Parable of the Chrome-Plated Printing Press

There once was a kindly seller who wanted to sell his nice printing press.  The printing press was chrome plated and everything, so it must be worth a LOT – let’s say $1,000,000 (why am I picking my teeth with my pinky :>). 

One day, a cold hearted buyer came around and offered the kindly seller a measly $500,000.  Oh, the insult!  The outrage!  The seller stomped his foot and rejected the offer.  He even refused to talk to that buyer ever again.

When the buyer walked away, he was asked by the seller’s neighbor why he would insult the seller so.  The buyer replied that although the printing press was very pretty, if he was going to spend $1M, he would rather buy the printing press in the next town.  After all, that printing press could print twice as fast.

Okay, as a parable, it stinks.  As a lesson in real estate, it is spot on.  Let me explain in two arenas.

1. Residential real estate.  Many agents can tell you that they have lived with this parable when they try to get a listing (or a price reduction).  The market is loudly saying that the price of the house is X, but the seller wants more.  Often for the reasons that they just spent $30K on new furniture, or their bold paint colors were the height of fashion 5 years ago, or they need $50K in profit so that they can buy a new car.  None of these things matter to a buyer who can find another similar house for less.  So what that it is ‘chrome plated’ – why is that a benefit to the buyer and why would they pay more for that?

2. Commercial real estate.  In many ways, commercial real estate is just like a printing press.  The buyer is looking to buy a cash flow that will take no more work than a similar investment.  Sellers in the commercial arena often talk about potential rents or ability to expand as reasons to pay them more for their properties.  Why is the buyer going to pay the seller for work that the buyer will need to perform?  If the buyer needs to raise the rents, and suffer the turnover that may happen, then why should the seller get more money?  Likewise, if the buyer is going to have to build new buildings to expand, or change the zoning to allow expansion, then why should the seller receive more money?  This would only make sense if this property is unique in its ability to expand or receive more rent.  How often is that the case?

Say you have the ability to pay up to $1M for a commercial property.  You look around and find 2 that appeal to you.  One of these properties has a cash flow of $10,000 per month and the other property has a cash flow of $5000.  Which one would you buy?  If the second property owner told you that you could increase the rents or that there is room to expand the buildings (you will need to spend more money to do this) and that you should be able to get the cash flow up to the $10,000/month range, then would you change your mind about which one to buy?