Investing in “Cheap” Real Estate: A $10 Million Pig Is Still a Pig
On occasion, a few have tried to disagree. But where I come from, pigs aren’t kosher.
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Over the years, I’ve written quite a few articles describing a concept in real estate investing that I coined as buying a “pig.” In the past, I was essentially referring to buying “cheap” properties—something I think many investors should avoid.
The concept of pig properties keeps coming up in the forums with persistent regularity, so I’m going to kick it up a few notches. Instead of talking about pigs in the context of a $30,000 house in the Midwest, I want to discuss a $10 million pig in the large multifamily space in one of the fastest growing markets in the country.
It’s a bit of a different breed of pig. And it’s definitely bigger. But—it’s still a pig. And it still ain’t kosher!
A 100+ Unit Pig
My partner Sam and I considered but walked away from this asset, opting to make a run at something else instead. It was a completely off-market property. We considered the deal for about three days and underwrote the numbers, but we ultimately decided to walk.
The interesting and educational component of this, however, is the fact that the numbers looked gorgeous. Everything lined up beautifully… on paper at least!
We still walked.
What Is a Pig Exactly?
First things first. Real estate investing is a synergy of two elements:
Every transaction is a matter of buying down the risk by lowering the price to the point where the reward is more attractive than the risk premium.
A pig is a deal in which the risk, for one reason or another, is so high that the amount of discount on price necessary to right the ship is simply not possible. In some cases, this means that the property is worth $0. And believe it or not, in some cases, it may even mean that the property is worth less than $0.
Secular Definition of Pig
This conversation could get very technical and scientific in a hurry—so let’s not. Let’s think in terms that all of us can understand instead.
The way I see it, more so than anything else, risk in real estate is mitigated by growth. And growth is driven by desirability. The more people want what you have, the lower the risk profile.
Think about this. If you own something that everyone wants, then it appreciates due to the demand. This means that you can feel good about deploying capital into CapEx as needed because you know you’ll get it back.
If you own something very desirable, then in times of an economic downturn this asset will have the greatest chance of maintaining value. Why? Because where it is and what it is, is desirable and will always be desirable.
The value will fluctuate, but you should be OK. Or if you experience personal distress, or if having made a bunch of money you experience a feeling of “screw it, I’m done,” well then you’ll have no trouble selling.
Why again? Because where it is and what it is has always been and will always be desirable.
Simply put, an asset that everyone wants is the opposite of a pig. Assets that possess a lot of desirability also possess a lower risk profile, which is the opposite of a pig.
The inverse, however, is also true. If you have concerns about the intrinsic desirability of an asset, well then you are probably looking at a pig.
Don’t buy a pig!
The tricky thing about desirability is that it has to be considered over a period of time. It’s easy to put lipstick on a pig and fool a lot of people for a minute—especially less experienced people and especially in a hot market.
But the question really has to be asked: “This asset may be desirable today, but will it be desirable 10 years from now? Why or why not?”
So, Are Pigs Always Cheap?
In the case of a $30,000 single family residential (SFR) pig property that I wrote about in the earlier articles, the market value is equal to its purchase price. They are both $30,000, which makes it financially obsolescent.
It was what it is, what it will always be: $30,000. You could put gold-plated toilets in this SFR; it’s value will remain $30,000.
In many cases, this works the same way in multifamily. If today you are buying multifamily for $30,000 per unit and with stabilized rents in this location being $500, you are definitely buying a pig.
In a world in which the average rent across the nation is $1,470, you have to ask yourself why the rents you are buying are capped at such a low amount. More importantly, you have to wonder what these rents will be in the future…
Those rents will always be what they are, and those units will never sell for more. Repeat after me: PIG!
Why is this the case? The rents will always stay low because there is not enough economic activity to facilitate growth. The value will stay at $30,000 because, if there is no growth, the market will forever discount the value.
This will lead to deterioration of the physical structure, because you’ll hate to put money into new mechanicals since you’ll never be able to get it back due to the lack of appreciation. It’s a vicious cycle that leads to slums… or pigs.
This is the cheap version of a multifamily pig.
The $100,000 per Unit Pig
Above is one version of how the story goes. However, Sam and I just walked away from a pig that would have cost us close to $100,000 per unit. The asset appreciated like crazy over the last decade because it’s in a very high growth area—Phoenix. While the in-place rents were low, we could have gotten the rents way up.
This wasn’t a $30,000 pig. This was a different breed of pig. But it was still a pig.
This asset penciled very well on paper, but relative to operations over an extended period of time, it wasn’t desirable to us and wouldn’t have been desirable to our buyers when we wanted to sell.
So relative to the exit, I felt that it wouldn’t be desirable to the widest cross-section of my potential buyer pool. There wasn’t enough sustainable desirability.
Yes, Sam and I could have gotten the rents up, but there was only one strategy that would have done it. These units would have been attractive to a particular class of tenant, but that class of tenant is not the majority.
Therefore, if something went wrong with this business plan, it would amount to a big oops.
Furthermore, the age, mechanicals, and footprint were all such that this would have been a difficult asset to sell. Everything sells today, but that’s not going to last forever. I want things that have lasting desirability!
Real estate is not about the numbers. Real estate is about stories.
Every story has a beginning, middle, and end. The very difficult part for so many of you to understand is that the underwriting rationale begins with the end. Nothing else matters if you can’t clearly see the exit.
This is not because you want to exit. If you want to hold onto this asset, fine. But hold it knowing that everyone wants it and you can get out whenever you want.
This is what defines safety. And this is what you want.
There are many ways to characterize a pig in real estate. Today’s characterization is an asset without a clear exit. Whether it’s because the asset is worth today no more than it was worth yesterday, or if for any other reason the exit is cloudy, it’s a pig.
Don’t buy a pig!
Have you ever invested in a pig? Do you know someone who has?
Tell us the story in the comment section!