Do you ever wonder why some people think investing in multifamily real estate is risky but putting money into a tech startup or a Wall Street stock isn’t?
While any investment with the opportunity for a return has some level of risk, the one thing that reduces risk is knowledge. Today, we will talk about the perceptions of the risks of real estate investing.
If this is the first time here, welcome. My name is Agostino and I’m a real estate entrepreneur, syndicator, and investor. In this channel, I share stories, lessons, and advice from my journey in multifamily real estate. If you haven’t subscribed, make sure you push the subscribe button and the notification bell so that you get all the content to stay ahead of the game.
As a real estate investor active on social media, I get calls from time to time from people asking me to invest in their venture or deal. Last time, it was a friend looking for me to invest in their tech venture. This friend has been a successful C-Level executive with several companies and is very familiar with the world of technology and business. He was looking to raise a total of $3.0MM in $100,000 chunks in exchange for a return plus equity in the business. During the conversation, he says, “I know the multifamily real estate you do is very risky as you are handing out some good returns. I figured you may want to invest in something that is not as risky. Maybe you or someone from your investor network may be interested in our tech concept. It’s going to change the world!”
Here is a guy that ran multi-million dollar budgets, international teams and many high-level projects. I’ve known him for a long time and can tell you he is very intelligent. However, he was brainwashed into thinking that real estate is risky. Prior to making my leap into real estate 15 years ago, I didn’t even consider real estate as something to invest in. Besides, the perceived risk level of sitting on a mortgage in the hopes that the tenants would cover it was a scary thought.
I began to understand the nuances of the business once I got into the real estate game. I started with single families and small multifamilies. I studied everything I could about real estate and spoke to mentors to get a deep understanding on how to purchase and operate deals large and small. Today, my team and I run our real estate portfolio as a business. I don’t do e-commerce, bitcoin or own a retail shop. All I do is real estate. My team and I are all in. I don’t consider any investments that deviate from my objectives.
Getting back to the conversation, I decided to address the risk of real estate. I asked him: “When was the building you live in, built?” He responded, “Maybe, 30 years ago”. So, for the past 30 years, that building has been throwing off cash. For 3 decades – every single month there was cash flow. Then I asked him, “Do you think that building will be around in another 30 years?”. He says, “I imagine so”. By that logic, that building will continue cash flowing for another 3 decades. I know where his building is and I know that as long as they operate the property well, it will continue performing.
When I look at an investment, I have two strict criteria: 1) I want capital preservation and 2) I want cash flow. Of course, there are the tax benefits and forced appreciation, but that’s the icing on the cake. I want to know that the cash we are putting into the asset will outpace inflation and still get us cash month over month. This is what we offer our investors as a way to preserve their wealth and offset earned income from the taxman while diversifying from risky stocks and indexes.
To me, stocks are a risky endeavor because I don’t know what kind of return I will expect the first week of the month. But, I can tell you that in my 126 unit apartment deal, I will have $90,000 in rents coming in next month. Your 401k can’t tell you that and neither will your stock. What’s more, if a tornado swept in from the sky and took out that entire building, insurance would not only cover loss of rents but also give us the cash to rebuild that property.
My background is in engineering technology, so I understood the tech my friend was pitching and it’s really interesting, but it’s a somewhat risky proposition. I don’t know if any of my investors would want to invest in something like that – especially since they are looking for reliable and steady cash flow. Sure, a multifamily deal may not be as sexy as a Silicon Valley startup, but the assets we invest in are real and will be around for decades to come.
With that, I told my friend that I would have to pass on the tech venture and will stick to the slow and steady cash flow of multifamily real estate. As I said, it may not be as fun as venture capital investing or trading stocks, but everyone has different risk tolerances.
Anyway, do you think stocks are a safe bet? Let me know in the comments.
And if you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel and don’t forget to hit the bell so you get notified when we post new videos. If you are looking for more content or coaching, reach out to us at BulletproofCashflow.com. We are working on getting new content out all the time to help you build your success in the world of multifamily. Be great.
Imagine this. Sixty days ago, you decided to rehab a property. But, you have already put a lot of cash into the deal – about the same as others on the market – and it’s still not done! What’s worse, you think you are still months away from completion. And yet, you are still putting time, money and energy into the failing deal. You may say, “I can’t quit now. I’ve already invested so much into the deal!”
Welcome to the interesting and annoying world of cognitive biases. These cognitive biases only exist in our heads, but they affect everything we do – from how we live, how we work and even how we invest.
As humans, we did not evolve to make logical decisions like a computer. We evolved to survive. Our brains evolved to expend as few resources as possible to conserve energy. To improve our ability to respond to external stimuli efficiently – as an attack by a hungry lion or spending days foraging for food – these biases helped us by providing shortcuts to keep us safe and alive. Think of cognitive biases as mental shortcuts designed to help us survive the hunter-gatherer world from tens of thousands of years ago. In today’s modern world, we do not have these concerns. Many of our scenarios demand more rational calculations than supporting the skills of hunter-gatherers. So, most times, we are left frustrated when what we think is best doesn’t get us the result we want or expect.
While we can’t eliminate our cognitive biases, we can better understand them and even use them to our advantage, not only for ourselves but also as it impacts others.
Here are three cognitive biases that will impact us as investors and some tools that can help you keep them in check. I’m not going to go deep into the science behind why these biases exist – unless you want me to. And if you do, leave a comment and let me know. I can expand on the topic and tell you about other biases that impact how we live.
1) The Anchoring Effect
The anchoring effect happens when we give priority to the first information we encounter – even when the information we uncover later is much more relevant or applicable.
We tend to be overly influenced by the first piece of information that we hear. For example, a broker reaches out to you about a pocket listing and throws out a price. With the anchoring effect, they have now set the expectation of what the sale price should be. That sale price becomes the anchoring point from which all further negotiations are based regardless of what your inspection or appraisal says. This is a common tactic in our line of business. It becomes even more important to bid according to your predefined criteria and not overpay. You need to stick to your metrics and not justify price based on emotion or justifications by the broker.
2) Optimism Bias
The optimism bias is our tendency to overestimate the likelihood that good things will happen to us and underestimate the likelihood of anything bad happening to us. We assume things like a job loss, divorce or even death will happen to someone else, but never to us. On the flip side, it’s worth noting that the optimism bias helps us create excitement for the future, especially as it relates to goal setting. This bias keeps us engaged and moving forward to achieve our goals.
The optimism bias helps us as entrepreneurs to push the limits when it comes to taking risks and driving innovation. Optimism is important to helping us find success, but if we get overly optimistic it can be a huge waste of time, money and resources. For example, you buy into a broker’s report of how a building is in an “up and coming” neighborhood. But, there are rough areas less than one block away. So, while you see great things happening in the nearby neighborhood, there are gunshots and crimes happening nearby. Instead of succumbing to the optimism, you need to be skeptical of the rosy expectations. Anticipate and budget to assume it will be more difficult and expensive than you think. Good ideas need hard work rather than just positive thinking.
3) Sunk Cost Fallacy
The sunk cost fallacy describes our inclination to commit to a project, person or thing because we have invested time, money or resources into it – even if it would be better to cut our losses and move on.
This is the bias I touched on at the beginning of this episode. You commit to personally rehabbing a property. You pour thousands of dollars into the deal and spend nights and weekends working on it. You are still months from being completed yet you have already exceeded the amount you can sell it for today. But you’ve spent so much time and money on the rehab, that you continue to put more resources into it, instead of selling the property to a contractor with the means of finishing it. In such a case, it would probably be best for you to cut your losses.
Commitment is important and required to have any degree of success in business. However, there is a fine line between determination and becoming a victim of the sunk cost fallacy. To avoid getting hit with the sunk cost fallacy, it is best to look for new evidence that it may not make sense to continue and act on it. Follow your projects closely and determine how it’s tracking to budget – especially where there should be a return. If the return does not materialize, it is best to get out of the deal and hand it off to someone that can handle it before it consumes all your resources.
Those are only three of the many cognitive biases that drive our everyday lives. These cognitive biases influence our thoughts, and this translates into our overall decision making. It happens automatically – unless we control what that thought process is and we catch it. Understanding these biases and learning how to control them will help in making better investments.
Anyway, have you ever fallen prey to these cognitive biases? Do you want me to cover others? Let me know in the comments. I can’t wait to chat with you there!