Numbers never lie. Or do they?

Today’s post addresses a common misconception that costs inexperienced real estate investors thousands of dollars over the long term. When analyzing investment properties, investors have a compulsive need to oversimplify the decision-making process down to a single metric. If the cashflow on the property is X, then it’s a good property. Or if you get X amount of built in equity, you’ve gotten a deal. Because in the end, numbers never lie, right?

A tale of two properties

Let’s say you’re considering two potential investment properties for acquisition. The first property costs $105,000, has $4,100/year positive cashflow and $9,519 Net Operating Income. The second property costs $130,000, has $2,831/year positive cashflow and $9,526 Net Operating Income.  Which one is the best investment property to buy? When I pose this question to investors that are just getting started, they almost always pick the first. More cashflow, higher returns on investment, a numerical no brainer. There are several reasons why that’s the wrong decision to make. For starters, an analysis that considers only the “what” without regard for the “why” always yields flawed answers.

Einstein said that “if you judge a fish by its ability to climb a tree, it will live its whole life believing that it is stupid”. Put a different way, if you’re measuring the wrong statistics, you’ll get to the wrong conclusion. More than looking at the amount of cashflow, a smart investor looks at the reasons behind the difference in cashflow. Could it be that the property yielding less cashflow is in a better location/neighborhood than the other? More than comparing returns on investment head to head, a wise investor investigates why one opportunity yields more return. Remember, risk and return are best friends that go everywhere together. Could it be that the property yielding more return is a greater risk? Looking at the naked numbers alone is like picking cars based on the number of cup holders alone. A Hyundai and a Mercedes may have similar engine specs, but there’s a reason for that price difference.

When in doubt

If you’re doubtful about which investing opportunity makes the most sense, here’s a simple rule. Always pick Quality (APQ). Don’t skimp on the quality of your portfolio for a few hundred dollars extra per year. As long as the price to rent ratio makes sense, always select assets that are located in prime neighborhoods: They stay rented longer, attract the best tenants, benefit the most from value and rent appreciation. Look at it this way: If you consistently pick B properties with seemingly sweeter numbers or A+ properties, either way you will arrive to the finish line with a paid off real estate portfolio if you execute a Blueprint. The question is which type of asset would you rather own? Exactly.

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If our investing philosophy makes sense to you and you’d like to talk about putting it to work for you, my number is 713.922.2702. I could be talking with you about this stuff over coffee and coffee makes everything better 🙂

Photo Credit: David Villarreal Fernandez