The Three Waves of Real Estate Investing

Real estate has long been known to be a good investment, and some believe it to be a great investment.

Others have sworn it off after hearing about or themselves having horrid experiences with tenants, zoning boards, squatters, and the like.

There are numerous factors at play with any individual investment and determining whether any investment is “good” or “bad” is outside the scope of our time together here. We will have a look at the three discernible phases of investment real estate that are easily seen in many metro areas.

For the sake of illustration I will use my market, Oklahoma City, for examples and reference points. Oklahoma City (OKC) has a metro population of about 1.3 million and encompasses several towns that have been connected by the urban expansion.

Within the overarching term “real estate investor” there are many subcategories with unique skills sets, experiences, focuses, and goals. As a real estate professional who has worked with people in extremely different groups who are all “real estate investors” it seems useful to explore a different terminology. Strap on your cowboy hat and join us on this journey back to the chuck wagon trail.

The 1st wave: The Trailblazers

There is a pack of heavy-hitters that lead the way in real estate investing and we’ll refer to them as the trailblazers or the pioneers. Even among this group there are distinct variances but the common trends are:

• Big budgets
• Ears to the ground
• Big moves

The trailblazers of investment RE tend to be professionals (if not of commercial or residential real estate then typically of a tangentially related field OR of a financial background that allows them to fund the Big Moves). These leaders often make the Big Moves in places that the citizens at large have doubts about (like wayward or downtrodden inner cities, defunct buildings, and the like). These moves are frequently underpinned by the Ears to the Ground – this can be any of several different forms, including friends in the City Planner’s office, Big Data, observing trends of key players (Whole Foods and Starbucks have been noted as useful markers to watch in investment RE) Some trailblazers have found many more and unique indicators to observe in order to know when and where to move.

With their Ears to the Ground and their Big Budgets, these pioneers are poised to get the very best deals to be had in an area (good for them) and often become the signature projects that spark the up-trending of an area (good for the next two waves).

Take for example Midtown, Automobile Alley, and the Deep Deuce districts of OKC: the trailblazers, with their ears to the ground, saw opportunities to revitalize these areas and they put their big budgets to work. The scale of what needed to happen in order to begin an uptrend in these districts was so large that those with smaller budgets (and less risk tolerance) didn’t give it a serious second thought. The trailblazers, though, had the budgets, the stomachs, and the ears to see the opportunity and make big moves.

Thanks to their bold big moves, the value of the area has skyrocketed, giving many people nice returns and giving the city a wonderful variety of inner-city beauty. What these innovators did set up the next wave very well.

The 2nd Wave: First-to-Follow

Now that the trail has been blazed, there is a discernible path to follow for strategic and observant investors.

There are a growing number of these 2nd wave investors and they, too, have some characteristics we can note:

• The First-to-Follow investors tend towards Single Family Residences (SFRs), small Multi Family Residences, and light commercial properties.
• The FtF investor is likely employing more professional-grade tactics in their investing than the 3rd wavers, like “farming” an area, buying lists of distressed properties, or regularly shopping the sheriff sales.
• These investors tend to have access to the best small-to-medium scale deals because of their pro- and semi-pro tactics.
• Many of the FtF group are employed in the real estate industry, or a tangential one – roofing, lending, etc.

These “early adopters” are often positioned to profit well by obtaining pre-trending or early-trending property values and being in position to renovate, raze, rent, or resell.

Below is the “Diffusion of Ideas” curve popularized by Everett Rogers’ research decades ago. Note even among one category — such as our FtF “Early Adopters” how much variance there can be depending on how “early” or “late” of an early adopter the investor is.Those who were leading the 2nd wave pack may have gotten good multi-family housing at a rate of (for example) $45/square foot while the later early adopters can buy at $60/square foot.

If the eventual value per square foot of a Multi-Family Residence in this example would be $150/sq. ft. then BOTH of the investors got a “good” deal, but one has $15/square foot MORE budget to work with and will have higher profits.

To the counterpoint, though, these later early adopters, the “back of the pack” of FtFs also have less risk. In exchange for the lower price per square foot in our example above, the second investor got to watch the Pioneers AND some of the pace-setting First-to-Followers move in an area and then got to pony up the money. In theory this means there is an ability to know that more investment is happening in the area or, at the very least, that the investment leaders are spending in the area.

As is usually the case: risk and reward are inextricably linked.

The 3rd wave: The Eldest Sons

The last to arrive in the Wild Western outpost of investment real estate are the the Eldest Sons. This group corresponds with the Early Majority on Rogers’ adoption curve.

Until the last 10 years or so (perhaps specifically the last 5 years) this third wave has been the first half of the Early Majority, but the prevalence of TV shows and pop-culture success stories singing the praises of knocking down walls, flipping houses, and husband-and-wife-design-and-demo teams has brought a much larger and less trained group into the outpost (not unlike what happened for those 2 years when Pawn Stars was a thing, haha.)

Now there is a large skew among the 3rd wave that makes it more difficult to describe the whole group. Here are some things that are discernible about the Eldest Sons.

• Not professionals (this is not their exclusive source of income)
• Less likely to have the all-around skill sets that the 2nd Wave has, making it more difficult or slower to get an accurate value assessment of potential investment.
• Have access to deals at higher rates on the open market or are paying middlemen for deals or leads.

Let’s hit these points one at a time: Not professionals. This is not a negative thing, but rather an observable trend among the 3rd wave — they tend to be employed elsewhere and invest in RE as a side hustle or a passive income stream.

Skill sets: because fewer of the 3rd wave investors are employed in real-estate-related fields (the tangential trend noted in the 2nd wave), these Eldest Sons are more likely to have a tenuous or loose grasp on property valuation, cost of updates, the value a specific update would bring, the tax implications of a property, etc. This does not need to be a liability to the 3rd wave investor, but rather should be acknowledged and provided for. With an adept real estate professional, a loan contact who does ARV loans, and an excellent handyman or inspector contact can give someone with nearly zero real estate, construction, or investing experience the ability to build great streams of income.

Higher rates: the 3rd wave tends to have access to deals at a higher cost than the 1st or 2nd wave would have for the same deal. This is quite simply a factor of speed and access (remember the pro and semi-pro tactics noted among the First to Follow?). To counter this it is not uncommon to see 3rd wavers paying for subscriptions to aggregator sites that offer them the access to apparently pro-level deals. Some of these have built-in ARV calculators (After Repair Value), area trend reports, and a host of other widgets. Some of these sites are good, some of them are not. Some of these sites are 2nd wavers liquidating some of their inventory at a slight markup.

An example of the waves

Let’s unpack this using a recent real-life example of a Single Family Residence home in Southwest Oklahoma City. The home is approximately 1,500 square feet in a well-located neighborhood that would allow the home to sell for $115,000 at adequate marketable condition.

As the property being discussed here is one SFR it doesn’t even show up on the Pioneer radars. It’s not typically in their wheelhouse.

The seller had not lived in the home for quite some time, so it was in need of quite a few repairs, replacements, and treatments. It was also legally recategorized from “owner occupied” to “not owner occupied” because the seller has a mailing address associated with their tax filings other than this house’s address. That triggers a flag in the pro/semi-pro systems of a FtF investor and many begin to direct-mail offers to the house. By the time I came into the picture the seller had received upwards of 30 direct-mail offers or solicitations for the home, most or all of them from 2nd wave investors. The top dollar offered for this home was $64,000 by one of the investors closer to the Early Majority line, but still clearly a 2nd wave investor.

The seller was advised to consult with a real estate professional, so I was called in. After assessing the home and determining the seller’s objectives, I called in various contacts and we went to work. For $0 out of the seller’s pocket we were able repair or replace about $14,000 on the home.

Having removed three of the biggest detriments to the home’s value, we were then looking at a market value of around $90,000.

At the point where I put it on the open market, the entire 3rd wave had access to it. Before that point only the 1st and 2nd wave could see it. Now that a significantly higher number of investors had access to the home it was a quick deal.

If the 2nd wave investors had purchased the home at $64,000 they would have spent $14,000 to get it to our marketed state=In for $78,000 at this point. If the 3rd wavers purchased it for $90,000 they would have received the SFR with $14,000 of value adds and a home warranty that put their out-of-pocket expense in replacing the oven, stove, or microwaves that are all late in their life-cycles at around $150 instead of $1,500: this 3rd waver could be “all in” for $90,000.

You can see here one example of the 2nd and 3rd wave investors and how their timing in the cycle gives them access to a home at different price points. Something of note here is that the FtF 2nd wave investor carries significantly more risk in the process that can be seen by this modification of the last story:

FtF investor buys house “as is” for $64,000 without it going to market and not using a savvy agent. They begin the $14,000 of work that is needed and all is going well until they discover a slight leak in the drip-tray in the attic has led to a subtle, yet wide-spread mold problem. How much mold? What type? That will require a more professional assessment: $650 for the mold inspection and mold sampling, then (if required) $4,500 for the whole-home treatment.

This FtF investor is still “all in” for less than the 3rd wave investor (sitting at $83,150 in this hypothetical scenario) but carries ALL of the risk whereas the 3rd wave investor would have been protected by the due-diligence process of a standard residential real estate purchase. So, the FtF investor can have access to a given home at a lower price-point because of their strategies and their timing in the sale cycle, but also carry a significantly higher risk level.

An aside for the seller

Let’s think through the lens of the seller of these SFRs; which is better for them?

In our example above the seller would have an approximate net of $64,000 with the FtF investor and $83,000 with the 3rd wave investor. So, $19,000 more by consulting a real estate professional and selling to the 3rd wave investor. Simple choice, right?

BUT the seller would have gotten the $64,000 in a week’s time (estimated) from the FtF investor (note: this is entirely subject to the FtF investor’s funding choice and how straightforward the title work would be on the SFR). With the real estate consultation, the repair work that would happen (for free in this scenario), prepping for market, listing it, fielding offers, and getting the home under contract, (and after it is under contract there are a few more steps) the seller would receive their $83,000 at least 6-weeks later than the FtF investor-purchase scenario.

This increased wait time and the uncertainty of what the home would fetch on the open market make the lower yield from the FtF investor appetizing because it is fast and more certain. This is not unlike what Zillow is rolling out in some markets with Zillow Instant Offers and a slew of other similar concepts in the real estate world. But, in the scenario that I have laid out (based on a recently observed transaction) 6-8 weeks of waiting led to the seller netting $19,000 more. Depending on the seller’s situation (like what is the carrying cost for the seller, what urgency is there for the cash, etc.) the quicker sale at a lower return may well be worth it.

Bringing it home

It’s a brave new world in the investment real estate realm. What used to the haunt of the Pioneer’s and the underworld kings of RE are now frequented by all ranks of investors or would-be investors inspired by the hoards of “let me make a buck off of you” Gurus (think Than Merrill, the El Moussas, and so on ad nauseam.

Regardless of where you are in the process or what your goals are in real estate investment it is invaluable to know the landscape that exists and the waves of investors. As a would-be investor or a seller evaluating your sales options, understanding these waves can give you solidarity in moving forward and a better idea what quality of deals you will have access to and why. If you are a current FtF or 3rd wave investor and are diligently learning more of your craft — kudos to you! Self-awareness is one of the qualities that differentiates long-sustained growth and “boom and bust” trends in investment. Know your tendencies, sharpen your skills and self-awareness, and constantly evaluate if you are doing the things you should be doing to succeed in the space.

Together we are in pursuit of all around excellence.

Keep it real, estate
Will Fraser