Does percentage still matter if the profit is high enough?

Question

So I met with someone the other day, and we got to talking about deals. He had been doing this for quite a while, but was super cocky and kind of demeaning. I showed him a deal that me and my company had worked on a while back, but he said he doesn't do any deal with less than a 22% return. I had mentioned one where the percentage of profit was only 16.5% but it was $380,000 in profit. I understand you have to have the capital to fund a project like that, But do you think it would be worth it?

Andrew Johnson · Answer

@Seth Thompson Just like @Christopher Phillips suggests, it's often about opportunities rather than hard dollars or ROI.  If there are abundant deals (in his world) at 22% it doesn't make any sense to do a 16.5% deal.  He can just do *more* deals with a 22% ROI.  But playing devil's advocate he might only seek out 22% deals because even if it there are hiccups it can take the cushion.  If there are cost overruns that cut out 15% of the profit, he still makes 7%.  I'm just making up numbers but 22% seems a touch random (as a threshold) so maybe he has had specific experience that tells him that's what the proforma needs to show to cover the unexpected.  I don't know.  I'm just guessing.  Or he has investors that demand a certain preferred return.  He has to have 22% because his investors get 7% (preferred) and he has to have enough left over to split the rest, pay operating costs, etc.  Again, just randomly guessing.  My only point is that cost structures on deals are far from uniform.

As for your deal of 16.5% and $380K in profit you just have to think about what happens if things don't go well.  When you start dealing with large numbers it doesn't take too long for "5%" to become real money.  And all of your eggs, presumably, are in the one basket so there's no amelioration of risk with diversification.  But, hey, no risk no reward.

Christopher Phillips · Answer

@Seth Thompson

% is relative to each investor. Most new investors are willing to take a lower profit margin because they are new.

It's all about risk versus return.

If an investor is only earning 1% in a savings account, they will be more willing to seek 5%-10% on an investment.

If the investor is already earning 10%-15%, they will be less likely to settle for less returns and will seek 15% to 20% or higher instead.

David Faulkner · Answer

I agree that returns must be risk adjusted ... so not only $Return/$Invested but also $Return*%Risk ... keep in mind that if you are an unknown entity to this investor, then he will likely adjust up %Risk. Also, whether it is deserved or not (that's another argument), if you are introducing yourself as a "wholesaler", then %Risk goes WAY up and professional respect often goes WAY down. Finally, experienced investors also think in terms of $Return/Headache ... if this property looks like it will be a PITA, then return expectations go up.

I'd see if you can convince the investor to go through his mental calculus with you of what specifically he is looking for and what specifically the deal you are presenting is lacking. You can explain, ok, this deal may not be a good match for you, but if you can describe for me what a good match would be then I can go out and find it for you. If he says no, you lose nothing. If he says yes but you can't find it, then you gained some knowledge. If he says yes and you do find it, then you gained some knowledge, another deal, an experienced investor to your network, and a possible mentor. I would not let cockiness get to you ... you have to grow a turtle shell to these kind of things if you want to make it in this business ... I'd just try to figure out if it is just unfounded hubris or as Mohamed Ali once said "It's not bragging if you can back it up."

Khaled Helmi · Answer

@SethThompson - its not just a return question its a question of risk.

Just doing the backwards math, it means a necessary $2.5mm investment to get the $380k profit & 16.5% return.

When it comes to corporate investments, 15% is kind of the unofficial minimum to higher risk development projects (i'm talking the mining industry not real estate) with 20% really being a good goal for a higher risk project.

It all comes down to what is being done (general project market), your experience in similar project, general past performance, and the quality of your plan on this project.

If you check all those boxes and this is a project similar to what you've done before, 16.5% return wouldnt be bad in my view.  If its something out of your wheelhouse, then i'd probably look for 20+% UNLESS you had an extraordinary plan to succeed in the project.

Whether this guy is right or wrong comes down to the project risk and your experience

Alexander Felice · Answer

Both matter, and you don't have to choose between one or the other

Percentage is a more valuable metric than raw volume, however because the average cost of living is (on scale) the same for everyone as you go towards larger volumes of money then the percentage seems less important.

I believe what you're saying is essentially: when it costs you 30k a year to live and you make say 10Million a year then it really doesn't matter if that 10MM was a 4% return or a 400% return. (I use extreme numbers for emphasis)

That said, returns are not just a measure of output, but also efficiency of input. So yeah if you make 380k on a flip that's great but the ROI % shows how well you're using the input money as well. if it takes you 10MM to make 380k you can still certainly live off that, but it would be a horrible use of capital.

also, negotiating between 16% and 22% is crazy since both returns r really high. Most 1st world problem of all time LOL

Lesley Resnick · Answer

I am somewhat skeptical of what he said.  It is easy to get to big percentages on small deals.  Larger deals or a lot of them tend to bring the returns down.  Typically the larger the deal the lower the cap rate.  There is a limited supply of homers.  I will take 380k "losers" all day long.

Steven D. · Answer

There is a percentage of risk that goes along with ROI. If you made that 380k on an investment of 10 million (Doubtful but looking at extremes) a few percentage points in the wrong direction could put you in the negative. I think that people look a bit too heavily on minimum return, but they do account for still turning a profit with worst case scenarios which bodes well long term.

Laura Alamery · Answer

@Seth Thompson What you wrote, said it all :) ... "He had been doing this for quite a while, but was super cocky and kind of demeaning."

Some times investors who have been in the business for a while think they know it all. But that is what can get them into trouble too.

Like @Christopher Phillips said, "% is relative to each investor." If you know and feel this would be a good deal, go with your gut feeling and look for another investor. Personally anything over 10% ROI in a year or more is worth taking a look at.

Seth Thompson · Answer

@Christopher Phillips  That makes sense. Thank you for your input!

Dan D. · Answer

All the deals I've done are deals that wouldn't pass the rules here on this forum, but I'm happy with each one (so far).

But my motivation is different than what the next random investor might want.

Does percentage still matter if the profit is high enough?

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