'll do it...
30 Replies
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
I am the one who advocated the focused strategy, so here's my reasoning:
In RE, as in any other investing, you can either be a professional or you can be a hobbyist / part-timer doing some deals on the side. For example, you may be a doctor who has some extra cash and decide to use it to buy a property and rent it out. My advice is not meant for such people because those are not economic optimizers.
For the rest of us on BP who want to be hugely successful, I would recommend that you do not get distracted into doing multiple strategies. Instead, you need to evaluate your options based on your interest and ability. Once you evaluate your options, you will find that there is one strategy that is optimally suited to you and provides you with the best returns given your skills and resources. At that point, I recommend that you focus on that one strategy and execute it as well as you can and scale it up into something sizeable.
I also believe that strategic flexibility is important. A strategy that works today may not work in ten years. You will need to adapt to changing marketing conditions over time. But strategic flexibility is not the same as strategic confusion, which is what was advocated by most people in the other thread. I think strategic confusion is a suboptimal strategy both in the short run and in the long run.
- Mobile Home Investor · Spanaway, WA · Member since 2008 · 1k+ posts · 578 votes15y
I would agree with the flexible focus. We started with single family - moved on to apartments and then into mobile home parks. While with SFR - we were 100% for this. While with apartments we were 100% for apartments. Now we are 100% into the MHPs. Tomorrow we may shift gears and be 100% for something else. Times change and you as an investor have to change with the times.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes15y
I don't understand how performing fix and flips to yield buckets of cash that will fund buy-and-holds is "strategic confusion." Would someone that is working and trading their time for dollars and also developing an investment niche where they are investing "optimally" also be strategic confusion Vikram?
How would one execute a buy-and-hold strategic advantage absent the liquid resources to fund operations without some other form of activity that generates liquidity? This is puzzling to me.
I understand where you are coming from about wanting a competitive advantage. In an ideal world with little impediment to growth because of loads of liquidity I can understand your reasoning. However, funding ongoing operations for buy-and-hold purchases is drastically expensive and just doesn't happen without some source of liquidity to fund portfolio growth. Not everyone has the same resources to compete and very few people have the resources early in their investing careers to fund all of the growth they want.
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Bryan, you will see my point within your answer. You have mentioned in your example that fix and flips generate buckets of cash - meaning high ROIs and a short holding period, I assume. I have read similar posts on BP in the past, where people want to generate cash from flips and then invest it in buy-and-hold assets. And I have always wondered at their thinking because it is really quite suboptimal.
Let us take some numbers to make this easier to understand. Suppose your fix and flips generate you 80% annualized ROI after taxes. And suppose your buy-and-holds generate 30% annualized ROIs. Why on earth would you put the cash generated by your fix and flips into a buy-and-hold instead of putting it back into more fix and flips? You would have double the money from the fix and flips within 4-5 years compared to doing the half-and-half approach. You will probably also be a better flipper if you focus exclusively on that because you will not let your decisions be clouded with alternative exits.
BTW, I am not advocating that everyone be a flipper. I am just suggesting that everyone should figure out what strategy works best for them and execute that strategy well instead of trying to do a bit of this and a bit of that. The latter approach, in my opinion, is amateurish and suboptimal. You will be hard-pressed to find many great investors who have taken such an approach with much success, whereas you will find that the vast majority of great wealth has been accumulated by people who have focused on and excelled at one thing.
- Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes15y
The problem with focusing on a single strategy that is not passive (like flipping) is that one day in the future, you're going to want to retire, and unfortunately, all your money will be sitting in a bank account.
What do you do then?
I assume the answer is, "Invest in something passive."
But, why is it okay to invest in something passive the day you retire and not sooner? Even if it means two different investing strategies simultaneously?
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes15y
Originally posted by Vikram C.:
Why on earth would you put the cash generated by your fix and flips into a buy-and-hold instead of putting it back into more fix and flips?1. Because you are comparing apples and oranges. The risk-adjusted returns for buy-and-holds are on par with fix-and-flips and many other (hard money, developing, etc.) RE activities. These projects also carry high time components absent the ability to hire staff. Not everyone has the capital base to support such an operation
2. Because fix-and-flip projects will almost always carry a larger time component than managing managers for rentals
3. Because paper losses are quite lucrative at the top-end tax brackets many investors ascend to in short order
4. Because it is good to diversify cash flow streams because systemic risk is uncontrollable
5. Because the end game for rentals provides consistent cash flow with virtually zero effort. ROE optimization is not the end-goal for all. Sufficient absolute cash flow with minimal effort is
...I am sure I can think of others, but those come to mind immediately.
Originally posted by Vikram C.:
You will be hard-pressed to find many great investors who have taken such an approach with much success, whereas you will find that the vast majority of great wealth has been accumulated by people who have focused on and excelled at one thing.You will also be hard-pressed to find very many GREAT investors. Concentration of wealth in high beta projects magnifies returns, but it also magnifies the dispersion of outcomes. For every Buffett there are millions of people who aren't the best at what they do.
Vikram...You have mentioned previously that you consider it prudent to carry sizable equity positions in your projects. Presumably this is to provide a shock absorber for bad bets, things that are uncontrollable, risk, etc. How do you reconcile this philosophy with the desire to place your bets singularly in one type of enterprise? If you are the best you are the best and there is no need to be conservative...right? Wouldn't an optimal ROE result from minimizing equity and managing the projects optimally?
I know you are a great investor, but this seems contradictory to me. Am I missing something? I am anxious to get your perspective on this because maybe it will add to my perspective on investing in general. To me you can't have it both ways. You are either the best and should maximize ROE by minimizing equity invested OR you hedge and diversify project types. How can this dichotomy be reconciled?
- Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes15y
Originally posted by Vikram C.:
And suppose your buy-and-holds generate 30% annualized ROIs. Why on earth would you put the cash generated by your fix and flips into a buy-and-hold instead of putting it back into more fix and flips?After reading this, the first thing that came to mind was:
Microsoft Windows pulls in about $13B in profit per year with margins of about 80%...
Given that, why does Microsoft take 75% of that $13B and put it back into the 40,000 employees, hundreds of products and half-dozen business units not focused on Microsoft Windows?
By your reasoning, Microsoft is being ridiculous by focusing on businesses unrelated to their Windows cash cow -- video games, set-top boxes, phones, teleportation research (yes, they have a couple guys focused on it), etc are all suboptimal investments.
Who at Microsoft didn't get the message? :wink:
- Real Estate Investor · Dania Beach, FL · Member since 2010 · 74 posts · 41 votes15y
Being that I am just starting out in RE investing, and having read many, many posts here, I thought I would give my .02.
J Scott - I think you made an excellent reference to Microsoft. If I can add, Microsoft started with one product, perfected it and then branched out, very successfully.
My own experience previously, deals with futures trading. I started out concentrating in one area of trading. When I became successful in that area, I moved on to other areas. And I stayed in the game for many years.
With RE, I am starting out concentrating on one aspect. I will give it everything I can, and then will branch out to other areas. I think diversification is necessary to fully achieve success in any endeavor.
I don't believe that you should put your resources into many different objectives when starting out. Start with one objective, perfect it, then diversify.
Just my thoughts.
- Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes15y
Originally posted by Kenneth Smith:
J Scott - I think you made an excellent reference to Microsoft. If I can add, Microsoft started with one product, perfected it and then branched out, very successfully.Exactly...amateur investors should focus...as you gain more experience, you start to look for the best investments, not necessarily the same investments...
The difference between good and great entrepreneurs is that great entrepreneurs can recognize a great deal, even if it doesn't fit their "niche"...
- Rehabber / Flipper · Simi Valley, CA · Member since 2010 · 597 posts · 259 votes15y
Vikram, I'm relatively new to investing, so I'm curious as to why you would say this: "Why on earth would you put the cash generated by your fix and flips into a buy-and-hold instead of putting it back into more fix and flips?" As soon as I read your question, I thought, "because I wouldn't want to be a full-time active investor for the rest of my life." Did you mean something else by this question?
- Tokyo · Member since 2011 · 6 posts · 6 votes15y
Think of it as there are two phases:
a) build wealth
b) enjoy wealthThe idea with phase 1 is to build your asset base quickly using a method you understand, are good at, and can leverage effectively, and then when you are ready for phase 2 you make a decision whether you want the income to be more hands-off and adjust your asset allocation accordingly.
What Vikram is saying is that during the first phase, if renovating is your strength then focus on that is you'll get to phase 2 quicker and with less risk of a major set-back.
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by Bryan Hancock:
Wouldn't an optimal ROE result from minimizing equity and managing the projects optimally?Bryan, whenever I refer to ROIs, I have meant risk-adjusted ROIs. I would never try to maximize pure ROI without factoring in the riskiness of the activity. Thanks for asking the question so that I am able to clarify this in case any newbie reads my posts and follows my advice. I am a very conservative investor by nature and am quite careful about the types of risks I take and generally do not like bankruptcy risk very much. :)
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by J Scott:
By your reasoning, Microsoft is being ridiculous by focusing on businesses unrelated to their Windows cash cowThat's not what I am saying at all. Windows does not present good reinvestment opportunities because of the huge amount of cash it generates and therefore the profit-maximizing decision has to be to deploy it in other profitable ventures or return the money to shareholders.
The subject of this thread is quite the opposite. It has to do with decision-making with constrained resources. How do you deploy capital with limited resources? The answer is that you should deploy it in the activity that gives you the best returns.
- Real Estate Broker · Boston, MA · Member since 2011 · 28 posts · 1 vote15y
I think every one is speaking about the same topic but different subjects. Vikram's makes a very good point about capital optimization by focusing on one area of what ever endeavor your company is trying to pursue. Bryan and Jason make very good points about the importance of diversifying ones portfolio with other investments within that field. All are good points but just refer to different segments along a business life time line.
At first Vikrams method of capital optimization by concentrating on what you do best is an excellent way to master a field and make lots of money doing it. But, later down the road it is imperative that one begins to diversify and get a better footing in their market.
For example Google: as they grew they began to by other money generating firms like You Tube, DoubleClick and most recently EBook. I doubt that they set out to be in the video sharing and digital book reading business back in 1998 when they first started.Kraft Foods started as a bundle of Ice cream makers. Now they own like half of all foods brands and sold in every super market world wide... ice cream --- super food Giant. Its the only right way of progression.
Young guys like me can’t start investing for our retirement till we first build our financial capital. And yes, the end game is rental commercial and residential property….. (newbie RE investors .o2)
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by Mike G.:
As soon as I read your question, I thought, "because I wouldn't want to be a full-time active investor for the rest of my life."Mike, this is a good point and one I would like to address. I regard the goal of a business as value-maximization. If I owned stock in a company and management was not focused on maximizing shareholder value, I would want to see them fired. Similarly, in my business, I focus exclusively on value-maximization. Otherwise, I should fire myself and replace me with someone who can get the job done. My advice is based on this perspective - thinking of the RE investor's business as a real business with the goals that one would have for it if it were a professionally managed one. If you have other personal goals, then by all means go for it - I cannot really advice someone on what they should do to personally satisfy them. However, I can say that a professionally managed flipping business can be less hands on than a poorly managed buy-and-hold business. The nature of a business and the degree of management it needs are not really related once you scale the business to a meaningful size.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes15y
So how does one acquire the capital necessary for building a buy-and-hold business without engaging in activity to shore up their liquidity Vikram? Are you suggesting that someone can procure capital to invest in building a portfolio in this credit-constrained environment absent more "active" activity?
Are you also suggesting that a complete concentration of funds in one line of business jives with the idea to have sufficient equity in each project to account for bumps in the road? Are these philosophies mutually exclusive? They appear to be at odds with each other to me.
- Real Estate Investor · Gilbert, AZ · Member since 2009 · 21 posts · 2 votes15y
I am new to RE investing but not to business. I think that everyone has a business model and is entitled to run their business how they want.
For instance, I have limited resources now so wholesaling, flipping, etc. would work great for me to raise some capital.
I plan on using a laser like focus when I settle on a strategy. But as it was said earlier, strategies run their course and we move on to bigger and better things that make us bigger and better checks.
- Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes15y
It seems to me that part of the issue is how "being in business" is defined and what the goals of a business should be.
Value optimization is a worthy goal for any business, but not the only concern of business IMO. There are other areas to address as well. Customer service level, quality of product to be delivered, Position in the market, etc.
Perhaps, you could say that my buy and hold business is a hobby, I certainly invest less time in it than I do my CPA practice. Using a buy and hold strategy though requires cash build up from some source in order to invest in cash flow. While flipping is not a focus area of mine it makes sense to employ this as a way to generate cash to further expand my buy and hold portfolio. In time I will get to the point the cash flow from these properties will be enough to further expand my portfolio.
It seems to me that what I'm hearing is that a buy and hold strategy is not really a business unless one starts with a boat load of cash or has cash partners to exclusively buy properties.
The type of busines
- Real Estate Investor · Alpharetta, GA · Member since 2010 · 415 posts · 484 votes15y
I think, "to each his own." Let the flippers flip, let the buy-and-holders buy and hold. Everyone has different goals, risk tolerances, time commitments, credit, access to capital, etc.
I think you can run those strategies in parallel, too. Sometime a great flip would make a lousy rental because the cap rate is just too low. If I buy a house for $140,000, put $20,000 into it, then sell it for $215,000, I might clear $30,000 pre-tax when all is said and done. That same house, however, might only rent for $1,200 a month, which is terrible.
I agree with Bryan, too, that flipping and renting is apples and oranges. Sure, in absolute dollars, the calculated ROI on a flip might be magnitudes higher than the current ROI on a rental. BUT, that is not at all taking into account the huge time commitment to a well managed flip. If you assign any sort of value to the time it takes to locate, negotiate, close on, renovate, market, and sell a flip, the numbers get a whole lot different.
I know in some cases flippers flip because they have no choice. They need chunks of cash to survive; a $100 or $200 cash flow each month isn't going to do them any good, even assuming that they had access to long term credit, which many of them probably do not.
I did a series of flips a few years back, and at the time I thought it was the greatest thing in the world. My very first deal, I net $25,000 plus at settlement, and I didn't put one cent of equity into the deal.
Thing is, it became harder and harder for me to find deals with that much fat in them, and when I started assigning a dollar value to my time (and paying the IRS their cut), I realized that the money wasn't as good as it looked.
Now I see the value in long term holds, and that is my new goal. However, if I encounter a potential flip that is too good to pass up, I'll do it...
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes15y
Yes an example would be if I bought a 10 unit apartment building for say 100,000 cash.
Each unit I can get 550 a month for.
So 10 x 550 = 5,500 x 12 = 66,000
66,000 divided by 2 = 33,000 NOI per year or 2,750 a month if all goes perfect.Keep reserves in and pay myself say 2k a month and that 100,000 investment is not enough to survive on.
When you analyze many deals that will include debt service as well it's easy to get in the hole real quick.
So I have to ask myself how can I put this 100k to work in a year to grow it as fast as possible?? Then when I have 2,3,4 times that amount I will look at the other types of deals.
When you are starting out you can't sink your total net worth into 1 or 2 deals long term .Now if you work another profession with other income real estate is a side job where you keep buying long term holds etc.
So some people have 500,000,1,000,000 already that they made in stocks or another profession.What they usually don't have is time to manage flips etc. and want a more turnkey investment.
I have clients that are very wealthy and they are selling because they are at the end of their life and want to retire or they just want a credit rated product that will keep up with yearly inflation.
In the beginning you take more risk to build wealth and later on minimize it to preserve it.
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by Bryan Hancock:
So how does one acquire the capital necessary for building a buy-and-hold business without engaging in activity to shore up their liquidity Vikram?Both flipping and buy-and-holds require capital, Bryan. Do whichever one you can create more wealth in, and focus on that activity.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes15y
Yeah...but they require different types of capital. It is easy to procure fix-and-flip capital. It is much harder to procure long-term capital absent the equity of your own required. It can be done, but not easily on the target projects desired once your balance sheet gets frothy.
This is especially true in the credit crunch right now. Again...apples and oranges.
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by Paul Broni:
I agree with Bryan, too, that flipping and renting is apples and oranges. Sure, in absolute dollars, the calculated ROI on a flip might be magnitudes higher than the current ROI on a rental. BUT, that is not at all taking into account the huge time commitment to a well managed flip. If you assign any sort of value to the time it takes to locate, negotiate, close on, renovate, market, and sell a flip, the numbers get a whole lot different.The ROI on a strategy has to be properly evaluated and should account all costs associated with the strategy. If you are a flipper, you must account for the cost of your capital when it is sitting around in the bank looking for a deal.
BTW, there seems to be some confusion that I am advocating a flipping strategy over a buy-and-hold strategy. I am not. I am just saying that all strategies are not going to be equally profitable for all people and someone who is starting out in business should focus on the one thing that works best for him.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes15y
I understand where you are coming from, but I think you are failing to recognize the reality of the "constrained resource" piece Vikram. Many people that are growing their wealth don't have a virtually unlimited source of capital to throw at projects. I agree that what you are advocating is true *IF* access to capital is virtually unlimited because it can be raised in the capital markets to support the size of projects desired.
If this basic premise is not true then spending time on "non-optimal" activities is very much optimal when taken holistically.
- Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes15y
Are you suggesting, Bryan, that buy-and-holds have a higher ROI for some investors but they cannot get funding for it and therefore have to engage in a lower ROI strategy such as flips in order to generate cash to invest in the higher ROI strategy of buy-and-holds?
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