What makes a deal a deal?

Question

For a newer investor the answer may seem fairly simple,  buying a property at a good price point.  I would suggest though that the answer is much more complicated than that.

I think if you consider it for awhile it becomes obvious that a multitude of considerations come into play that make a property a good deal.

One illustration,  I happen to know an investor in Seattle that is and has been doing quite well for years buying apartments, holding them for 5 years or less and selling them.  He has been doing very well for years.  The are he purchases in has cap rates of 5 and it is rare to find a 6 cap,  the price he pays is a consideration, but doesn't define the deal.  For my current investment model this is not the place to look for good deals.

So what makes a good deal or a great deal?  Is it really only price or perhaps just price and location?

J Scott · Answer

It really depends on your goals, and everyone has different goals.  While a lot of people say that it all boils down to something financial -- profit, ROI, IRR, etc -- this is rarely the case.

For example, if I said you could make a 100% return in a week by investing $10K and generating $20K in return, would you consider that a good deal?

Most people would say yes.

But, what if I said you had to work 80 hours that week rehabbing a house in a war zone using unreliable contractors?

Would it still be worth the 100% return on a $10K investment?  Probably not.

So, it boils down to defining your goals, and finding investments that fit both your financial AND your other goals.

For me, a deal is good if:

- I can generate at least 50% annualized ROI by the end of the project;

- I can generate at least $1000/hour on my time (so, a typical $15K profit flip, I'd spend less than 15 hours of actual work);

- My risk level is such that I don't lose any sleep and my total worst-case risk is less than 10% of my total net worth;

- I can decide where/how I want to spend my hours (i.e., the deal won't fall apart if I decide to take the weekend off or spend the day at the park with my family).

For me, a deal has to (at minimum) meet those criteria for it to be considered a "good" deal.

I'm not saying I'd never do a less where the criteria didn't come in less than that, and I'm not saying that I wouldn't trade some aspects of the deal for others (for example, taking on more risk for a small amount of time for the opportunity at greater profit).

Just my $.02...

Chris Martin · Answer

Well put. The idea is to surround yourself in people who can execute on your ideas... that kind of thinking makes billionaires out f millionaires IMO....

Chris Martin · Answer

Jay DeCima wrote some books many years ago about this concept. It still holds today, so hats off to the "forced appreciation" model of investing. I think this has major potential for areas like Raleigh where there are spot areas in downtown where a cash/capital/redevelopment infusion would create an incredible value add. Some people have vision... and I applaud their efforts, especially when they they transform a community for the better.

Account Closed · Answer

Knowledge and experience can prove to be great assets in investing.  I think it is quite possible to do well in real estate in almost an market.

I would also say that it can be tough for some to do well in almost any market.

Understanding what it takes, what is a good deal, arranging the financing and making it all come together is what investing is all about.  IMO.

Chris Martin · Answer

Wow. You can't argue with J Scott's success. I, however, am more of a $1/hour investor. Yes, that's correct. $1/hr. 24 hours a day. 365 days a year. That's $8,640 in a year. Actually, from a QB report of 4 low end properties I (actually via an LLC) acquired in the past year in one traunche, it's close enough at $8,959. And depreciation "expenses" remove almost all of the taxable cash flow. So the LLC has virtually no current tax liability. The properties are accretive to earnings after accounting for fully leveraged financing using 75% of contract lease and 50% expense rule which includes reserves and depreciation. So obviously a different model, but our LLC members have a different goal. To some degree, the "value" of the properties is not material if cash flow models are satisfied. Realistically, the properties are "worth" about 40-50% more than their basis today... but our expectations are to sell in 4-10 years... or whenever the market dictates. In the interim, we collect rent and tax deferred cash flow, and our 'round trip' cash investment is close to $0.

Account Closed · Answer

Jeff, I agree it makes little sense for most of us to buy at a 5 cap.  I did find an investor though that is buying apartments in Ballard with cap rate between 5-6 and he is doing quite well with these purchases and looking for more.

He has a good eye for what might make for a good value add.  He has been able to change apartment configurations, added new apartments in existing buildings, made storage areas more usable or profitable, and had other creative ideas for adding value.  He also looks at current rental rates compared to neighboring properties.

He has a great business model and is making good money buying properties that many wouldn't touch.  Are these properties good deals, for him they are.  For someone without the appropriate knowledge, team members, financing, etc most likely not.

Account Closed · Answer

Jason,  great points.

In my opinion price is rarely the only criteria for a good deal.  Like Jason said, it is far more important to understand your investment goals.  I would also say that what makes a particular property a good deal might be different for different investors because of the goals one has.

If I paid 200K for a property, rehab it, sell it for $400K and make $100K that was a good deal.  A buy and hold investor might pay $180K and have a marginal at best cash flow, I would say that under the circumstance that probably was a poor deal.  Same property different outcome.

Chris Martin · Answer

It's just like picking stocks. What makes a good deal? If you listen to IBD founder William O'Neil, you are always buying near the all time highs. Yet you can't argue with his CAN-SLIM model success in virtually any market. Buy high, sell higher... but only at the technically correct point. Yet there are lots of people, myself included, who with real estate buy low in bad cycles and hold until the long term trend improves... when selling is relatively easy. Remember those days? Warren Buffett is a value investor... sounds like the investor Charles knows. Buffett seems to be doing okay with his investment model over the long haul.

I think the key is choose a model that you can make work... and if/when it works, stick to it. And no, two highly successful people would not all define a deal the same way. Any, no, there is no right answer.

Dale Osborn · Answer

What I would be looking for in a deal would be for each individual investment property to be able to support themselves. I do not want to take money from one investment property to support another property. Being a CPA, you might have had clients that are looking for a tax break and for them a deal could mean negative cash flow to counter balance income from other properties. I have not really got to the point where I consider it an opportunity to be able to lose money on a particular investment. Therefore, I will always be looking for those that support themselves until my tax situation changes!

Bryan Hancock · Answer

Yeap....those properties would all fail this beloved "50% rule" test too Charles.  I am sure all have been great investments too.

What makes a deal a deal?

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