Play the Odds When Managing Properties

If you’re managing investment properties and losing money, it’s most likely your fault.

When managing an investment property, there are a lot of things you can know. You can find out the age of the roof and the furnace. You can look up what other properties are charging for rent in your area. You can even find out whether or not applicants can afford the rent or has debt collectors chasing them. So why do so many people lose money managing a property? The answer lies in understanding the game of poker.

I recently listened to a podcast with Annie Duke, the former professional poker player turned business consultant, who wrote: “Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts.” Annie helps people think probabilistically, the aim of which is to go from ‘I have no idea’ to a position where you have confidence the probability of something is, say, between 30% and 60% or that you might win 70% of the time or that the odds are maybe two-and-a-half to one in your favor.

“Obviously there is still a lot of uncertainty in there,” she says. “You are not anywhere close to 100%.

“But the fact you are really making this commitment to try to get as close as possible to an answer – that helps you with the biggest problem we have. It is not so much that the probabilities are unknown – because they are somewhat known – but the fact the incomplete information we are working with is actually the driver of most of our mistakes.”

As Duke goes on to explain, incomplete information falls into two categories:

“There are things you don’t know – that would be the on the ‘information asymmetry’ side,” she continues. “But then, within the things you do know, your own understanding of how good that knowledge is – how biased it might be, for example, or how confident you should be in it – is actually incomplete as well.”

“One of the drivers here has to be a total unwillingness to accept that a probability is unknown,” adds Duke.

“As soon as you do not accept a probability is unknown, that puts the quest for better knowledge in the forefront, because it is the better knowledge that will allow you to start narrowing down those probabilities. You just have to be comfortable with the fact – and this is true in poker as well – that there is almost never going to be a precise probability, that it is still going to be a range.”

To apply this to property management, do not accept not knowing the probability of the water heater breaking or a tenant bailing on rent. There are only so many things that actually need to be fixed:

• Roof
• HVAC
• Flooring
• Plumbing
• Fixtures (plumbing and electrical)
• Water heater
• Appliances
• Components (garage door/breakers, etc.)
• Structure (foundation, framing, drywall)
• Kitchen (cabinets/countertop)
• Windows
• Paint
• Landscaping

All of these items have a finite life and will need to be replaced. Don’t just make a blind bet that your carpets are going to last forever, take the time to research the average useful life for the one you’re installing (I’d recommend applying a safety margin on top of that) and save the appropriate amount each month to be able to replace it when the time comes.

Your cash flow might not be as great for several years as you build up your reserves, but thinking probabilistically will dramatically reduce the odds of losing money which is really the first rule of investing.