Michelangelo is one of the greatest sculptors in history. I never thought 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 work. It’s already there; I just have to chisel away the superfluous material. “
When I first read this quote, I thought it was ridiculous. Was that a strange puzzle?
But this is a strong truth, and it covers a wide variety of topics including art, love, and real estate investing.
Take a stone block. It was carved out of a quarry by an operator along with hundreds of others who look alike. It’s a commodity with a price tag of probably a few hundred dollars.
Now give this marble block into the hands of an artist. An artist who can imagine what this piece of rock could be. Give them the right tools and time, and the result could 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 that is exponentially more valuable than a rock. It could even achieve the “priceless”” Rich.
So, Paul, what does that have to do with real estate again?
Increase Your Investment
Imagine being friends with hundreds of real estate investors and entrepreneurs. Now imagine if you could have a beer with each of them and casually chat about failures, successes, motivations and lessons learned. That’s our goal with The Advance Guide Podcast.
The current situation in real estate investments
This is a historically difficult time to buy real estate. Demand is at an all-time high, interest rates are near historic lows and inflation is looming. The Advance Guide community has taught 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 a reasonable level as the price will always go up. Well, maybe it will continue. But ask the millions that were burned in the Great Financial Crisis of 2008 how well it went. And ask Warren Buffett and other top investors who say this is nonsense.
Other investors are looking for value-add deals. I applaud you warmly. But most of the value has already been added to most of the assets that most investors want to acquire. Why? This is a result of the popularity of multi-family systems and this long-overheated market.
Advance Guide colleague Kris Bennett has investigated this multi-family situation. He concluded that approximately 93% of apartment buildings with more than 50 units are owned by companies that own multiple apartment buildings.
Not all of them are well managed. The value was not wrested from everyone. But my experience is that most of the added value has been added. It’s hard to find value-adding opportunities in apartment buildings, and these sought-after offers usually go to insiders.
Single-family homes are in a similar boat. It’s difficult to find good deals to fix and flip or rent.
So if we can’t make a profit by adding value, what should we do?
Introduction to the concept of “Intrinsic Value Extraction”
For our discussion we define external value as the selling price of an asset. The price at which you can purchase an asset. For our sculptor, this is the price for the marble block.
And let’s define intrinsic value than the true potential value of the asset. This is the primary hidden probable value of the asset that can be obtained by a trained professional. This professional has both the ability to spot an asset with intrinsic potential and the ability to extract it.
I encourage you to get so professional. Or connect with one.
I decided to take the last option. And I’ve made the highest consistent profits in my 20+ years in real estate.
6 examples of the extraction of intrinsic value
I will not delve deeper into the mechanisms of intrinsic value extraction, as the specifics vary significantly depending on the asset class. Instead, I’m going to give you a handful of quick examples to add to your excitement.
My company invested in a self-storage facility in March 2019 that was acquired by a warring group of Texas siblings for $ 2.4 million in cash (extrinsic value). After the marketing and operations modernization, the facility was valued at $ 4.6 million. The operator had borrowed $ 2 million, leaving only $ 400,000 in equity. When the property sold for $ 4.6 million (intrinsic value) in late 2020, shareholders walked away with $ 2.6 million in cash.
Find clever land uses
My son bought 85 acres of mountain property for $ 215,000 (extrinsic value). He sold the wood from it for $ 200,000 within a month. Within a few years he will have the opportunity to break it down into about ten lots, valued at an average of $ 30,000. In the meantime, he can rent hunting rights for at least $ 1,000 a year to cover his taxes, and he can potentially keep a long-term lease on a cell tower worth $ 800 a month. After adding some value through surveys and ground tests, its intrinsic value is north of $ 600,000. (Can you say i’m proud of my son?)
Flipping mobile home parks
My company invested in a midwestern RV park in early 2020 that was purchased for $ 7.1 million ($ 3.5 million in equity and approximately $ 3.6 million in debt). The owner hadn’t visited the park in over five years and it was in decline. Our operating partner cut the bloated costs and improved the community. He returned the ancillary costs to the tenants and modestly increased the extremely low rents. Within a year, the park was sold to a great operator who saw the benefit of occupying around 50 vacant lots. The sale price was over $ 14 million with an IRR of 347%.
Rising gross rents
My friend, real estate agent, Eric Eickhof, is helping Minneapolis investors buy seemingly overpriced homes near the university campus for around $ 400,000. Most investors turn up their noses at these homes, which rent for around $ 1,500 a month. But Eric teaches them to rent them for $ 700 a bed, which often brings them gross rent well over $ 4,000 a month.
Increase in the advertising budget
My friend Jerry paid $ 5 million ($ 1.7 million in equity) to purchase a 125,000-square-foot warehouse with a net operating income of $ 200,000. He saw a way to add value by implementing some basic business strategies. He spent $ 45,000 on advertising to fill vacancies and increase rents. He even charges $ 500 rent for the parking lot food truck, which goes straight to the bottom line. It is now worth $ 7 million and its equity has more than doubled.
Share and conquer
AJ Osborne, an innovative self-storage developer, acquired a Super Kmart in Reno for $ 6 million. He sold the parking lot to a home developer for $ 2 million, leaving him with $ 2.5 million in equity plus debt. He cut the building in half and created a nice self-storage facility. With only 40% of the property rented, he turned down the $ 26 million offer from an institutional investor.
There are other examples as well. A friend of mine is trying to buy underpriced office space in DC to sell to individual buyers. One of these is the strategy of converting shopping centers into senior citizens’ homes. Another bought a house and converted it into commercial space. I bought a five acre non-divisible waterfront neighborhood and got a variance to create a small subdivision.
Asset classes with the highest potential intrinsic value
I mentioned the challenges of finding multi-family and single-family homes with high value potential. So which asset types have the greatest potential?
Some may believe that types of investments in dire straits have the greatest potential. Malls, retail stores, and hotels certainly have low scores now. But buying just one asset at a rock-bottom price, even in a foreclosure auction, doesn’t necessarily fit this model. As in the example of the Kmart, it can be switched to self-storage. But not always.
I would argue that the best places to find deals like this are in mothers and fathers property – types of property with a highly fragmented property base and owners who do not have the knowledge, desire, or resources to grow incomes and to maximize value.
These owners often have had their assets for a long time. And they benefit greatly from the compressed cap rates, which drive up the value of almost all property values.
My two favorites are self-storage and RV parks. I have discussed my reasoning about these types of assets in a variety of previous articles. Here’s a graph comparing multi-family ownership to self-storage and RV parks. I’d like to thank Advance Guide member Kris Bennett who originally designed this comparison for Ten Federal Storage.
Do I sound biased towards these asset classes? I probably do. I have started my third decade in the world of real estate investing and so far these are the best types of investments I have seen. But that could change tomorrow.
One thing that won’t change is my passion for investing in assets where the intrinsic value significantly exceeds the price. Hope you see the value of this powerful strategy.
Oh, and thank you, Michelangelo.