Understanding brokers

General Advice

DEC 11, 2021

Almost always, the main revenue model of an online guru is from the sale of their courses. This isn’t a commentary on the efficacy of a guru’s course, if you get value from it — great for you. But I’m dumfounded at how self-proclaimed stock and real estate prophets generate the bulk of their money from course sales, while sharing so little about their own portfolios.

A note re: stock gurus — If you dollar cost average over the same period, you’ll out earn all funds, traders, and any other guru that graduated from TikTok university.

I’ve been kind with my thoughts on REI; I don’t want people to get a sunshine-and-rainbows impression of it (like you would from a guru). Making the wrong decisions in RE can set you back financially for generations; your grandkids will suffer because of the mistakes you make. I don’t like drinking the Kool Aid, so here’s to some skepticism — below, I’ve written about 2 moving pieces of a transaction (the deal, and the broker) and how things can get ugly with each. I’ll write about the other pieces in the coming weeks (re: the contract, and the loan).

(1) The Deal

When I first started to underwrite deals, I would fall in love with the idea of the property. What I came to recognize is my proclivity for confirmation bias. It’s in our nature to look for things that reinforce our opinion, and disregard other things.

What does this look like when analyzing a deal?

I ignore the big warning metrics I set for myself. When researching residential deals, I have a litmus test: Cash-on-Cash ratio range of 8-12%. If a property falls below, move on. However, there were (and still are) moments when I would still continue my due diligence on a property. Writing about it now feels absurd — I willingly spent time & money on trying to make a deal work when, on paper, it didn’t.

I’d focus on other metrics to justify the low return. For example, if a property didn’t pass my test but it was on a really good street — I’d dig deeper into understating my expenses & overstating my revenue in order to justify the investment model. It’s bonkers, no one is immune to confirmation bias and I was practically committing financial fraud on my own self. LOL.

(2) The Broker

Decent brokers are worth more than the commissions you’ll pay. A broker can part the 7 seas in order to find the right deal for you, but there’s a lot of poorly incentivized brokers out there. Brokers get paid out a % of the total deal value only if it closes — you can probably tell where I’m going with this.

The ‘principal-agent’ problem is one that I’ll continue to face; it’s one of the main reasons why I got my RE license, so I could bypass brokers altogether. The principal-agent problem specifies that there’s a conflict of priorities between the principal (you) and the representative authorized to act on your behalf (agent/broker). Brokers are incentivized to close deals, that’s the only way they’ll get paid. So if a broker is incentivized to close a deal, there’s a higher chance she’ll push for the closing even if it’s against your best interest.

What does this look like when you’re underwriting a deal?

You’ll be surprised at how crappy of a job most commercial property owners do when maintaining their financial records. People get lazy and don’t bother updating costs, revenues, financial reports, etc. in their bookkeeping. This makes it incredibly difficult for aspiring investors to get a firm grasp of the numbers on a property before pulling the trigger — so who do we turn to? The broker.

Brokers will usually market a property by providing some financial info, this is called the Pro Forma. You should never underwrite a deal with numbers listed on a Pro Forma — you might as well assume the numbers are completely bullshit because they’re based on either: best case scenario, or completely extrapolated out of the broker’s ass (yup). I’m a strong advocate of never buying any kind of real estate sight un-seen, I don’t care if it’s a 100% Cash-on-Cash return. Up until the final closing, be ready to walk away. I say this because it’s crucial to physically walk through any property you’re purchasing to get a good ‘feel’ for it — you’re able to get a better idea of the actual building profile by seeing & touching it. This will also give you an idea on the numbers of a property when you’re doing your due diligence.

There are a lot of things that can fail with any kind of real estate transaction, but most don’t realize that a lot of what can go wrong is non-tenant facing; it’s internal. For example, you can get lazy when underwriting a property and not realize when a broker’s just trying to close a deal. On the other hand, REI is a fantastic tool to create a hugely positive social impact on a community — but much like anything, it requires sweat equity to follow through and be profitable.


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