Have you seen The Sixth Sense?
I watched it for the fourth time or so last week. I love many of M. Night Shyamalan’s movies. The twists and turns leave my brain in knots.
I like Christopher Nolan’s films even more. Inception, The Prestige, and the Batman series are big favorites at my house.
Why do we love brain-teasing plots in movies, books, plays, and life?
What makes us flock to watch movies and buy books that challenge our minds and cause us to struggle to grasp the intrigue of the plot?
Why do I watch and re-watch these films again and again—and even make detailed notes to support my theories on what is really happening?
Why did I have a family meeting (well, it was actually over a dinner or two—or four) to discuss and debate whether Cobb was inside his own Inception? (I can prove this. You see at the end of the film, the spinning top… wait, I’m off topic again.)
Psychologists tell us that we thrive on intrigue. Our brains were designed to unpack mystery, to solve riddles and to make discoveries. We were brilliantly and intentionally designed to be explorers, creators, inventors, and entrepreneurs.
Complexity may stimulate your brain, and extend your life—but kill your business!
As entrepreneurs, we are a pretty competitive bunch. We like to solve mysteries, create solutions, and unpack complexities all so that we can win in the game of business.
Do you recall the excitement on the face of the guy who first explained the internet to you?
Or for you Millennials who grew up online, the person who told you about blockchain technology?
And though we put a man on the moon, no one has unraveled the mystery of semi-boneless ham to this day.
But What Does Warren Buffett Say About Complexity?
Did I tell you that Warren Buffett is my real estate mentor? I wrote about this recently, and I plan to continue to work with my brilliant friends and Bigger Pockets cohorts, Bryan Taylor and John Jacobus, to unpack Buffett’s wisdom for real estate investors.
Buffett has a lot to say about simplicity and complexity. And I think we should listen to the most successful investor of all time. Like I said before, if you would have handed Buffett $1,000 in 1964, it would be worth about $16,000,000 today. Wow.
Buffett has graced us with his investing wisdom in over 50 annual letters to shareholders. Let’s see what he has to say about this topic.
From Buffett’s 2013 Annual Letter:
“You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick ‘no.’”
From Buffett’s 1996 Annual Letter:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
(Christopher Nolan is never going to make a film out of Buffett’s investment strategies. It would certainly be a yawner.)
What Does Warren (Mr. Buffett to You) Mean by This?
Warren preaches the importance of being able to successfully describe an investment thesis to your grandmother. If you can’t do that, and she cannot follow your logic, then you’ve probably over-complicated the investment and/or don’t adequately understand the thesis.
In addition to keeping it simple, Buffett is steadfast in his advice to stay within your circle of competence. He rarely ventures into technology investments. It’s not because he thinks the risk/reward in tech is unsatisfactory. It is because he simply doesn’t understand technology companies and can’t reasonably predict the future prospects of a rapidly changing industry 10 to 20 years from now.
Related: The REAL Importance of Warren Buffett’s Words About Today’s Market [An Alternate Interpretation]
“I have an old-fashioned belief that I can only […] expect to make money in things that I understand.[…] I mean understand what the economics of the business are likely to look like 10 years from now.[…] The internet isn’t going to change the way people chew gum.”
So How Does This Apply to Real Estate Investing?
In real estate investing, it’s important to keep your investments simple—or at least to a level that you can fully understand.
For example, class B/class C multifamily housing is a simple concept to understand.
- There is a shortage of affordable housing in areas with robust economies, growing populations, and land use constraints.
- People always need shelter in good and bad economic times.
- People will continue to pay for a basic necessity and will pay a premium when their needs are consistently met or exceeded.
- The basic product (housing) has existed for centuries.
- Technology is unlikely to disrupt the concept of affordable housing/shelter (and tenants’ consumption of chewing gum).
- Your grandma understands rental housing.
Buffett teaches us to understand what we’re investing in. So before you invest in a new market or jump into a new product type (e.g. fix and flips, large multifamily, short-term vacation rentals, Airbnb, mobile home parks), make sure you have expanded your circle of competence to comprehend it.
Resist the urge to jump quickly into something new and shiny to chase a quick profit. It is better to say a quick “no,” as Buffett teaches us.
And if you don’t fully understand what you’re investing in, and neither does your grandmother, you may want to rethink your approach.
I Failed to Heed Buffett’s Advice. And it Cost Me a Small Fortune.
When I left Ford Motor Company in 1993, I became an entrepreneur. When I sold my company in 1997, I became an investor. And I started down a path of serial-entrepreneurism (I just made that up).
I made a lot of mistakes along the way, and my losses (and gains) led me to my obsessive focus on commercial multifamily real estate today.
- I confused investing with speculation on many fronts. I “invested” in gold and silver based on the predictions of a variety of pundits who “proved” that Y2K would cause a disruption to the financial markets and infrastructure. It certainly caused a disruption, but it was mainly to my personal balance sheet.
- I invested with a Charlotte financial guru who had an undisclosed algorithm to make 3% profit monthly through foreign currency trading. I couldn’t possibly understand it (or he’d have to kill me). That guy still won’t tell the Feds where he hid $18 million of investors’ money. But hey, he’s only got 138 years left on his 153-year sentence in the federal pen ‘til he can go enjoy it.
- Before getting my MBA, I had earned a degree in petroleum engineering. So when presented with a very complex exploration opportunity in the oil and gas realm, I was all in. Though no one (even the engineers and geologists) could perfectly predict the results, it looked great on paper. And that’s the last profit this project ever made. On paper. (Have you noticed that Buffett doesn’t invest in oil and gas exploration?)
- After building and managing a very profitable multifamily operation in North Dakota’s Bakken oil country, I thought, “What else does this desolate region lack, and how can I make a profit there?” Wireless internet! I researched this carefully, and partnered with a company who was succeeding with the same technology in rural Tennessee. We launched a company, and it is still operating six-plus years later. But it has never made a satisfactory profit. I would have been multiples more profitable by keeping it simple and staying within my circle of competence: commercial multifamily real estate.
You see, as entrepreneurs and investors in the information age, in the good ole USA, we have more opportunities than we could ever evaluate or comprehend.
As I’ve evaluated deals over the years, I’ve encountered quite a few professionals who attempted to lure me into opportunities by projecting an image of sophistication with complex analytical models and a small army of research staff.
I’ve made a determination to reject these options in order to pursue investments in commercial multifamily real estate. The simplicity and steadiness of multifamily real estate appeals to me because I can wrap my head around the concept of providing safe, affordable housing options to residents with rising incomes in markets with growing populations.
It’s unlikely that Google or Facebook will disrupt this business model. It doesn’t take a PhD to master these concepts and make reasonable projections about the demand for housing five to 10 years from now.
Even Warren Buffett (and my grandmother) could understand this strategy.
Have you ever fallen for the trap of complexity?