“Wait… what? How is he achieving a 64.5 percent IRR?”
That was my original question, as well. But now I know the answer.
I did an investor webinar recently to introduce our investors to the newest operator in one of our funds. My company and I have received a lot of great feedback from investors since the webinar. My favorite reaction was perhaps the most common.
Today I was speaking to one of my most experienced investor friends. (He and I have invested together since the early ’90s.) When he heard about the new operator we’re giving investors access to, he exclaimed: “Wait… what? How is he achieving a 64.5 percent IRR?”
It’s not a simple answer, because it involves acquisitions, upgrades, operations, and finding a great buyer at the end of the line. But there is one thing that this operator does extremely well, and I hope you can learn to do it, too. If you can do it successfully, you may be on your way to world real estate domination (or at least a nice stream of passive income).
What the Most Successful Real Estate Investors Do Differently
This operator looks for anomalies. Wait… that’s too simple.
This is what has made Warren Buffett one of the world’s richest men. Warren’s strategy was actually quite simple—that’s the beauty of it.
Warren spent his days and nights studying companies. He made his fortune by looking for anomalies.
Warren didn’t use fancy spreadsheets. He rarely used a calculator. After years of prodding by friends and co-workers, he reluctantly bought a computer—but just to play Bridge.
(Buffett plays Bridge for eight hours a week—sometimes with cards, sometimes online. I find this amusing, but I’m guessing life can get boring at the top.)
Succeed in Real Estate by Pouring Over Numbers & Spotting Anomalies
Because Buffett stayed hyper-focused and poured over information on thousands of companies, he was able to spot inconsistencies between prices and earnings, between cash-on-hand and shareholder distributions.
Buffett became a master at spotting anomalies.
I just read The Snowball, which is the authorized biography of Warren Buffett. I learned that Buffett made dozens of small investors into millionaires while he was relatively unknown.
Those were the days when he hated the spotlight. As I said, he spent his nights and days studying. He read and studied for up to 80 percent of his time. He still does.
Now that’s focus! And dedication.
Be Focused & Dedicated—to One Thing
Those who know me know that I am fairly obsessed with The One Thing by Gary Keller and Jay Papasan. My life goal is to live out the principles in that short but powerful volume.
This book teaches us to obsess over one thing, the life goal we want to achieve. But it also boils us down to focusing on the one thing we need to do today, in this hour, to get there.
Warren Buffett’s long-term, big picture one thing was making money. But his daily one thing, that micro-level effort that demanded his focus, was reading and studying—looking for anomalies.
They say you make money when you buy. That is partially true.
A typical operator in the commercial real estate space these days analyzes a few dozen deals that are brought his way. Though multifamily if dreadfully overheated, there are still deals in self-storage and mobile home parks.
With several dozen deals to choose from annually, a good operator may be able to acquire a few good ones. And because of the fragmented market, they can often achieve good returns.
Be Strategically Different Than Your Competitors
Our newest operating partner has a different strategy. With four full-time people working the phones daily—making calls to about 2,000 owner-operators each week—he has the opportunity to sift through hundreds and hundreds of potential deals each year. He has the pick of many deals that others will never see or hear about.
He has the chance to find anomalies.
This is one of several reasons he is achieving seriously outsized returns. And these independently verified results have led his company to be named the No. 1 performing value-add real estate fund (under $50 million) nationwide last year and No. 2 this year.
But like Warren Buffett in the late 1960s, you’ve probably never heard of him (yet).
An Example of the Upside of Anomalies
Let’s take a look at one of his recent self-storage acquisitions.
As I said, this operator has a team of four or five full-time acquisition specialists who work the phones. They call about 150 to 200 self-storage and mobile home park owners and managers each on a daily basis. Many of these are mom-and-pops. Their goal is to drum up off-market transactions.
They are looking for anomalies.
Spot the Anomaly
One of their team members, James, made contact with the owner of a facility built in the late ‘70s. She seemed nervous but admitted that she wanted to sell. James connected her with Matt, the owner of the firm, and he began a dialogue with her.
She explained to Matt that she had been the owner and manager for a very long time, and things were not going well. Though she had 80 percent occupancy, her delinquency was also running at about 80 percent. So four out of five tenants were not paying on time, and some had fallen months behind.
As Matt got to know her, he figured out why. She was neurotic, fearful and overbearing, annoying. She had apparently alienated the tenant base, and they learned that they could pay late (or not at all).
The operator visited the facility, noting many typical symptoms of a mom-and-pop self-storage asset:
- Serious delinquency issues
- Below-market occupancy
- Below-market rents
- Deferred maintenance
- Poor systems and accounting
- Poor customer service
Matt was not only the prospective buyer for this facility, but he became the seller’s personal therapist and retirement planner. She called him several times per week—sometimes as early as 4 a.m.
Make an Attractive Offer
Matt patiently walked her through the process time and time again. It became clear why she didn’t go through a broker when he saw her books, which were written with pen and paper and were in complete disarray.
Matt had to sell his banker on the significant upside potential of this asset since the revenues were light and the expenses were heavy (also typical of mom-and-pops).
Acquire, Then Fix What’s Broken
After much wrangling and suspense, the acquisition finally closed a little over six months ago.
In the first six months, Matt and his team have created value in a variety of ways:
- Increased occupancy to 92% from 80%.
- Decreased delinquency to 5% from 80%.
- Increased gross income by 17%.
- Rebranding of the facility, creating a new image and enhancing the customer experience of existing and new tenants.
- Replaced the front gate and signage, prioritized new landscaping and resurfacing of multiple sections of the asphalt.
- Brought in U-Haul Truck Rentals, which has resulted in increased monthly income by $3,900 and helped to drive traffic and, in turn, rentals to the facility.
- Began online marketing through Sparefoot, enabling the facility to generate 50 new move-ins in only four months.
- Built an online brand presence via website creation and Google, which has generated significant traffic.
- Hired a new management team with outstanding customer service and sales skills, who have been able to execute the management strategy quickly and efficiently.
Check out the new and improved property below!
Revel in the Glory
This facility has 71,762 net rentable square feet with 650 units. It also has 114 RV parking spaces (which could provide an opportunity for facility expansion later). The facility was acquired for $4.3 million.
At the time of the acquisition, the facility had a net operating income of $295,322. Six months later, the income was increased by $161,569 to $456,891.
This translates to a projected increase in value of $2,300,000 to $6.6 million—or even better if the cap rate is compressed.
Value = Net Operating Income ÷ Cap Rate
Since the original debt on the facility was about 50 percent, the equity raised was about 50 percent, as well. That’s a little over $2.15 million in equity.
That equity just doubled in projected value.
The facility is projecting a cash-on-cash return from operations of 21 percent and a 47 percent IRR (internal rate of return). If operations go according to plan, the property will generate a 4.2X equity multiple in four years to be shared by investors and the operator.
This Strategy Is Repeatable
Can this type of scenario be routinely replicated? Well, not necessarily. Unless you’re committed to finding off-market anomalies.
This is just one of two operators in our funds who have achieved these types of results over and over again for most of the past decade. Another one of our operators has provided investors with a 40 percent-plus annual return consistently over the past 21 projects that have gone full-cycle.
He employs a similar strategy of finding off-market mom-and-pops with latent potential. After upgrading the facility, he achieves:
- significantly better net operating income
- a compressed cap rate by selling to a REIT
By applying leverage, these operators are generating outsized returns for themselves and investors.
It’s Your Turn
So how can you follow in the path of Buffett to find anomalies? If you’re in the single family home world, maybe it means driving for dollars while your competitors compete for houses on the MLS and the courthouse steps.
If you’re in the multifamily or self-storage arena, perhaps you can take the time to build relationships with mom-and-pop owners, who will eventually sell to you rather than go through a broker. The same goes for mobile home parks.
And if you’re busy pursuing a full-time career, or enjoying retirement, perhaps you should consider investing passively with someone like Matt—an expert operator, who knows how to find anomalies.
I mean, hey, if you had the opportunity to either invest with Mr. Buffett in the 1960s or go it alone, picking your own stocks evenings after work and on weekends, I’d ask you the same question I asked myself last year: “Why work harder than you need to… to make less than you could?”
Have you learned to find anomalies?
Tell us how you’ve done it.