Between Bitcoin, Nasdaq, and yes … even some real estate markets … there’s a growing concern about bubbles blowing up on giddy investors who’ve been partying like it’s 1999.
Of course, if you sit out to play it “safe” … you might miss out on all kinds of exciting gains. Buy into the hype … you might be left without a seat when the music stops.
So what’s an investor to do?
Fortunately, these are much easier problems for a real estate investor to resolve than for those investors playing purely with paper assets.
That’s because real estate is unique among investment vehicles.
First, real estate is almost impossible to commoditize.
Every property is a one-of-a-kind collection of condition, location, potential, financing structure, and seller motivation.
And unlike nearly all other investments … you can influence many of the factors which contribute to the financial performance of real estate.
On the other hand, every Bitcoin, ounce of gold, share of Apple stock, or 10-year Treasury are essentially identical anywhere in the world …
… and there’s virtually nothing you can do to influence the supply, demand, or financial performance of any of them.
Of course, this doesn’t necessarily make those “investments” bad. But they are very different than real estate.
Our point is that when pundits toss real estate into the commoditized investments bubble warning basket, it’s not a completely valid argument.
Real estate provides a level of safety and control not available in commoditized investments … and the key is basic analysis and underwriting.
Now don’t be intimidated. It’s not that complicated.
However, income property analysis and underwriting is a different process than analyzing a stock, bond, or commodity.
As for crypto? We’re the first to admit we haven’t the slightest idea how to analyze or underwrite a crypto-currency.
But back to the business of analysis and underwriting …
In simple terms, “analysis” is simply looking at the numbers and drawing some conclusions about what they mean.
“Underwriting” is fact-checking the inputs which create the numbers you’re analyzing to be sure the numbers are rooted in reality.
“Technical” analysis is looking at the supply, demand, and price trends. It’s about patterns, and using the past to help predict future price action.
“Fundamental” analysis is looking at the operating income, the market, the management, and other competitive factors, to estimate prospects for future success.
Fundamental analysis is what Warren Buffet is famous for. And because he’s really good at it, he often finds companies whose stocks are cheap relative to their potential.
So a “good deal” is something selling for less than it’s potential … so long as you have the funds, expertise, and control to develop the potential.
When it comes to stocks, Warren Buffet is big enough to have some direct influence on how a company develops its potential.
Unfortunately, Main Street investors can’t play the stock game at Buffet’s level.
The great news is real estate lets you get your Buffett on much better than just some speculating amateur playing pin-the-tail on the hot stock donkey.
So here’s a simple way to approach real estate deal analysis and underwriting so you can recognize a bargain … even in a hot market.
The goal is to buy a property that isn’t already at the top of its value range (a bubble).
For this discussion, we’ll assume you’ve selected a market and neighborhood that’s in good shape and stable, or trending in the right direction.
When it comes to the actual property, you’re analyzing it for acquisition, improvement, and long-term production of income.
Already, the distinction between real estate and a commoditized investment should be apparent.
When you acquire a commoditized investment like Bitcoin, Apple stock, gold, or a bond, you’re bidding into a very competitive environment.
Sure, there may be a little wiggle room in the price, but it’s based on timing … not negotiation.
But with real estate, there’s often the possibility of negotiating price, concessions, carry-back, equity participation, etc.
Often, you’re only competing with a handful of other bidders, so your negotiating skills can make a big difference.
Real estate is personal and individual. It’s NOT a commodity.
So one way to mitigate the risk of buying at the top of the value range is to simply negotiate a better deal at the start. Skill matters.
But that’s just the beginning.
Most properties aren’t perfect when you buy them.
Depending on the condition and potential of the property, there’s often a variety of improvements a new owner can make to create additional value.
If you’re smart, creative, and cost-effective, you can make micro-investments into the property and improve its macro performance.
For example, our friend Ken McElroy likes to add washers and dryers to his apartment units. When he does, he can get a $600 investment per unit to yield an increase in rents of about $300 a year.
You can’t do that with Apple stock. Even if you buy 100,000 shares.
This is where your “cap ex” (capital expenditure, or “fix-up” budget) ties in directly to your income analysis.
So you have the acquisition costs and the cap ex as your “cost basis” going in. It’s the amount of capital you need to get a return on.
That “return” is called Net Operating Income. It’s simply revenue less expenses before debt service.
Once again, this is where real estate sets itself apart from commoditized investments.
With real estate, the line items of your revenue and expenses often contain things which you can improve with good management and creativity.
So as you analyze and underwrite the deal, make a note of each item over which you have some degree of influence or control.
When you do this, you’ll see the potential and probabilities for improving the financial performance, and thereby the value … and you’ll develop a solid foundation for a viable business plan for the property.
This is “duh obvious” to seasoned real estate investors. But for newbies, it’s a VERY important distinction.
Real estate isn’t a good deal simply because it’s real estate. And real estate isn’t dangerous simply because values have risen in the aggregate.
Real estate can’t be measured in the aggregate. Each property is unique.
That’s what makes real estate fun and challenging.
But to our way of thinking, what’s dangerous is buying a commoditized investment you don’t understand, can’t control, with no plan … hoping it will do something awesome all by itself.
It might. But it might not.
In ANY investment, there are ALWAYS stories about people who get stupid rich by dumb luck.
But for every lucky winner, there are a hundred gamblers who get crushed trying to get lucky … with no plan.
Be smart. Do your homework. Make executable plans. And when you see a deal that makes sense … just do it. And don’t let bubble talk scare you.
There might be bubbles forming all around you, but you don’t have to buy one.
Until next time … good investing!
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