As you might imagine, I get a lot of questions from folks all over the country, and really, from people around the world, about investing.
They ask me for the secret to investing in real estate or which business they should get into and how.
The variations of the questions are great, but the answers are simpler than maybe you think they are. Yes, of course, there are details to any transaction that are maybe not so simple, and even complex at times, but the strategic idea of tangible value is really pretty simple.
Let me show you what I’m talking about. I had a woman ask me about—what else?—real estate. This lady was very worried about the state of the housing market, and when she should buy another property, the value of her current properties, and what might happen in the near future.
My answer to her was simple but, I think, also very appropriate. In a time when many investments are less tangible, the ones that are tangible make the most sense. And actually, I have always invested in tangible assets—things that have value—and which that value can be measured and seen and is not easily changed.
The notion of value is sometimes not what we think it is, or rather, is more than what we think it is. There are more aspects to value than just “sales price,” but unfortunately, that is what everyone focuses upon. I understand the perception, but in most cases, it is an inaccurate perception. Most people have an incomplete understanding of value, and they get overly concerned when in many cases it is not necessary.
So, I asked about her real estate portfolio—did it yield cash? She said that it did, but that the market values had dropped by 40%. Okay, but was she still making positive cash flow? She was, but was still worried about the market value.
The point here is that the purpose of the real estate portfolio is, of course, to grow in value; but also, it is to provide positive cash flow. When I asked her if her rents had increased the past three years, she said they had. Do you see what has happened?
The market values of the properties themselves have declined; she would get much less than just a few years ago if she wanted to sell them. But, the rental value had increased due to the current stresses in the economy. Also, there is another value that she did not consider: replacement value.
I asked her, could she build a house cheaper than the current low values on her properties?
Her answer was ‘no,’ and she was right. The fact is construction costs are almost always going up. Commodities like lumber, sheet rock and other construction materials are rising. Labor may drop, but that is not likely to offset the hard costs of materials.
So, the market value had dropped by a lot, it’s true; but her rental values had increased by 20%, and her properties were still worth more than the cost of construction in her geographical area. Do you see how the value had shifted from one part of the value equation to another? But there was still value to be realized—and she was realizing value in higher rents—she just was only focusing on where the values had become less, not where they had improved or held steady.
Now, is this the case all the time, everywhere? No, it’s not. That’s why I always avoid generalizations, because they don’t help anybody in their own particular situation.
Avoid Low Tangible Value Assets
Here’s another example…
A gentleman asked me about investing in trailer parks. His reasoning was that since the economy was poor, that more people would be moving into trailer parks. I told him that he may be right about that, but that I didn’t recommend trailer parks as a desirable investment. My reasoning is simple, and it relates to my concept of tangible value that I mentioned earlier.
With trailer parks, there is less stability in the tangible value because not only can the asset–the trailer–be easily removed, and, even if owned by the park itself, it is less tangible, less durable than improved real estate. Do you see the correlation? Improved real estate has a high tangible value factor, whereas a trailer park has a much less tangible value factor. It’s much more changeable and variable. Also, the financial stability of the tenants tends to be less than those renting houses. Finally, there is a higher danger of both tenants–and weather–causing large amounts of damage to individual trailers. I don’t find that asset class attractive to my way of thinking. I’m not saying that there isn’t money to be made in that asset class, I’m just saying that it doesn’t rise to my threshold of a stable asset with a high level of stable tangible value.
Now, another gentleman asked me about commodities. He asked if I invested in commodities. I told him ‘no,’ and that no one “invests” in commodities. People only trade commodities. There’s a big difference. And, as I hope you know by now, the reasons I gave him were the same as the example above. There really is almost no tangible value in a commodity trade. You’re not collecting pork bellies and keeping them in your garage until the price rises to where you can make a profit, are you? No, you’re betting—and that is the word—that prices will move in your favor. If they do, you’ve made some money; if they don’t, you’ve lost your money. It’s that simple. Again, do people make money in commodities? Sure they do; but as an investment, they don’t fulfill my criteria for tangible value.
And by the way, I feel the same way about gold.
Other Forms Of Tangible Value
Now, when I invested in a radio station, there was plenty of tangible value there. I knew that a certain amount of people were listening to the radio station at various times during the day. I knew that the station had name recognition. I was reasonably certain that radio would not be replaced as a medium any time soon. My challenge was to increase the audience to increase advertising revenues. Could it be done? I knew that it had been done many times before across the country. My main challenge was to get an accurate read of who our audience was, and what would appeal to them and what would attract a larger audience. And I figured that I could do that. But think about it; we owned a name brand, in an established niche (radio), had an audience, and had a tangible opportunity to grow value by properly analyzing the market. So the point here is, tangible value doesn’t just apply to real estate; it can apply to any investment analysis.
All the best,