Writing for The Street, commercial real estate guru David Scherer lists 6 Rules for Value Investors to Buy Real Estate at the Right Price. While he is speaking specifically to commercial investors in his article, I will describe how to apply each of Sherer’s rules to residential real estate.
But first, why is buying at the right price so important? It’s the only way you can ensure you make money. Redevelopment projects can take long enough for the markets to change, sometimes radically. That’s all well and good if the market goes up, but it can be devastating if the market tanks. As the truism goes, “You make your money when you buy. You just get paid when you sell.” Or as Sherer puts it, “For real estate investors, it starts by understanding the difference between price and value. Price is what one pays, while value is what one receives. Buying investment property at too high a price isn’t a good value.”
Now for my first caveat. If you do pay too much for your property, all is not lost. You can still make a profit if you can afford to hold the property long-term. Real estate prices historically trend upward given long enough. But when you’re getting started, a single bad deal can end or significantly slow down your business. That’s why it’s so important to do your homework, know what you’re buying, and know what you can sell if for.
- Identify the sweet spot.
Identifying the sweet spot means knowing your market. You have to know the current value of the house, how much it will take to bring it to the top of the market, and what it will sell for after renovation. The sweet spot is where you get the highest return by buying right, improving right, and selling right.
- Follow the fundamentals.
To me, this means applying Buffet’s rule: “Never lose money.” Of course, that’s much easier said than done. With residential investing, this means not letting your emotions get the better of your judgement. Just because you love quartz countertops, doesn’t mean they’re appropriate for every project. Or, as we’ve learned the hard way, just because you believe a neighborhood is turning around and ready for redevelopment doesn’t mean it actually is.
- Find the path of growth.
Sherer advises, “Rather than buying investment property where competition is fierce, identify emerging sub-markets by watching the drivers of growth.” For us, that meant concentrating on the outlying areas rather than the hottest parts of the market. These are areas where price growth in the interior is pushing middle-income families. The returns are lower, but so are the risks. And our goal includes a growing portfolio of buy-and-hold properties.
- Pick your shots.
Don’t cast so wide a net that you can’t focus on a specific area. Especially when you’re getting started, it’s much easier to understand one area of town, or even a single neighborhood, than it is to know all the different trends going on in a city, county, or region. Be a specialist in your niche so that you don’t compete with every investor in the world for the same property.
- Put boots on the ground.
I take this advice literally. There is no substitute for door-knocking or cold-calling. If fact, one of my friends landed a deal by door-knocking. The seller explained she had received a trash bag full of direct mail. She was willing to sell him the house because he was the only one who actually talked to her.
- Be prepared to walk away.
Warren Buffett says he got rich by walking away from 99 deals for every one he took. We follow that advice, and more. We will walk away from a deal if any of the parties feel like they are being taken advantage of. It’s more important to be able to look yourself in the mirror than to make any individual deal. And, of course, we’ll walk away if we don’t have a reasonable chance of making money.
If you have a deal you’d like help reviewing, please email me. Understand, I’m not an expert on all markets, but I can look over your basic numbers and, maybe, point out some things you’ve missed. If the deal is in one of the markets we work, we maybe able to come to a wholesale or joint venture arrangement.