It's Time…we applied value investing principles to Residential Real Estate
IT’S TIME…we applied value investing principles to residential real estate.
In early 2012, the famed value investor, Mr.Warren Buffett, commented that if he could buy 200,000 single family homes, he would. His reasoning was classic value investing philosophy. Home prices had fallen in relation to home rental income to a low multiple. So a home selling for $160,000 and with a rental income of $1,600 per month was now at an 8.33 multiple. As an investor, his thinking was clear. He was not befuddled with comparable sales valuation or with current home prices versus historical home prices. His thinking allowed him to see clearly the investment opportunity at hand.
In 2012, the Blackstone Group of New York City also saw what Mr. Buffett saw in the residential real estate market. In contrast, Blackstone acted upon it. They made a fantastic investment by purchasing 50,000 single family homes in selective markets in the USA. That was an $8 Billion investment. This was a counter market move because the general consensus was that the Real Estate market had tanked and there was no telling when it would come back.
Blackstone’s initial observation was the same as Mr. Buffett’s; the price/earnings ratio of a single family home was so low as to turn single family homes into a major investment play.
Historically, stocks sell for 10 to 15 times earnings. Applying the same numbers to a home in 2012, Blackstone discovered that homes were a bargain. Example: a home with a 2012 monthly rent of $1000 would be equal to $12,000 yearly income. Multiplying this times 10 would give this house an approximate quick value of $120,000 on the low side. And if Blackstone could buy this home at the foreclosure sale for $60,000 [5 times earnings] that confirmed to them quickly that this was a bargain investment deal.
Rental income was Blackstone’s guide to value. An investment is worth what it will produce in income. This is basic value investing philosophy.
Contrast this clear and simple value based investment thinking with comparable sale thinking. Someone trained in comparable sales valuation would be looking at the current home prices in 2012. They would not be able to correlate the price data with any other data that was meaningful. Comparable sales prices are conclusive in and by themselves. Prices are not value contrary to what people in real estate are taught. Oh, people could look to see what home prices were in other past markets but that would be inconclusive. Further, if you recall 2012, there was no assurance that past real estate prices would come back. Not only that but people trained in comparable sale thinking would not be able to see the overall real estate market trends. Blackstone was able to see these trends clearly.
It’s time that we first looked at residential real estate from a value investment perspective. Then we should look at the comparable sales data.
It is how we look at something that determines our knowledge.
The residential real estate market sets the market attitude for the general real estate market in the USA. By being able to quickly establish a baseline of value, then we can see where the residential real estate market is trending. For example: today, if a home rents for $3,000 or $36,000 yearly, that house should have an approximate base value of $360,000 [10 times gross revenue] on the low side to $540,000 [15 times gross revenue] on the high side. And if the house has a comparable sales price [not value but price] of $700,000 or more than it can be safe to say that houses in this specific market are trending beyond their intrinsic value.
It’s time to think like a value based investor.