What Makes a Good Deal?
Is this a good deal?
As an investment sponsor, this is a question I get asked all the time. My clients want to feel good about placing their money into a particular real estate venture—and justifiably so!
One easy response is: “We only promote good deals!” In one sense, that’s absolutely true. We make it our top priority to find and underwrite fundamentally sound real estate deals. But that fails to answer the real question behind the question, which is: “Is this a good deal for me?”
Answering that question is not as simple as identifying a yield, internal rate of return, potential appreciation. Even if these all look good, a property’s characteristics or an investment’s financial circumstances may mean that it isn’t a good deal for some investors.
We may not always know if a property purchase will turn out to be a “good deal” for a particular investor, but we can do more than shrug our shoulders. We start by recommending that our clients only consider an investment a good one if it meets at least these five criteria:
- It is financially prudent for the investor
On October 20, Blackstone announced that it is buying Peter Cooper Village and Stuyvesant Town, two very large apartment communities in Manhattan. The price: $5.3 billion, one of the largest real estate deals in history. Clearly this is a deal that most appropriate for very sophisticated high net worth or institutional investors. It is definitely not a deal for the individual who wants to invest his $25,000 bonus with a nice return and a high degree of certainty of receiving all his money back when he needs it. This extreme example illustrates the point that some deals can be good for some buyers, but bad for others. A deal can hardly be “good” if it stretches the buyer’s finances beyond prudent boundaries.
- It fits into a plan
Some investors seek a steady cash flow from a portion of their portfolios. In today’s environment of very low yields on liquid investments, real estate can provide this. Other investors can afford to wait patiently for a property to appreciate because they have other assets producing income. Well located land might be a good investment for this investor. In both examples the real estate fills a particular need in the portfolio or investment plan. Remember the old TV commercials claimed that the sugary cereal was part of a healthy breakfast? It was not the entire breakfast. The same principal applies to a healthy investment portfolio.
- It’s better than alternatives
Will the property outperform others in the same asset class? Can we take on and manage more risk to achieve a better return? Here is where due diligence and wise counsel come into play. Experienced professionals don’t have a crystal ball, but they can identify factors that historically result in superior financial performance.
- It works for everyone involved
Deals which are based solely on price are tough to make. The best deals are those in which each party has a distinct motivation that the other party can accommodate while maintaining the primary reason for entering into the transaction. When this happens, neither party gets everything it wanted, but get what is most important. Buyers and sellers who are more collaborative tend to be more successful in the long term than “bullies” who squeeze every cent out of a deal.
- It performs at least as well as expected
One of the best strategies for making good deals is creating and managing expectations. Just about all real estate investments carry a degree of uncertainty which impact the ultimate financial outcome. Most investments have both a quantifiable and a speculative component. We tend to focus on what we can quantify and view the speculative component as a more of a bonus. While it might make the deal look less attractive on the front, it also allows us to exceed expectations.
It takes more than good real estate to make a good deal, and the parameters are different for each unique client. But that doesn’t mean there aren’t common factors. These are just a few of the ones we consider when recommending new investment opportunities to our clients.