There something to be learned from the most successful stock investors as many based their investing principles on value investing. Now, how does that help with real estate investors?
Value investing was conceptualized by Benjamin Graham, and David Dodd, in their classic book, "Security Analysis". Although they were talking about stocks, value investing can be applied to other investment vehicles. This includes real estate.
Now, what can real-estate investors learn from value investing?
# 1: Investing vs. Speculating
In value investing, it's crucial to draw out the differentiation between being an investor, and being a speculator. In "Security Analysis", it is defined as this:
"An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative".
There are 3 things needed for something to be an investment:
- You need to have done thorough analysis.
- You need to be reasonably sure that you won't lose your money.
- You need to be reasonably sure that you will make money.
In terms of real-estate investing, this means that just buying real-estate hoping it will go up in price does NOT make you an investor. You are speculating.
# 2: Value and Quality
Value Investing doesn't really have any mathematical formulas, or rules. It is more of a theory, with some general principles. Because of this, there are many ways to do value investing, and different ways to apply it.
Benjamin Graham focused on buying stocks significantly below value. This can be a useful strategy for a real estate investor, particularly when they are first starting out, and need to build up equity fast.
Warren Buffet still looks at the value of a stock, but puts more emphasis on the quality of the stock. He only buys stocks that have good long term prospects, with a bright future in front of them.
This is a stable money making strategy for real-estate investors as some with rather go for higher quality tenants, who will pay the rent reliably even it means a lower return.
# 3: Margin Of Safety
One of the most important principles in value investing is "margin of safety".
Margin of safety is the idea of making sure that you only invest if your calculations show that there is a significant profit to be made. There is no surefire way your analysis can be 100% accurate, but with a margin of safety gives you a buffer.
Suppose you are looking at a deal, and you found a property with an appraisal of $1,000,000, but you can get it at $900,000, you can sell it to someone else for $1,000,000. That gives you a buffer. But some might not feel it's enough. What happened if you can get it for $500,000 plus $100,000 worth of repairs is that bigger safety of margin?
In investing, you have to limit your risk, and that's what margin of safety is about.