Business Focus With Constrained Resources
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
On a separate thread today there is a debate about flipping versus buy-and-hold. The point was made that one should focus their investment strategy and that diversion from focus is a sign of an amateur. Others disagreed as did I.
With limited resources one is forced to do "non-optimal" activities to accumulate capital to do what one does best. The alternative is to invest in someone else's enterprise and let them take all of the upside that is skill-based. To me this represents an opportunity cost larger than investing in a manner that is "non optimal" or different from one's singular set of expertise.
Do you agree? Disagree? What is your experience with investing your time on activities that are profitable, but perhaps you don't consider yourself an expert at? How would you get to be an expert if you didn't practice with your own funds?
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...
No...I am suggesting that some investors aren't singularly-focused on optimizing ROI as was stated earlier in this thread. Some investors are focused on optimizing absolute cash flow with minimal effort and fix-and-flips provide the capital to do this.
This does not make them an amateur...it makes them have different goals than you do.
This does not make them an amateur...it makes them have different goals than you do.
Then we either disagree on the basic purpose of a business or we are using the word "amateur" in different ways.
To me, a professionally run business has one goal - to maximize shareholder value. That is the only goal for the business. If I owned a business that was managed by others, I would expect them to work towards that one goal. If I buy stock in a company, I carefully select companies whose managements are working towards that one goal. If the management of a company says that they want to do something that generates cash flows but with minimum effort, I and other investors will find it quite bizarre and unprofessional.
I also agree that any person should be free to make life choices for himself, including the choice to minimize effort. I call such people hobbyist or amateur investors because they are doing things for a personal goal.
When someone who is starting out in RE comes on BP and asks for our advice on which way to go, I believe I should give him advice that maximizes his chances for wealth accumulation. I do not believe I should give him advice such as "Do whatever you want. Each of us is different."
I think the standard goal for almost anyone engaging in real estate purchases is to increase cash flow and minimize the effort required...not to optimize ROE. An optimal ROE requires a huge time component and increases bankruptcy risk as you have already conceded. It also exposes one heavily to systemic risk, regardless of how skillful one is at running their business.
Modern portfolio theory accounts for all of this. People have their own unique efficient frontier given their tolerance for risk. Some people want to concentrate wealth, maximize ROE, and ignore systemic risk because they are risk lovers. Others want to diversify their cash flow streams, spread their bets, and hedge systemic risk. Calling one system something that only "amateurs" engage in is silly. Everyone invests differently and has different goals. People having different goals than yours does not make them an amateur...it makes them different.
Furthermore, almost all businesses have more than one set of stakeholders and myriad purposes. Maximizing shareholder value can come at the expense of killing the environment, putting the bondholders at huge risks for the sake of popping share value, etc. Claiming the only purpose of a business is to maximize shareholder value is shallow at best.
Bryan, I think we have a really different idea about the underlying philosophy and purpose of business then. I am fairly sure if you speak to any large investment company, they will agree with my idea about value maximization. The other things - environment, customers, employees, etc. are means towards that one goal. They are not really the goals of the business.
In any event, I do not want to sit and debate this endlessly with you. I am sure readers have got both our perspectives clearly by this point and can decide what they wish to do for themselves.
I certainly agree with not debating it endlessly. I think that most people have recognized that they don't want to work 100-hour weeks for the rest of their lives to optimize ROE and thus they have made the completely non-amateur and rational decision to diversify their business into activity that allows them to enjoy the fruits of their labor at some point.
Everyone is certainly entitled to their own opinion and goals with what to do with their lives.