Real estate investors often get the entrepreneurial itch to venture into new and unexplored realms of realty, hoping to get wealthy.
But they forget the cardinal rule of investing, popularized by Warren Buffet’s friend and the vice chairman of Berkshire Hathaway, Charlie Munger.
The Munger rule: Know your limits.
Munger calls it the “circle of competence.” He says that when investors step outside their circle of competence they get into trouble fast.
But when they continue to innovate and improvise their investing strategies within their circle, where they have the experience and knowledge, then they have a competitive edge.
Munger’s principle is ridiculously simple to follow, yet even the most disciplined real estate investors get trapped outside their circle of competence.
They cross boundaries when the sentiment is bullish and the markets are peaking, often with catastrophic outcomes.
Munger sums up the theory in one line: If you try to compete in a game where others have the aptitude and you do not, you are going to lose.
Core strength
If you invest in real estate investment trust (REIT) companies, for instance, you must carefully analyze whether they are operating within their circle of competence.
Washington Prime, for instance, is a mall REIT spun off from Simon Property Group with the goal to getting of rid all the investments outside Simon’s core competence while delivering a high-yielding alternative to the REIT investors.
That is precisely what happened, and Washington Prime is today among the top-yielding REITs in the industry with a yield of 14.8 percent.
However, of late, it seems that now Washington Prime is straying outside its circle.
According to analysts at S&P Global Market Intelligence, Washington Prime’s decision to acquire one of its top tenants, Bon-Ton Stores, is not going down well with the mall REIT’s investors.
When the company should be focusing on selling assets and allocating funds for redevelopment projects, allocating capital to activities outside its portfolio is a bad idea.
Good times
The time is ripe for real estate investors to multiply their profits, if they are able to stay committed to their circle of competence.
Real estate has just received a big boost from the Tax Cuts and Jobs Act. Landlords can potentially emerge the biggest winners if they play their cards right.
The new provisions of the law particularly favor rental properties. According to analysts, the tax code long has given preferential treatment to real estate investors, which makes sense since people who own land tend to take better care of it.
The tax reform of 2018 has further boosted that preferential treatment.
There is no dearth of tenants in many real estate markets, and housing is currently in short supply.
Scarcity could translate into higher rents, lower taxes, and more profits for real estate investors – provided they are willing to pay heed to Munger’s advice and stay within their circle of competence.
