I am not particularly known around here as a proponent of serious discourse.
Having said this, what the hell? Let’s try it. 🙂
If you listened to BiggerPockets Podcast 152, I am sure you came away having formulated several conclusions. One of those conclusions, I am sure, was that next to Serge Shukhat and Brian Burke, Ben Leybovich is certainly the best looking, most able to express himself eloquently, and most genteel.
I see you nodding your head. Good. Glad we got that out of the way.
I’ve had a couple of folks reach out to me for clarification of something that was said in that podcast. Why must you buy below intrinsic value?
About the only thing the three of us, meaning Serge, Brian, and myself, agree upon, besides me having no talent, is that in order to succeed in this business, you must buy property below intrinsic value and buy with a value-add component. Let’s talk about this.
Let me ask you a few questions:
Question: Why do you think it is so important to us to buy below intrinsic value?
Answer: It’s not because we are cheap. All three of us will spend big money for quality, so long as it is below intrinsic value and there is value add. The strategy that allows us to achieve outsized returns revolves around taking assets from below intrinsic value toward their intrinsic value. It is in this delta that we make money.
It is this delta that allows us to exit our capital via sale or cash-out refinance, thereby completing the cash flow cycle via taking original investment capital off the table, which drives our IRR. But this is very much a function of buying below intrinsic value.
Let’s say you buy a C-class building at retail, which is what all of us are telling you NOT to do. But let’s say that you do it.
Question: What happens to your C-class once someone puts up a brand new A-class building half of a mile down the road?
Answer: Assets don’t live in a vacuum, and the reason your asset is currently deemed as C-class is because that’s where it stacks up against the newer and better B-class buildings in your marketplace, as well as the really spiffy seven-year-old A-class ones.
Related: 9 Low-Cost Ways to Dramatically Increase the Value of Your Rental Property
Well, now that a brand new A-class went up, what used to be A-class suddenly becomes B-class, and what used to be B-class suddenly becomes C-class. And your C-class — that’s now crap that nobody wants to live in.
So How Do You Guard Against This?
Simple: You have to buy this C-lass as though it is D-class. In other words, you have to buy this asset (or any other) at a discount — buy it below intrinsic value. And then you have to do what you need to do in order to make your C-class building, which you bought as though it was a D-class, competitive with the current B-class, which will become the new C-class as soon as that new A-class goes online.
I know that’s a mouthful, but that is how this works.
The only other thing left to mention here is that aside for buying below intrinsic value, you must buy value-add, since being able to force the competitiveness of any asset is a function of value add.
Buying anything at intrinsic value is the “buy and pray” model, whereby the investor hopes that the market will take care of them.
Don’t do that!
Naturally, this rules out the turnkey model. Furthermore, unless you are dealing with a very reputable and very professional PM with thousands of units in their portfolio, which you won’t be unless you are buying 100+ doors, then property management is also ruled out, since managers typically won’t handle value add as well as you need them to.
So if you are going to be an investor, then get dirty, and good luck! But, if you are going to pretend that buying RE investments is just like buy mutual funds, whereby the entire road to success will be handled for you, just say no!