How’s your fantasy life?

Do you ever fantasize about being a movie star? A rock star perhaps?

Me? Sometimes I fantasize about being a famous investor. Someone to whom people listen and even quote. Someone witty and charming. Someone who makes billions and helps others do the same. Someone who has tens of millions to give away to fund important causes.

Warren Buffett fits this bill. Perhaps the most iconic investor of our time, he is a rarity among the Fortune 100. At No. 5, Berkshire Hathaway is the only top-ten firm that doesn’t directly make or sell anything.

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Buffett and company make their living from investing in the success of other companies. These firms are often subsidiaries, but their largest holdings are not. (Berkshire’s biggest stake among their top ten holdings is in Kraft Heinz, at under 27% of that company.)

I’ve got great news for you: As a real estate investor, you and I have a real chance to invest like Buffett—actually, more than most stock investors could ever dream of.

If you are a real estate investor and your fantasy is to invest like Buffett, there are some very real strategies that could get you there. Read on…

Price is what you pay—value is what you get

Buffett’s success is largely due to his ability to spot the difference between price and value. He learned this from his mentor, Benjamin Graham.

Buffett takes issue with the Efficient Market Hypothesis. This hypothesis essentially claims that everything that can be known about a company and a stock is known by a very broad cross section of analysts and investors. As a result, there are no good deals. Every public stock is priced right where it should be.

If you believe this (as I generally do), then you won’t believe your Uber driver’s “hot tip” on an underpriced stock. And you won’t fall for your drinking buddy’s logic that you all need to buy Coors stock because the price will go up as soon as it hits 80 degrees in Louisiana.

There are literally millions of eyeballs, and billions of dollars in software, analyzing this stuff. Trying to beat them is like trying to compete with Amazon.

So how does Mr. Buffett, armed with only a handheld calculator, beat the market decade in and decade out? Not alwaysut—but definitely most of the time. Check the scoreboard from 1964 through 2020:

• S&P 500 total return: 23,454%
• Berkshire Hathaway total return: 2,810,526%

Buffett, who for over seven decades has spent virtually all his time reading and studying, is a master at spotting intrinsic value in corporate valuations (stock prices). Intrinsic value (real, potential value) exceeds extrinsic value.

How Buffett employed intrinsic value to beat the market with Berkshire’s largest holding: Apple

Buffett started buying Apple stock in 2016. This is surprising since he said he didn’t understand tech and thought it was too risky for Berkshire’s portfolio. He began buying at $27 per share and continued while the price ranged from about $20 to $40. By the end of 2018, he had amassed a billion shares.

Here is why Buffett was attracted to Apple as an investment.

Investors misunderstood the intrinsic value

The public was concerned about Apple’s ability to innovate without Steve Jobs at the helm. This concern caused investors to overlook the intrinsic value indicators and kept the share price depressed. Buffett likes to buy companies when they’re “on sale.”

A temporarily depressed price, strong consumer brand, and intelligent capital allocation were factors that led Buffett to believe the shares could be purchased for less than their intrinsic value. In other words, the extrinsic value as determined by the market was significantly less than the intrinsic (real) value of the company.

In three years, the shares quadrupled in value and became Berkshire’s largest investment by far. This was significant because Apple was already the world’s largest company (as measured by market cap) when Buffett began purchasing shares in 2016.

Such a large increase in such a well-analyzed company indicated the market’s inability to accurately assess its long-term intrinsic value—and Buffett’s ability to do so.

Brand loyalty

Warren Buffett also witnessed his grandchildren’s habitual use of multiple Apple products, their attachment to the brand through repeat phone and computer upgrades, and their willingness to pay a premium for Apple products. This behavior reminded Buffett of similar consumer behavior he had witnessed with prominent brands he already owned: Coca-Cola, See’s Candies, and American Express.

Buffett was famous for shunning tech companies. However, his expertise in consumer behavior through his decades-long ownership of other favorite consumer brands enabled him to view Apple for its valuable intrinsic characteristics. Others seemed to miss Apple’s ability to compel customers to consistently pay a premium for its products and demonstrate brand loyalty through frequent repeat purchases.

Consumer behavior and brand affinity among Apple customers allowed Buffett to view Apple not as a technology company susceptible to obsolescence, but rather as a global premium consumer brand with consistent, predictable, high-margin buyer behavior.

Annual cash flow

In Apple, Buffett saw a business that produced significant annual free cash flow, led by an intelligent capital allocator: Tim Cook. Cook deployed capital astutely by buying back undervalued shares and committing to a shareholder-friendly program in order to return significant capital to investors.

Applying Buffett’s rules to real estate investing

As a stock investor, it is quite difficult to unearth unrealized intrinsic value. In real estate, it’s actually quite possible. This is because real estate is largely fragmented.

There are not millions of eyeballs analyzing the fourplex on the edge of town. There is no standardized cross section of data comparing that mom-and-pop-owned self-storage facility to thousands of others. That 90-year-old mobile home park owner who agreed to sell to you on a handshake is not offering that property on the broad market with thousands of bidders.

You have an inside track, Mr. and Mrs. Real Estate Investor!

So how do you pull this off?

Do you want to follow in Buffett’s shoes by locating assets with hidden intrinsic value? Then start by thinking through the asset types where fragmentation plays the most significant role.

• These are typically mom-and-pop-owned assets.
• They are often (but certainly not always) found off-market.
• Sometimes they can be repurposed or rezoned. (Like the off-campus home that could be rented by the bed or the Kmart building that could be converted to self-storage.)
• If they are run as mom-and-pops, they can often be upgraded by a pro. The increase in net income and value is often dramatic. (We’ve often seen doubling or tripling of equity in under five years.)
• Sometimes just adding professional marketing—like a website—can boost revenue and value significantly.

A brief example: increasing net operating income (NOI)

We work closely with an operating partner who built his company largely on Buffett’s principles. He has a large acquisition team relentlessly scouring the nation for off-market self-storage and mobile home park deals.

In the fall of 2018, this partner acquired a Colorado storage facility for $4.3 million. The property had over 700 units plus RV parking. Our partner acquired it at a 10% cap rate with serious delinquency issues (80%!), below-market rents and occupancy, poor customer service, and deferred maintenance. Expenses were out of control, and so were the books.

Our operating partner quickly undertook drastic measures to improve operations and upgrade the facility. This included:

• Slashing delinquency from 80% to 5%
• Increasing occupancy from 78% to 86%
• Increasing rents to market levels
• Hiring and training a new onsite staff
• Rebranding the facility and correcting deferred maintenance
• Adding U-Haul which increased revenue and expanded occupancy
• Building an effective online marketing presence

Improvements and operational refinements resulted in an $111,000 increase in NOI within the first year; this translates into a $1,700,000 increase in value at a 6.5% cap rate. The asset will generate $260,000 of free cash flow (after debt service and expenses), which results in a 21% cash-on-cash return to investors.

Think about this: this project utilized ~ $3 million in debt and ~ $1.5 million in equity. If the property is sold, the investors would enjoy over 100% return on their equity if the property were to be sold.

See, it is possible to invest like Buffett in the real estate arena!

Even if you’re not experienced enough to pull this off, you still have options. You could find an asset type that works for you and start on the track to get that experience.

Or you can partner with, or invest in, operators who have this skill and track record. That’s what I do, and I’m having the time of my life.

You and I may never have the fame and fortune of Mr. Buffett. But as real estate investors, I truly believe we are uniquely positioned to profitably extract intrinsic value from fragmented assets. And to help our tenants and investors in the process.

Now that is quite satisfying.