Real Estate and Pencils

Let’s compare real estate to the pencil business. You are in the pencil business and your standard pencil sells for an average price of $0.10. Some fancy stores sell the pencil for $0.12 and some discounters sell it for $0.08. You are the pencil manufacturer. To make a profit of $0.02 per pencil, you must get a wholesale price of $0.06 per pencil.

Who cares if one guy makes one cent on a pencil and another guy makes three cents on a pencil and someone makes two cents on a pencil? Who cares about pencils? The point of the pencil analogy is to help you to gain insight into the real estate investment business. You can do the same thing with real estate that the pencil guy does with his pencils. The difference is that his pencil may cost $0.10 and your real estate may cost $200,000. He makes a couple of pennies and you make thousands. If someone can make 10%- 20% margins buying and selling pencils, you can make 10% -20% margins buying and selling real estate. The business principles of buying at wholesale prices and selling at retail prices are the same.

Actually this isn’t totally correct because investing and making money in residential real estate can be a lot easier than being in the pencil business. In the pencil business, all of the parties involved: the manufacturer, the wholesaler and the retailer are certainly very knowledgeable about pencil values. In contrast, in residential real estate, you may be dealing with a seller who has little personal knowledge of value who is being advised by an agent who may not know much more. In many residential transactions, your specialized knowledge of value will give you a clear advantage when you negotiate.

If you were buying stocks, would you ever invest through a stockbroker who never bought stocks for himself? You would not. Then, why would you choose to work with a real estate agent who never bought investment real estate? In fact, very few real estate agents own investment real estate. It may be difficult for you to find a residential investment agent in your community. The obvious reason is that the agents who buy investment real estate make enough money that they don’t have to be real estate agents any more. Being a real estate broker can be a tough job.

Make a lot of offers and you will make a lot of money while suffering through a lot of rejections and indignation from both sellers and their agents. The overwhelming majority of people cringe from any type of rejection regardless of the potential reward.

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