Michelangelo is one of the greatest sculptors in history. I never dreamed he could teach me so much about real estate investing. But he did.
Michelangelo said: ‘The sculpture is already finished in the marble block before I start my work. It’s already there; I only have to chisel away the excess material. “
When I first read this quote I thought it was ridiculous. Was this a strange riddle?
But this is a powerful truth, and it covers a variety of topics, including art, love, and real estate investing.
Get a block of stone. A machine operator cut it from a quarry, along with hundreds of others who look the same. It is a commodity with a price tag of probably several hundred dollars.
Now hand over this block of marble to an artist. An artist who can imagine what this piece of rock could be. Give them the right tools and some time, and the result can be magical.
The artist can imagine the intrinsic value of the stone. And by bringing it to life, the sculptor can create a valuable work of art with a value exponentially higher than that of a rock. It could even achieve the ‘priceless’” rich.
So, Paul, what does this have to do with real estate again?
Increase your investment
Imagine being friends with hundreds of real estate investors and entrepreneurs. Now imagine grabbing a beer with each of them and talking casually about failures, successes, motivations, and lessons learned. That’s what we strive for with The Pyjama People Podcast.
The current situation when investing in real estate
This is a historically difficult time to acquire real estate. Demand is unprecedented, interest rates are hovering around historic lows and inflation is looming. The Pyjama People community has educated and encouraged hundreds of thousands of investors to get into the game. But it is not easy.
Some investors have been told to buy even above sensible levels as the price will always go up. Well, it can keep going up. But ask the millions burned during the Great Financial Crisis of 2008 how well it went. And ask Warren Buffett and other top investors who say this is foolishness.
Other investors are looking for value-added deals. I warmly applaud them. But most of the value has already been added to most of the assets that most investors want to acquire. Why? It is a result of the popularity of multi-family investment and this long-term overheated market.
Fellow Pyjama People investor Kris Bennett researched this situation in the multifamily realm. He concluded that about 93% of multi-family homes with more than 50 units are owned by companies that own multi-family assets.
Not all of these are well managed. Not all have squeezed the value out. But my experience is that most of the value has been added. It’s hard to find value-added opportunities in multi-family homes, and those coveted deals usually go to insiders.
Single-family homes are in a similar boat. It’s hard to find good deals to fix and flip or rent out.
So if we can’t make a profit by adding value, what should we do?
Introduction of the concept of ‘intrinsic value extraction’
Let’s define for our discussion extrinsic value as the selling price of an asset. The price at which you can acquire an asset. For our sculptor, this is the price of the marble block.
And let’s define intrinsic value as the asset’s actual potential value. This is the mainly hidden future value of the asset that can be achieved by a trained professional. This professional has both the ability to recognize an asset with intrinsic potential and the ability to extract it.
I encourage you to become that professional. Or join one.
I chose the latter. And I have the highest consistent profit of my 20+ years in real estate.
6 examples of extracting intrinsic value
I’m not going to delve into the mechanics of intrinsic value extraction, as the details vary significantly by asset class. Instead, I’m going to give you a handful of short examples to increase your excitement.
My company invested $ 2.4 million in cash (extrinsic value) in a self-storage facility purchased from a feuding group of Texas siblings in March 2019. After upgrading its marketing and operations, the facility was valued at $ 4.6 million. The operator had acquired $ 2 million in debt, leaving only $ 400,000 in equity. When the property was sold for $ 4.6 million (net asset value) in late 2020, shareholders walked away with $ 2.6 million in cash.
Finding smart land uses
My son bought an 85 acre mountain package for $ 215,000 (extrinsic value). He sold the wood for $ 200,000 within a month. In a few years, he will have the chance to divide it into about ten lots with an average value of $ 30,000 each. In the meantime, he can rent out yacht rights for at least $ 1,000 a year to cover his taxes, and he can potentially keep a long-term cell tower rental contract worth $ 800 a month. After adding some value through surveys and ground testing, his net asset value is north of $ 600,000. (Can you say I’m proud of my son?)
Flip mobile home parks
My company invested in a Midwestern mobile home park in early 2020 that was acquired for $ 7.1 million ($ 3.5 million in equity and about $ 3.6 million in debt). The owner had not visited the park in over five years and it was backsliding. Our operational partner reduced high costs and improved the community. He returned utilities to tenants and modestly raised extremely low rents. Within a year, the park was sold to a great operator who looked to benefit from filling about 50 vacant lots. The sale price was over $ 14 million, with an IRR of 347%.
Rising gross rents
My real estate agent, friend Eric Eickhof, is helping Minneapolis investors buy seemingly overpriced homes near the college campus for about $ 400,000. Most investors poke their noses at these homes that rent out for $ 1,500 or so per month. But Eric coaches them to rent them for $ 700 a bed, often giving them gross rent of well over $ 4,000 a month.
Add to the advertising budget
My friend Jerry paid $ 5 million ($ 1.7 million in equity) to acquire a 125,000 square foot warehouse with a net operating income of $ 200,000. He saw an opportunity to increase value by implementing some basic business strategies. He spent $ 45,000 on ads to fill job openings and increase rent. He even charges $ 500 for rent for the food truck in the parking lot, which goes straight to the bottom line. Its value is now $ 7 million and its equity has more than doubled.
Divide and conquer
AJ Osborne, an innovative self-storage developer, bought a Super Kmart in Reno for $ 6 million. He sold the parking lot to an apartment developer for $ 2 million, leaving $ 2.5 million in equity plus debt in the deal. He cut the building in half and created a beautiful storage space. Because only 40% of the facility was leased, he turned down an institutional investor’s offer of $ 26 million.
There are also other examples. One of my friends is trying to buy overpriced office space in DC to offer condolences to individual buyers. One of these is a strategy to convert shopping centers into seniors. Another bought a house and converted it into commercial space. I bought a five acre non-divisible stretch of waterfront and was given a deviation to create a small subdivision.
Asset classes with the highest potential net asset value
I mentioned the challenges of finding multi-family and single-family homes with high intrinsic value potential. So, what types of assets have the greatest potential?
Some believe that types of assets that are in serious trouble have the highest potential. Shopping malls, shops and hotels are certainly low-priced now. But just buying assets at a rock bottom price, even in a foreclosure sale, doesn’t necessarily fit this model. It is possible, as in the example of the Kmart conversion to self-storage. But not always.
I would say the best places to find deals like this are mom and dad properties: properties with a highly fragmented ownership structure and owners who don’t have the knowledge, desire, or resources to increase and maximize their income. value.
These owners have often owned their assets for quite some time. And they take huge advantage of the compressed cap rates that drive up the value of almost all real estate assets.
My two favorites are storage and mobile home parks. I have discussed my reasoning about these asset types in several previous articles. Here’s a graph comparing multi-family ownership to mobile home storage and parks. I want to thank Pyjama People member Kris Bennett, who originally came up with this equation for Ten Federal Storage.
Do I sound biased against these asset classes? Probably. I have entered my third decade in the real estate investment world and as of now, these are the best types of assets I’ve seen. But this could change tomorrow.
One thing that won’t change is my passion for investing in assets whose intrinsic value significantly exceeds the price. I hope you see the value of this powerful strategy.
Oh, and thank you, Michelangelo.