Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
Even though Net Present Value is used mainly in financial management I think it is probably the best ratio/calculation for analyzing a real estate deal. Unfortunately in Real Estate Analysis people usually use mainly return on investment or cash on cash return. These ratios are described in many books, but they don't take in count the time value of money and therefore NPV makes much more "real" picture of the investment.
I learned to use NPV and IRR back at the university and also in the book by Frank Gallinelli : What Every Real Estate Investor Needs to Know about Cash Flow... And 36 Other Key Financial Measures.
There is lot of successful investors at this forum, so I am interested what is everybody using in their Real Estate analysis? What are your opinions on NPV in Real Estate?
Buffett's letters when he ran a hedge fund that he referred to as the Buffett Partnership. I believe you can get those by googling or at this site: http://www.ticonline.com/buffett.partner.letters.html
Buffett's letters to shareholders are better from the perspective of understanding the bigger picture. The letters to partners are more useful if you wish to be a stock investor. They are both enjoyable to read because he has a very nice writing style with plenty of aphorisms, wit and humor.
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
15y
Buffett's like us. He does not like overanalyzing stuff with formulae. His situation is a bit different from ours in that he invests in companies with a good long term prospect whereas we invest in deals. For us, the IRR is very useful.
For him, the most important metric is ROE. As his buddie, Charlie Munger, has said very well, your long-term return in a stock asymptotically reaches the company's ROE. This means, provided leverage is reasonable, ROE is pretty much the key metric for a long-term investment in the stock of a company.
P.S. ROE is also often called RONW (Return on Net Worth).
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
ROE is what I focus on for my real estate projects too. It is important to re-leverage investments where the debt has amortized and your equity is no longer working for you well. That is why I love 1031 exchanges...they force you to trade up and to think about optimizing ROE (or RONW).
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
15y
Originally posted by Vikram C.:
1. NPV, as Bryan has mentioned, is for investors with a known cost of capital and a known ability to continue to raise funds at that cost. It is used to determine if a project is worth investing in or not. If the NPV is positive, you should invest and if it is not positive, you should not.
About time you joined us in this thread Vikram! :-)
My only comment on what you wrote (it's all great stuff) is with the text above. This is true iff (if and only if) you have an unlimited supply of funds.
With a limited supply of funds, doing a side-by-side NPV analysis of multiple investments won't tell you which to pursue and which not to pursue; in other words, a higher NPV isn't always a better investment among two or more choices.
But, if you can determine which investments have a positive NPV (i.e., which would be worth pursuing with unlimited capital), you can run an IRR analysis -- using best- and worst-case scenarios -- and then run a risk analysis to compare multiple positive NPV investments head-to-head. It's quite possible, given your capitalization and your risk tolerance, that a lower NPV project is preferable over a project with a higher NPV.
Btw, the other reason that Buffett is less concerned about detailed financial analysis is that he is more concerned than most people about the quality of managers he hires. His businesses would succeed even without great financial projections because his managers know how to reposition businesses, not just operate them.
As George W would say, his managers are good at "strategery" in addition to operations... :)
Btw, here are a couple quotes from Buffett and Munger that I was able to dig up about their view of financial analysis:
Buffett: "I've seen lots of presentations, on 19 corporate boards, all have calculated IRR. If they burned them all, the boards would have been better off. You just get nonsense figures."
Munger: "I have a young friend who sells private partnership interests to investments, and it's hard to get returns in that field. I asked him, “what returns do you tell them you can get?†He said 20%. I said, how did you come up with that number? He said, “if I told them any lower they wouldn't give me the money.â€"
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
15y
Agreed, Jason. In fact, if you had limited funds, you can dispense with the NPV analysis altogether because your IRR analysis will give you the information you need to select between your projects. (Unless, of course, you assume that the projects have different risk levels, in which case you may either make a subjective determination of the discount rate or base it on the normal required return for that type of project.)
Jason, I do not agree with your analysis of Buffett, though. He actually hates having to reposition companies and very much prefers buying a well-run company in an industry with good long term prospects and leaving it alone. As he often says, he would rather invest in a good business with mediocre management than in a mediocre business with good management. I, too, agree with his philosophy in that it is quite easy to make money in a prosperous industry whereas it can be quite difficult to make money in a declining industry even if you have very talented people working for you.
Although Buffett has not explicitly stated his investment criteria, if you examine his deals during his peak years, you will find that he liked buying companies with ROEs greater than 20% (with low leverage) and a P/E ratio of around 8 to 12.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Wow! This is officially the thread of the month if not the thread of the year!
Originally posted by J Scott:
Buffett: "I've seen lots of presentations, on 19 corporate boards, all have calculated IRR. If they burned them all, the boards would have been better off. You just get nonsense figures."
I couldn't agree more. Can you believe that people actually get paid heaping sums of money to pump out this drivel at jobs all of the time? Crazy!
Originally posted by J Scott:
Munger: "I have a young friend who sells private partnership interests to investments, and it's hard to get returns in that field. I asked him, “what returns do you tell them you can get?†He said 20%. I said, how did you come up with that number? He said, “if I told them any lower they wouldn't give me the money.â€"
I am starting a private equity company right now and this statement couldn't be more accurate either! That is why most shrewd investors want to see a track record and circular file the projections!