The bucket list - Applying Value Investing to real estate

The bucket list - Applying Value Investing to real estate

The value investing approach to public markets has been made famous by "super investors", notably Warren Buffett of Berkshire Hathaway, and its principles are not new. In the wealth of knowledge that can be gained from this approach; there are three critical insights for institutions investing in commercial real estate:

Lesson 1: Keep digging, and then dig further - understand intrinsic value.

o "Price is what you pay; value is what you get." - Benjamin Graham

o Institutions looking for core, low-risk income-generating investments are better served by adopting the principle of paying a fair price for a wonderful property rather than a wonderful price for a fair property

Lesson 2: Solid defence first, then attack selectively

o "Rule No 1: Never lose money; Rule No 2: Don't forget Rule No 1." - Warren Buffett

o Defensive investing—or focusing on the risk side of the risk-return relationship—is a key aspect of the value investing perspective. Institutions should ask whether they and their advisers are defenders. Are they concerned with the possibility of loss and how do they try to prevent it? Do they worry about the things they might not know? Do they appreciate that even well-informed decisions can be hit by bad luck or surprise events, and prepare for these?

Lesson 3: Dine with risk. Invite it to the table, get to know it and appreciate it

o "After all, you only find out who is swimming naked when the tide goes out."  - Warren Buffett

o Most people equate risk to volatility, but we think volatility in an asset's value over time is just a proxy for risk, it is a temporary fluctuation. With the staying power (and willpower) not to sell during a down cycle, these changes in value only took place on paper and no actual loss was incurred. Volatility can be benign (if you can hold) while risk results in permanent loss.

o In value investing, risk means uncertainty with respect to future outcomes and the probability of permanent impairment or loss when an unfavourable condition occurs. Taking more risk can result in a higher range of returns (rather than higher returns per se) but it is challenging if not impossible to quantify due to the unpredictable nature of future events.

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Published on Institutional Real Estate, Inc (IREI), April 2015

The bucket list - Applying Value Investing to real estate