When billionaire Warren Buffet buys a company, do you think he bases his decision on a coin toss, his investment instincts, or an analysis of the company's business models and financials? If you know anything about his unprecedented investment success, the answer is obvious: Buffet focuses on the numbers and won't commit a dime until a company's performance matches his strict investment criteria. As it says in Buffetology, Buffet "commits capital to investment only when it makes sense from a business perspective." How does he know the deal makes sense? Because Buffet's mastered the science of knowing where a company's money comes from. And, if as a real estate agent, you think your money comes from commissions, read on.

The first step in analyzing a company's financials is to take a hard look at its economic model. In other words, Buffet first investigates where the company's money comes from (the activities that lead to gross revenue), where it goes (expenses), and what's left over at the end of the year (net income). In short, Buffet follows the money. He does this because he understands that a business without a sound economic model probably isn't a sound investment no matter how undervalued it may be. Buffet's careful analysis of economic models is one reason he's an amazingly successful business person and one of the wealthiest people in the world.

Now, some of you reading this column may wonder what all of this has to do with real estate sales? It has everything to do with it, especially if you want to make the transition from being a sales person to being a business person. If you do, then learn a lesson from Buffet: Understand the underlying economics of your business and focus on the key activities that have the greatest impact on your profitability.

All the top-producing agents that we interviewed for The Millionaire Real Estate Agent (McGraw-Hill 2004) successfully made the transition from a self-employed sales person to being a business owner by mastering their economic model, which is one of the four foundational models outlined in the book. Think of your economic model as a formula that describes the way your business works. It is your equation for success and describes the relationship between a series of activities and the specific outcomes they produce.

In real estate sales, the specific outcome most agents focus on is their net income. After all, at the end of the day, you are solely responsible for paying yourself. So, let's quickly outline the basic economic model of a real estate sales professional and then show you how to put it to use to target a net income for your business.

If you look at Figure 1, The Basic Economic Model of The Millionaire Real Estate Agent you can see that everything starts with seller and buyer listing appointments. If you don't have buyers and sellers, well, it's unlikely you'll have sales, right? So the model begins with the number of appointments you successfully convert to buyer and seller listings taken. Next, you take into account that only a certain percentage of these will actually close and multiply that number times your average sales price and commission to get your revenue numbers.

The Basic Economic Model of the Millionaire Real Estate Agent

After you calculate the gross revenue from each side of your business, subtract your expenses (which your Budget Model should be tracking!) and that figure will be your net income. Obviously, tracking all the numbers in your economic model (if you aren't already) becomes your first business task. Most are easy enough to discover except possibly for your conversion rates, which will require a little attention over time. Until then, the percentages included in Figure 1 reflect solid, conservative averages to guide you.

So you see, your money doesn't really come from commissions. Sure, that's ultimately how you get a check. But, if you just focused on this aspect of your sales business, you'd miss the overarching point of your economic model: Appointments converted to seller and buyer listings converted to closed sales equals gross income. It's important to note that your personal conversion rates are the key variables in your income equation, which brings me to another important point about economic models: They highlight the knowledge and skills you need to reach your ultimate goal. If conversion rates are key to increasing your net income, then you need to master your scripts and dialogues so you can make convincing listing presentations. If you can't do this, then you won't be very successful no matter how many appointment leads you generate!

Over time, as you get more and more insight into your conversion rates and average sales price, you'll be able to confidently set net income goals for your business. Then all you have to do is create the opportunities for the appropriate number of listing and buyer appointments to reach your goals. Figure 2 (below) shows what your numbers might look like to reach $100,000 or more in annual gross income.

The Basic Economic Model for $100,000 in Gross Income

The interesting thing to note is that with these average conversion rates and an average sales price in keeping with the current national average, you'd only have to go on a little more than three appointments each month to hit your gross revenue goals! Unfortunately, many business people have no idea where their money comes from, how it is spent, and what's left for them at year's end. What happens to these people is that their economic model is based on activities with no projected outcomes attached. As a result, they have no visibility into their actual conversion rates and can't accurately project their income based on their day-to-day activities. Buffet doesn't run his businesses that way and neither should you.

My question to you is what does your economic model look like? If you're unaware of how it really works, then you're not being "on purpose" in your money matters. So the issue isn't whether or not you're following an economic model. The issue is uncovering what model you are following so you can identify what's working, what's not and what you can do about it.

Find out now because when it comes to business, ignorance isn't bliss; it's undependable, unpredictable, and often unprofitable. So remember that an economic model not only shows you what your revenue, expenses and net income are, it also helps you determine the source of your success. Ask yourself if you run the type of business that Buffet would invest in. If not, you now know what to do.

Published: September 7, 2004

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