Is it Ever Okay to Overpay in Real Estate Investment?

Posted by Chris Clothier on Thu, Oct 26, 2017

moneymanagement-overpaying-realestateinvestment.jpgWhen we’re taught about real estate investment strategies, especially as they relate to single-family properties, it is drilled into us that we have to buy below market value if we want to see good returns.  The problem with that statement is that each real estate market is unique and there are always different strategies that different investors employ at different times.  So, one statement, that while on the surface looks like great advice, may not always make sense for each investor.

We are also told that if we ever want to make it in real estate investment, we absolutely cannot “overpay” for an investment property.

But what is “overpaying?” Who decides if you are or are not over-paying.  Please don't go down the route of appraisals here.  While I have nothing against appraisers and have many friends who do a fantastic job in that role, they will be the first to tell you that appraisals are subjective and you can line up ten appraisers and will likely get ten different values.  So the real question is, are there times when it’s okay to purchase a property above an appraised valued? When is it worth it? Is it ever?

What you thought you knew about investing in real estate may not be so concrete. There are times where the rules of real estate investment can and should be broken.


What Does it Really Mean to “Overpay” for an Investment Property?

So, first things first: when you hear someone use the term “overpay” in the context of investing in real estate, you need to stop and ask them to define their terms. What do they mean by that?

For us, "overpaying" should mean paying an amount for a property that negates or significantly diminishes its actual value. It hurts your returns not because you overpaid, but because there is no value behind the price. It makes sense here to remind everyone of the saying "price is what you pay, value is what you get".  Charlie Munger made that profound statement years ago and investors, especially Turnkey real estate investors, would be wise to remember it.

This is why it’s so important for real estate investors to do their math and compare that math with the value you are getting before they buy an investment property!

So if we’re thinking about “overpaying” in those terms, should you ever overpay? No! You don’t want to buy a property if it does not provide you significant value.  That value could be exceptionally good property management or the high-comfort of great customer service.  Those are valuable to passive invresors. You need those services to be top-notch in order for the numbers to make sense.  They can also siginificantly effect your ability to make a profit.  

Some investors belive in limiting the dollars they spend as a way to earn a return.  They refuse to pay more and refuse to spend more.  They value saving rather than valuing comfort, peace or secutiry.  They simply define it differently.

Investors that we work with, heck it is a philisophy the Clothier family uses in building their own portfolios, believe that there is great value in having someone else provide value for you.  We save our time and our dollars by spending on the front end.  We eliminate or drastically reduce the number of move-outs, high costs of turnover and any time spent worrying about our portfolios.

We pay fo that comfort and security.  Renovations are higher and the price we pay on the front end for homes is higher.  However, our personal portfolios and the portfolio that Premier Property Management manages for investors both outperform any other property mangement company that I am aware of.  BY a wide margin! 

But there’s another common definition of “overpaying” for investors that we need to consider: buying at market value.

That’s a whole different question.


When Should You Buy an Investment Property at Market Value?

When looking at potential investment properties, many real estate investors, especially those who have been trained in a traditional strategy (buy low, rehab low, rent low and fast, repeat), tend to skip over properties that seem “too expensive,” or they drop out of the bidding war when it gets too heated. The question is: is that always the best choice?

Here are a few factors to consider when asking yourself if you should buy a property at market value:

Ego

We have to be honest with ourselves: ego can sometimes get in our way when we’re looking for real estate investment deals. Greed, too, can hinder us in making the right decisions for our investment careers. You may find that in your quest to get exactly what you want out of a deal, you start losing a lot of deals. Every real estate investor would do well to remember that deals work best when they’re a win-win: not just when you get what you want.

It’s not necessarily about giving in and buying a property at market value: it’s just about remembering that you don’t always have to argue a seller down to a bottom-of-the-barrel price to be “winning.”

At Memphis Invest, we are often asked to lower our prices by interested investors.  We rarely negotiate unless the buyer is a client with a proven track record of closing their contracts.  Why?  Because we provide more than just a house.  There is an in-depth service attached to it that has great value and is in great demand.  

The ego often gets in the way of investors who can't wrap their heads around paying full value for something.  It goes against all of the books written (some by very inexperienced investors who managed to get books deals) about how to invest in real estate.  The bottom line is this:  Don't let ego keep you from striking a great deal on a great property that provides real value.

Risk & Minimum Criteria

If you haven’t thought about it before, start thinking about what your absolute minimum investment criteria is. What percent cash-on-cash return is acceptable to you? What’s unacceptable? If you know this and refuse to budge, it’s going to make your decisions a lot easier.

You’ll be able to know quickly when the bidding should stop and when you should skip a deal altogether. It will save you a lot of hassle and wasted time.  

Strategy

Strategy plays a huge role in what you should pay for an investment property. For example, a turnkey real estate investor will usually pay around market value for their properties. Does that mean that they’re overpaying? No! It’s a different strategy.

Think about it: an investor who buys a property below market value without a turnkey provider is going to have to renovate the property, market the property, find a property manager, and go through the process of finding and vetting tenants. That’s expensive and time-consuming, and when it’s all said and done, they’ve probably spent about market value on the property anyway.

A turnkey real estate investor might be paying about market value from the outset, but they’re buying a property that has renovations taken care of, management taken care of, and tenants handled...along with everything else! They’re not just paying for the property, they’re paying for simplicity, peace of mind, and services.

The strategy you choose plays a huge part in how much you should pay for a property. Don’t let preconceived notions skew your thinking.

Idealism

Are you idealizing a property? This can go both ways when considering the price of any given investment opportunity. You can idealize your goal price in that you won’t accept anything but the very best deals: in which case, you’re going to have a lot of trouble finding investment properties to suit your criteria. You can also idealize the property itself by thinking that it’s going to be a passive-income gold mine that’s worth any cost.

Both sticking too hard to an idealized budget or falling in love with some perfect vision of an investment property leads to trouble! Check your rose-tinted glasses at the door. Realistic expectations, hard facts, and real numbers are the surest way to real estate investment success.

Want a real estate investment strategy that works without all the hassle? Learn about the strategy that has worked for thousands of Memphis Invest clients:

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Topics: buying a property