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“Hey, here’s a couple of numbers; is this a deal; should I do this deal?” This is a really, really common question in our community of real estate investors, because we’re always looking at opportunities and trying to evaluate them. In this episode, Jeff talks about a less common but much more strategic approach to evaluating the answer to that question.
Episode Transcript
“Hey, here’s a couple of numbers; is this a deal; should I do this deal?” So this is a really, really common question in our community of real estate investors, of course, right? Because we’re always looking at opportunities, looking for opportunities and trying to evaluate them. So it’s really, really important that we are able to, at some point, arrive at an answer of is this a deal? And should I proceed? Or not? But there’s a very common way to look at answering that question. And there’s a less common way. And today in this episode, I want to talk with you about a less common but much more strategic approach to evaluating the answer to that question. So let’s cue up the theme and we’ll jump right into this very important topic.
Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chest of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting We Buy Houses signs are just looking for “motivated sellers” to make lowball offers to. You see, we are people-oriented deal makers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles, and buy properties nobody else even knows are for sale. I’m Jeff from the Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media, this show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.
Thank you for joining me for another episode of Racking Up Rentals show notes can be found at thoughtfulre.com/e177. Please do us a big ol favor by hitting the follow or subscribe button in your podcast app. Obviously it helps you make sure you don’t miss any episodes coming up, but it also sends a message back to the platforms that you’re listening and it helps them spread the message to other fellow thoughtful real estate entrepreneurs like you and me who are looking for a show just like this one. Thank you for that. Onward with today’s episode.
In today’s episode, I’m really hoping to help you reframe and have a different but I would say a much broader, bigger higher level perspective on this topic of evaluating whether something is a deal. So when somebody asks “Is this a deal?”, what are they really asking? I mean, what they’re really asking is, is this a winning financial opportunity? Or maybe even more simply, will I make money if I do this? And I want to help us reframe how we answer it or even approach thinking about this question. Because while we can certainly think of it from a mathematical or analytical perspective, and to a large degree, we should absolutely do that. There is also an additional perspective that is more philosophical, it’s more strategic, it’s more conceptual. It’s more big picture about the general principles of when do we make money and what actually does make money.
So why am I thinking about this right now? Well, this has come up several times, I would say in conversations with coaching clients recently. I had one really that’s top of mind for me right now, that was just a few weeks ago. And I was talking with this coaching client. And she had asked about a seller that she came across who she started talking to this person about property a and he wasn’t interested in selling property a but he did say, Well, I have this other property that is a lot, or it’s a vacant lot, already divided off of my other property. And is there an opportunity, she was asking me, for me to maybe try to buy and wholesale this vacant lot? So again, it’s a version of the question, is this a deal? Is there an opportunity here from a wholesale perspective on making some money with this vacant lot? And so we proceeded to kind of have a conversation that similar to what I want to unpack with you today because this is very, very practical.
I want to first start with one very simple but important premise that we need to kind of agree on. You may have heard it said before, you may have heard me say it even deals are not found. They are created. Now we use the word find a lot of times in our community to discuss the process of trying to connect with deals and things that we can buy but it’s not really a process of finding I always picture somebody on a beach early in the morning with a metal detector walking around With this mentality that, you know, somebody’s gold watch is just sitting there under the sand and my job is to find it. But that’s not really how deals work. That’s not how deals come together, deals are more created by putting the pieces together in the right way. And because deals are created, the act of creation is an act of entrepreneurship. That’s why I’m such a big advocate of thinking of what we do as real estate entrepreneurship, not real estate investing. Because I think investing is much more about just placing your money into something that sort of is what it is, but we’re not doing that we’re trying to create deals, and that act of creation is an entrepreneurial activity, one of the earliest definitions, maybe even the first definition of the word entrepreneur, and I’m paraphrasing just ever so slightly, but the bottom line was, an entrepreneur is somebody who takes resources from one level of utility to another higher level of utility. And that’s really what we are doing, when we are out trying to create deals that work. So I want to start this before we jump into a couple examples, I want to start this by just stating a three point super important premise of this whole conversation.
Number one, nobody makes money ever, in any way, without creating value, okay, we’ll circle back to that. But nobody makes money ever, without creating value. Secondly, the amount of money that that value creating person makes, is in direct proportion, to the value that they create. And it’s in direct proportion to the size of the value that they create, but it’s also in direct proportion to the rareness of the value that they create. Okay, and the third point is that value is created for someone. And that someone is ultimately, who compensates us for the value that we create.
Okay, so three points, nobody makes money ever without creating value in the amount of money is in proportion to the size and the rareness of that value that they create. And the value is paid one way or the other directly or indirectly by the someone who is the recipient of the value that we have created. Okay, so there is our philosophical framework for this. And I want to just jump into providing some examples of what this means and how it works. So that ultimately we can reframe the question we’re asking ourselves, when we wonder, is this a deal.
So I just went through my three points there, our simple premise about nobody makes money, unless they’re creating value, etc. Let me just give you a couple examples. In case you are wondering about that, or doubting that, think of a very, very simple job setting, a doctor gets paid more than the person who makes the french fries at the restaurant. They’re both creating value, so they’re both getting paid. But the doctors getting paid more, because the size of the value that they create, keeping somebody alive. And the rareness of the value they create a very small percentage of people know how to keep others alive, is much more valuable than the value created by the person making the fries. So the person making the fries is still absolutely creating value. But it’s the size of that value and the rareness of that value that’s infinitely less than the doctor. So you think of the difference between people making money in that sense.
Let’s think about like a wholesaler. If a wholesaler ties up a $200,000 property for $100,000, they will get paid more than the person who ties up the property next door for $200,000 at $190,000, right, so that the wholesaler who has tied up the property at the Greater discount, he’s going to get paid more than the person who has tied up the same property at a smaller discount. Why? Because the size of the value that they’re creating in the rareness of the ability to create that value is very different between somebody who can get a $10,000 discount and someone who can get $100,000 discount.
Now you might be wondering, in the case of wholesaling, if we’re arguing that value is always created for somebody who is the somebody for whom we are creating value. We’re going to come back to that in an example, in just a minute. Let’s just look at a couple more examples of there are simple premise here that nobody makes money without creating value.
Think about an actor, an actor or an actress who can predictably and reliably drive $100 million in box office sales is going to get paid more than the actor or the actress that nobody has heard of yet. And thus, we don’t know for sure what kind of revenues we can reliably depend on them to deliver. Right? Again, the size of the value that they create, is much bigger, the rareness, there’s very few people on the planet who can come in $100 million movie, The rareness of that. So who is going to pay more for that the people making the movie will pay more for that, because of that unique value creation.
And just to provide one more type of example, if you are maybe a skeptic saying wait a minute, there’s ways to make money that don’t involve creating value, like what happens when I buy low, sell high and some stocks, the same principles are at work, it’s just that they are far more abstracted, right? So think about an Apple stock that you bought for $150. And now you’re selling that Apple stock for $200. Well, how are you creating value that just sounds like buy low sell high, right? Well, yes, but there are people who want to buy Apple stock, because they feel like investing in Apple and owning Apple stock is in their best interest that the stock price, maybe it’s headed in the right direction, and they need to buy some so the person on the other side of the transaction is the one for whom you are creating value, because they consider $200 a great deal. Whether you paid $5 For that share, or $195 doesn’t make any difference to them, what they care about is they’re more than happy to take this stock off your hands for 200 bucks a share, because they feel like it’s going in the right direction for them. So they’re the ones for whom you have created value.
So the principle is of value creation is being the key to making money, and that the amount of money made is proportion, proportionate to the size and the awareness of that value for whom we are for the person we’re creating it for. These are universal principles.
Okay, so let’s stop the philosophy lesson. And this brings us back into the context of real estate, let’s start to put all these things together. Our starting question is often is this a deal? And as we’ve discussed, what that really means is we’re asking ourselves, is this a money making opportunity for me? Am I going to make money? Is this something I should pursue? Because I’m going to get a financial win out of that? Okay. So is it a deal means? Is this a money making opportunity? But that’s really asking the question, is there a way somewhere here for me to create value somewhere in this picture? Somewhere in the picture of this deal? Is there a way for me to create value? And ideally, large or where value? And for whom? Would I be creating value? Right? Because if we can ask the question, is there a way for me to create value? How big or rare is that value I could create? And for whom is that creating value? If we can answer that question with compelling answers, then yes, we have a deal, because we’re going to be creating a lot of rare and unique and substantial value for somebody, we’re going to get paid for it.
So let’s look at a couple scenarios of real estate where this plays out. Let’s start with the first example just being a rental property. A rental property is what we talked about here a lot on this show this what a lot of us in this community are primarily focused on right. So this is very, very, very common in our communities and our forums and our Facebook groups. And somebody will say, hey, purchase price 200 rents 1200 Is this a deal? And as a side note, that always drives me a little bit bananas, because I’m thinking great, I would like about 200 other data points, please, before I can really weigh in for you on whether that deal. Makes sense. But let’s step back, and let’s look at this conceptually. So rental property. Is this a deal? In other words, we’re asking ourselves, is this a moneymaker as a rental property? So instead of asking the question, is this a deal? I’m hoping we’re going to reframe, and we’re going to ask a different embedded question instead, which is, how would I be creating value in this case? And for whom? Because if the answer Is I’m not? And for nobody, then no, we probably don’t have a deal. But let’s look at our questions. How would I be creating value and for whom? Let me give you some possible answers.
Now, obviously, every property is different, every seller is different, every market is different. So here’s some possible answers, though that are, I would say, in my own world, very, very common. For whom might I create value, we’ll start first with the seller, in our process of buying the property, we could be creating value for the seller, the most obvious potential way is this seller wants to move on from his property, there’s other things that they want to do doesn’t even necessarily mean they’re distressed by any stretch of the imagination, but they’re ready to spend their time and energy doing different things. And you make it easy for them to move on to what they want to be doing instead. And thus, you are able to negotiate potentially a lower price, because you’re making it easy for them. And they’re happy with the experience they’re having with you.
Let’s take the seller situation a little bit further. The seller, if you’re buying the property off market, like I hope you are, if you’re a listener to this podcast, the seller is going to be not paying commissions to a real estate agent. That’s a way you are creating value for them. How are you going to get paid, you are going to get paid by the seller in the form of a lower price that reflects the amount of money they’re going to save, right? So if you say, hey seller, on your $200,000 property, you know, normally you’d pay your 5% commissions, that’s 10 grand, you’re not going to be paying this. So my proposal to you gives you net the same amount of money at $190,000 that you would get if you listed on the property or listed the property on the market, but with a lot greater ease. Would you accept that proposal and they say yes, so now the seller has just paid you for the value you’ve created, which is that you’ve helped them avoid commissions. And they’ve paid you not by writing you a check, but by giving you an additional discount on the property.
Let’s move on and think about what we’re going to do after we buy this property. Let’s say we’re going to renovate this property. Eventually, we might refinance the property, we might sell the property. For whom are we creating value? Well, let’s say this property, again, this is very common in my world has a basement that is not finished or not finished, fully or kind of brought to its full potential for whom are you creating value? Well, you would be creating value for a tenant if you were to finish the basement. Because now the home has more utility, it’s more useful to them. And when it’s more useful to them, they can have more people living with them, perhaps they can just do more and accomplish more with the house. And so they will pay more in rent, because there’s more utility. So the tenant is the person you’re creating value for one person you’re creating value for by finishing that basement. And you’re getting paid because they’re getting paid for that value creation because they’re going to pay more in rent.
Let’s think of another different audience though. For whom you are creating value when you finish the basement, you are also creating value for a future owner. Whether you quote, flip this property or hold on to it for five years, and then resell it or hold on to it for 30 years and then resell it. In the future, the next owner of this property will be getting a property with a finished basement as well, which creates more utility for them more utility than a comparable property without a finished basement. What does that mean? That means the purchase price, or the your sales price from your perspective of the property is higher because you have created more value for that future owner.
But here’s one of the really cool things too is that you can create value for a future owner that doesn’t yet exist. A person that doesn’t even yet exist and may never if you decide to hold on to this property forever, but you’re the one who gets the value out of what you’ve created for the future owner, because your property is now worth more, right. So you don’t actually have to sell the property to a future owner for you to get the value out of it. Because if you were to simply refinance the property, the property would be valued at what a future owner would be willing to pay for it. And now you are the beneficiary of creating value for a future owner even if you don’t decide to hand the property to a future owner.
So the point is, as we look at the prospect of a rental property, we have to ask the question, Where would I be creating value here? And for whom? Now? If the answer is I’m looking at a property, the seller has no desire to move on, they have no desire to really sell the property at all. It doesn’t matter to them, if they pay commissions. There’s nothing I could do to or with this house, that’s going to make it any different than exactly what it is today. There’s no ability for me to add value, then we’re much closer to the end of the spectrum where the answer is no, this is not a deal. And because there’s no great place, there’s no great way, there’s no great method to create value for really anybody in this picture, the seller or the tenant, future buyer, or anybody else. But the question is rooted in asking, is there a place for me to create value? How much value would I create? How rare is that value? And who receives that value? Who is willing to pay me for it one way or the other?
Let’s take a totally different type of real estate example. And this will bring us back to the story I told you at the very beginning of me talking to one of my coaching clients. Let’s take the example of a wholesale deal. We have a potential wholesale deal in front of us. And we ask the question, is this a deal? Which really means we’re asking the question, is this wholesale level? And could I make money by wholesaling it. But I want us to reframe our question. Instead of asking, Is this a deal? I want us to ask, how would I be creating value? How much value and for whom? So how does a wholesale deal work? Well, the first party that we’re going to come across or talk to you is the seller, because now we’re negotiating on the buy side of this deal. The seller in this case, perhaps has a property that is in disrepair that they want to sell. But they don’t know how to sell it because they don’t know who would want to buy a property in this particular condition. They don’t know who would want to buy it, they wouldn’t know how to find that person if they needed to. But here’s the thing you do, you know how to do the thing that they don’t know how to do. That’s where your value add comes. How do they pay you? Well, again, they don’t write you a check in the literal sense, but they pay you to solve their problem in the form of allowing you to buy the property at a lower price. If it wasn’t a problem for them, if they knew exactly who to call to sell their property, then there’d be no way for you to create value, but you’re creating value by addressing an issue they have, which is that they need to move this property and they don’t know how to find the person who will take it off their hands, but you do. That’s how you’re creating value. That’s how you’re getting paid in the form of a lower price.
Let’s talk about the other side of a wholesale deal. The as I would like to think of it the placement side? Who is the buyer and going to be? Well, so the buyer, how are you creating value for the buyer? Well, here’s the buyer situation. This buyer, let’s say that they are, you know, a house flipper, for instance, they need inventory of houses to flip because their business is dependent on buying properties, making them better and then reselling them. They need properties to do that too. But their core competency is not finding those deals. Or maybe they know how but they start how they want to spend their time. But they need inventory. And they either don’t know how or don’t want to spend time getting that inventory. But you do. That’s a problem that you can solve for them. Thus, that’s what creates value for them. And they pay you for that value in this case more literally, they pay you for that value by being willing to buy the property from you or through you depending on your deal structure I guess for more than you have tied it up at for more than you have put it in contract at because you’re creating value for them. They need products to work on their businesses swinging hammers and painting their businesses not finding and negotiating.
So let’s extrapolate this even further because there’s kind of another layer with buyers. It’s not just that they need inventory. They need the right inventory. They need profitable inventory where the margin hands are going to work for them, right. So their business is buying something at a price where they can put their own money and effort into it. And then when they list it on the market, it’s still available to an end buyer at a price that the end buyer thinks is a fair price for that product as well. So not only does the buyer have trouble getting inventory, and you can get paid to help keep their inventory pipeline filled, they actually need help, finding the right deals at the right prices, where they can make money, as well. So you’re creating value for them by being good at finding and negotiating not just inventory, but inventory at the right price, or maybe even the right price in terms that make their flip feasible. So again, they’re in the business of repairing things, they’re not in the business of finding it, they’re certainly not in the business of negotiating the best possible deals. But if you go out and you do that for them, and you can create for them the right combination of a purchase price that makes sense for them and the amount of repairs that will still result in a profitable flip for them and put a property on the market at a reasonable price that a retail buyer would want to buy it. That’s the value that you are creating for them. And they will pay you for that value in the form of buying the property from you at a price that is more than what you contracted it with the seller. So if we take this wholesale deal idea, and we blow it apart, we see that there’s actually lots of different places where we can add value.
So value creation, let’s just step back and think about value creation broadly for a moment is about I would say probably mostly two things, solving problems, and seeing greater opportunity, now solving problems and might say, Well, yeah, no kidding, Jeff, we talked about solving problems in real estate all the time. But what’s really kind of interesting is that we are always solving problems. But there’s sort of two categories of problems, problems that the seller or a person problems that a person is aware that they have, and problems that a person is not aware that they have.
For instance, when a seller you talk to you says I have a problem, my property is in disrepair, it’s not financial, they know that they have that problem. But when they are selling maybe a property that has a less than functional type of layout, they may not really realize that they have that particular problem, which creates opportunity for you to solve both problems that they know they have, and problems that they may not even know that they have. But you see that if you were to solve this problem, there would be great upside in it. So we create value through solving problems. And we create value through seeing greater opportunity. I call this opportunity vision. This is one of the greatest skills that we have as real estate entrepreneurs opportunity, vision, our ability to see possibility.
I remember the moment that my coach Greg, for the first time said something; I remember where I was sitting, what spot at the table I was sitting at, when he said the entrepreneur doesn’t see what is there, the entrepreneur sees what could be there, that has stuck with me. And I think about that on a nearly daily basis. Our opportunity vision allows us to see what not is just there. But what could be there. And that’s a huge part of how we create value. I often like to say in the bird community. And I will note that this is not a popular perspective, I get a lot of pushback from people when I say this, but a burr does not require you needing to buy the property at a discount in the first place. Does it help? Yeah, absolutely. It helps. And we’ll we will always take the lower price if we can get it but you don’t have to buy a property at a discount to do a successful BRRRR.
Instead, you could simply have a much larger vision for what is possible with that property. Because the bottom line with the BRRRR strategy is that we have to create value there has to be a big delta, big difference between the picture that we buy and then the picture that we ultimately create. We can’t buy something for $190,000 and make it worth $200,000 and really expect that to be a great burger. But we could pay $190,000 for a property that’s absolutely worth exactly $190,000 if we have a vision for how we can do it easily or profitably transform it into a $500,000 property. The vision is what creates the upside. It’s not that we had to negotiate a huge discount, it’s that we navigated a huge vision for the upside.
So back to my coaching client and her question about the wholesale deal. So she comes to me and says, this seller would be willing to sell off this portion of a lot. And I’m wondering if there is an opportunity for me to wholesale it. So we have to just pull it apart and ask, Where in this picture? Could we possibly add value? And so let’s just take a look at that right now. Does the seller feel like they have a problem at all? Does the seller feel like they could make one phone call and place this vacant lot in the hands of a builder? Who would happily buy it from them and build another home on it? Well, if the answer is yes, then we might not be able to add value in that case, because why would the seller talk to us when they could simply make one call and sell it to the right builder? Who’s kind of the end user for a vacant lot. But if the seller is looking at you coaching client and saying, I’ve had this vacant lot, but I have no idea who would possibly buy something like this? I have no idea how to find them. Now there is an opportunity potentially to create value for the seller.
Now how about a buyer? Well, a buyer of a vacant lot is going to normally be somebody who’s going to build another building on it, let’s just call it a house, you’re gonna build a house on it. What does the buyer need to accomplish? Well, the buyer needs to be able to find and source the vacant lots to build on. But they have to build a source of vacant lots at a price. That’s reasonable, right? A homebuilder can’t buy a lot for $200,000, build a house and then expect to sell the house for $250,000, that just is not going to work. Because it’s going to cost them too much to build the house. So they can’t sell it at $250,000. But if you could find a builder, who builds let’s say, $400,000 houses, and you could put this lot in their hands for $100,000. They might look at that and say, Hey, that actually works for me that’s financially feasible. So now you’re going backwards, and you’re saying, Well, is there a delta between the $100,000 that I know I could place this lot in the hands of the builder for and the price I could negotiate with the seller. And if you say, Yeah, you know what the seller would be happy, they would consider it a win. To sell this property for $80,000. I know somebody who would pay $100,000 for it, boom, now we have a margin of $20,000 that we’re getting paid for. Because we’re creating value that the seller needed to create, they didn’t know how to address their own problem that the buyer needed this value, because they need inventory and inventory at the right price that will make sense for them. And between the value that’s created for both of them, they are directly and indirectly paying us $20,000 For the value that we are creating.
So let’s just wrap this up and say, when we ask the question, is this a deal? First of all, I’m glad you’re asking the question. Is this a deal? Because that means you’re even out there looking at things, you’re trying to create things, you’re finding things, you’re evaluating things, you’re seeking opportunity, you’re not sitting on the sidelines. So first of all, I’m happy when people are asking the question, is this a deal? But is this a deal? is really asking the question, of course, is there a money making opportunity with this transaction with this property? The answer to that question is going to be no or close to No. If we are not creating any or much value for the different parties involved. The seller may be a buyer, maybe a tenant may be a future buyer, maybe a private lender, even if the answer is no. It’s going to be because we’re not creating value. But if the answer is going to end up being Yes, yes, this is a deal. Yes, this is a money making opportunity. It’s going to be a yes. Because there’s lots of value that we think we can create that is rare and significant. And ideally for even multiple parties. So if you look at your scenario, and you say yeah, I can see how I’m adding significant value to this group, and to that group and to that group, then chances are the answer to the question. Is this a deal? is yes, it is a deal. Am I creating value.
And that is it for today’s episode of Racking Up Rentals again, show notes can be found a thoughtfulre.com/e177. Please do us a big favor by hitting that subscribe or follow button in your podcast app. And if you really want to do us a big favor, take just a second to rate and review the show. It’s truly, truly helpful. And it’s also truly, truly noticed and appreciated by me. Thank you so much for that. Did you know also that we have a Facebook group for thoughtful real estate entrepreneurs? Yep. It’s called Rental Portfolio Wealth Builders. And you can find it by simply going to group.thoughtfulre.com. If you liked this episode, please take a screenshot of it. Post that screenshot to Instagram and tag us; we are @thoughtfulrealestate. So I’ll see you in the next episode. Thanks again for being here today. Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off.
Thanks for listening to Racking Up Rentals where we build long term wealth by being win-win dealmakers. Remember: solve the person to unlock the deal and solve the financing to unlock the profits.
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