- Weekend Reading and Poll Results - [...] Lessons from Business School Mad Fientist talks about negotiation prowess, barriers to entry, and economic incentives in one big …
You stare at the final question. You are tired and the words seem to melt into all the ones that came before them. You are not quite sure what the answer is but a sense of relief starts to well up inside; you finally made it to the end.
You take your best educated guess and you scratch the graphite into the final circle. You flick through the packet of paper one last time, put away your pencil and calculator, and head to the front of the classroom.
After handing in your exam, you step outside and the winter air instantly brings you back to life. As the snow silently falls around you, you smile and breathe the fresh air deep into your lungs. You’re done with exams, done with school, and you have only one thing left to think about…Santa.
Okay, it didn’t happen exactly like that but I did just finish my last class for the year and it feels really good!
As I wrote about in the Free Ivy League Degree article, I am currently pursuing a master’s degree part time while I work full time. It is definitely a lot of work but it is also really rewarding. This past term highlighted how lucky I am to be pursuing this degree because I had the privilege of taking a real estate investment course at one of the top business schools in the world. It was one of the best classes I’ve ever taken and since the material is still so fresh in my mind, I figured I’d share with you some of the key takeaways from the course.
While we explored some interesting real estate case studies, did a lot of modeling and cash flow analyses, and covered some really interesting real estate topics, I’m not actually going to focus on what I learned about real estate. Instead, I’m going to discuss some of the bigger ideas that came up in the course that can be applied to many different types of businesses and investments. In each class I found myself scribbling some key nuggets of wisdom that I wanted to remember so here are a few of my favorites…
Most of us probably understand that investments with the possibility of high reward usually come with high risk. While risk and reward normally go together, you don’t necessarily have to accept the high risk. In real estate, as in other types of businesses, the truly successful people are those who are able to identify the high risk/high reward investments that allow them to use their expertise to mitigate most of the risks.
Rather than simply accept higher risk when attempting to achieve higher reward, think about what you are good at and find investments that will allow you to use your knowledge and experience to create low risk/high reward investments.
The profitability of an investment is usually determined by your purchase price, not the selling price. When you sell, you are simply at the mercy of the market and can expect to receive the market value for your investment. To maximize profits, you need to make sure you obtain the best price when you buy the investment.
A quote that I wrote down during one of the lectures was, “Low cost basis can right a lot of wrongs.” Even if some of your assumptions are incorrect or if you make some mistakes along the way, if you got a really good deal on the investment when you bought it, you can still be profitable.
For example, if you buy a foreclosed warehouse for a fraction of what it would cost to build an identical warehouse, even if you make mistakes when acquiring tenants and your vacancy rate is higher than you predicted, it’s possible you’ll still be in a position to make a solid profit due to the fact that you bought the property for pennies on the dollar.
The previous topic leads nicely into another topic that was frequently discussed: negotiation.
I actually used this tactic when I purchased a used car a few weekends ago. I did a lot of research on the car that I was hoping to purchase and then emailed the dealership to present the amount I was willing to pay for the car. In my email, I described the data that went into computing the price and the reasoning behind my calculations. Only when they agreed on my price did I go in to the dealership.
After test driving the car, I noticed that the tires were bald so I lowered my number further to account for the fact that I’d have to replace the tires. The salesman said to me, “look, my manager already lowered the price more than I thought he would allow me to so I assure you that you are getting the best price.” My reply was, “we agreed on a fair price under the assumption that the car was in clean condition…bald tires were not expected so obviously if I was willing to pay x for the car before, it is understandable that I am only willing to pay x – $500 now.
Since I had built credibility by presenting the information I used to compute the fair price, there really wasn’t any way for him to argue with me at that point. He spoke with his manager again, they agreed on the new price, and we bought the car. Had I just picked a number out of thin air without doing any research, it would have been very easy for him to say, “oh, the extremely low price takes into account the bald tires” and I wouldn’t have had any way to argue otherwise.
It’s important to assume the worst and plan for it accordingly. If you run the numbers and your investment will still be profitable in the worst-case scenario, you’ll feel a lot more confident proceeding with the deal.
That’s not to say you should plan for armageddon or even another financial meltdown but if you think that rents have a 90% probability of being between $100 and $125 per square foot, make sure you are still profitable when running the numbers at $100.
Real estate, as well as many other types of businesses, are cyclical. Even though it may feel like the good/bad times will last forever, they never do. If you can recognize when people are overly optimistic/pessimistic and can get a sense for when the tides are about to change, you can position yourself to profit when others are losing their shirts.
When entering any sort of agreement where multiple parties are involved, make sure that everyones’ incentives are aligned.
When I bought my first house and needed to replace my bathroom, I did a bad job of aligning incentives with my contractors. I paid too much money up front so the plumbers had no real incentive to do the work quickly. It made more sense for them to work on a different job that they hadn’t yet been paid for so we spent weeks without a working bathroom.
For beginning real estate investors, the most common investment is usually some type of residential property (single-family home, duplex, etc.). While these investments can be good for first-time investors, there are many other types of real estate that could potentially be more profitable.
For example, industrial/warehouse space could potentially provide higher, more consistent returns so rather than only focusing on finding the most attractive residential investment, it may be worthwhile to investigate entirely different and less obvious types of assets.
No matter how much planning you do up front, things are going to happen that you weren’t expecting. When they do, it sometimes forces you to completely change direction and develop a new strategy. As long as you are flexible and don’t try to force yourself to stick to the deliberate strategy when it is no longer effective, you can still profit from the emergent strategies.
When choosing investments or starting businesses, think about how hard it would be for competitors to enter the market.
If you are planning to develop a new retail store in the center of a city but anticipate many zoning headaches, for example, even though those headaches will be a pain to you initially, you could eventually benefit from the stricter zoning regulations. If you are able to tackle the rezoning process and complete the project successfully, the project will end up being that much more valuable after you do because it will be difficult for a competitor to complete a similar project.
In the final class, the professor offered some general advice to the MBA students as they prepare to enter the business world. His final slide contained the following quote (if you follow me on Twitter, you will have already seen this):
“Today’s mighty oak is just yesterday’s nut that held its ground.”
Sometimes it’s when everyone is telling you that you’re crazy that you will find the most success. Hopefully during those times, you’ll have the confidence and resolve to hold your ground in order to see what grows.