How Do I Get Started in Real Estate? For the young professional

Since I am relatively young (age 31), I do get a lot of younger folks asking how to get involved in real estate so they can start building a cash flow stream for the future.  I am always a big apprehensive to give that advice due to the fact that my journey to real estate did not start with me being 21 and just wanting to get in.  I had been investing since I was 13 in other types of investments so I had a strong basis for understanding numbers going into it.

However, this does NOT mean that it isn’t not something you should look into.  Getting into real estate can actually be just as fun as it can be stressful.  There are just very common pitfalls I have learned through my years of mistakes that could make it easier for younger people to get involved.

1.) Why Do You Want to Invest in Real Estate?

If your answer is “Because I see a lot of people getting rich off of it” then back out now! That’s no reason to get involved with anything.  Real estate is a great way to build wealth through paying down debt, buying good properties that will appreciate over time, and generating cash flow for future goals.  If you don’t know how much to expect to make, find a professional who you may know to talk with.  There are PLENTY of people you know who have rentals, I can assure you. Just start asking your friends and family if they know anyone who does it.

2.) How much do you have?

You then need to figure out how much you have to invest.  The younger you are, the harder it will be to have a stash of cash to start with, which isn’t a point of giving up, but just a hurdle you have to overcome. Go out and figure out how much your first property will cost you from a downpayment side and figure out how much you need. If youdon’t have enough, you have three options: 1.) Save more money 2.) Borrow from family and friends 3.) Bring on partners

All three of these options are viable but I suggest the first one as your way of proceeding.  It is much easier to make decisions with your own money than someone else’s money. Also, it’s hard to bring on partners or borrow money when you have NO experience whatsoever. Yes, you will have family who will just help you becaus they’re family but I don’t recommend it.

3.) Start looking.  Yep, that’s it. You can start looking.  Use the info you learned from the professional person you spoke to in order to determine what properties to look for and what kind of deals there may be out there.  

Pitfalls

A few problems that amateur investors run into (like I did at one point) can really sour you to an investment. It’s ok to be picky and to stand your ground, but most people who are entering a new business can’t do that out of fear of either making another person mad or sounding like they aren’t knowledgable.  Real estate is very intuitive.  If it doesn’t make sense to you, don’t do it.  If a specific piece of property doesn’t make sense, there is a reason for that.  

NEVER EVER EVER EVER listen to a real estate agent or real estate broker. Their job is to show you properties.  They are NOT investors.  I’ve never met a broker/agent who is a good investor.  Ever.  This is 100% a fact. The good brokers/agents will be the ones who admit this and who just say “My job is to show you the deal and your job is to pass or buy it.”  If you find that your representative is talking very highly of a certain deal, there is probably a higher commission.  Yes, it sounds cynical, but it is 100% true.  Do your own research.  Look at the numbers and talk to the real estae expert that you know who actually own properties to figure out what it will take to renovate or operate a property.  

Which leads to my last concern: Most amateurs, yours truly included, didn’t know the costs to operate a property.  I thought it was just mortgage and some light maintenance.  Oh boy, I was wrong.  Please talk to someone who has operated properties and ask them for the budget items that you may not be thinking about. 

I am a big believer in pushing yourself to do more, so please make sure you proceed with caution and don’t jump into the first deal you find. There will be others.  I have 825 units and only 3 or 4 I can say, honestly, I would have regretted not buying.  

There are deals out there, just don’t jump in too quickly. I believe in being aggressive and trying new things, but ask as many questions as you can from people who have proven they are where you want to end up.

Is Whole Foods (WFM) a Good Stock to Buy? What is Whole Foods Worth?

Whole Foods Market (WFM) just came out and crushed earnings causing the stock to go up 10% today.  I owned Whole Foods a few years ago but sold it for a nice profit at around $40 per share.  Right now it’s at $103 per share.  Ouch right?  Well, yes and no.  Let’s see what I think the stock is worth right now.

I am a big believer in buying companies that have strong balance sheets and Whole Foods definitely has that. They have enough current assets ($2.1Billion) on hand to pay off their ENTIRE debt with one stroke of the pen ($1.49Billion).  Good start.  Obviously a company that will be able to weather some downturn and pay their bills if push came to shove, or restart their business with a new strategy if they needed to.

So now let’s look at book value, which the weight of any business. Currently, their book value per share is $19 which puts their Price to Book Value over 5, which is quite the premium.  Based on the Graham method of Book Value valuation, which I seem to have enjoyed, he likes a PE Ratio X Price/Book Value to be under 22.5.

Looking at their earnings, they have increased revenues and earnings steadily over the last 10 years. Revenues came in at $3.149Billion and Net Income of $98MM in 2003 and this past year, 2012, they had revenues of $11.7Billion with Net Income of $465MM.  And the path to that is very steady and consistent. All around a solid company with solid financials and solid earnings.

Finally, cash flow from operations was $961MM, which is phenomenal.  As a comparison, the market chain, SuperValue (SVU), has revenues of $17Billion and Free Cash Flow of $751MM, so the revenue to free cash flow ratio is much better for Whole Foods, but it is to be expected with higher margins and higher end customers. 

But as we always say, great companies can sell for terrible prices and I think this is one of those situations.  It is still a high end grocery chain with $11Billion in revenue so the top line revenue growth is probably not going to grow at past rates.  2003-2007 saw revenue growth of 16% per year while 2008-2012 was 8% per year.  Now, in all fairness, 2008 to 2009 was one of the worst economies to hit this country and high end shoppers were probably a bit more apprehensive about spending money at these stores…

So what do I think it’s worth?  Definitely NOT $103 per share.  At this price, I would pass on Whole Foods and find another company to invest in.  Which one?  I won’t get into that now but check my posts in the future for good stocks to buy…But what do I think Whole Foods is worth?

I have taken the last 3 years of Net Income and averaged it out to get $351.34MM and then multiplied it by a factor of 20.  The reason for the higher multiple than is typical in the market is that this is an average of 3 years so the number is supposed to be lower than current.  If we do this, this takes our market cap to $7Billion and compared to the current market cap of $18Billion, I would need to buy this for around $38 per share.  Yes, quite the discount to today’s price, but remember, right now, they are selling for 38 times earnings which is WAY too much for a company like this.  Also, at $38 per share, it would take the PE to 15.5 and the Price to Book Value to 2.  Now based on the Price X Book Value per share of 31 being a little rich, I am actually not as concerned about it due to the brand that is here and the strength of that brand.  With nice margins, as compared to other grocers, and the steady growth in revenue and earnings, I am willing to look past the value of 31 there. 

This would also take the dividend yield from 0.9% to 2.4%, which is nice and healthy.  And speaking of dividend, their dividend payout ratio has been inconsistent which is one of the only bad things I can say about the company.  

All in all, great company. Great financials.  Bad value. That is pretty typical these days, but I would love to buy this stock sub $40 per share, which is where I had sold out at…years ago.

Is Real Estate Back?

I was driving down the freeway the other day and I saw a HUGE billboard with the words “REAL ESTATE IS BACK!” I chuckled, thinking to myself, that is a prime example of people convincing themselves of something that couldn’t be further from the truth.  

Historically, real estate goes up in value along with income.  Nothing else is more fundamental to the value of real estate, long term, than income levels.  Now, of course, you are saying that interest rates obviously have an effect on real estate, and you are correct, but at the end of the day, interest rates can fluctuate dramatically over short periods of time.  

And the interest rate points makes my point exactly…real estate “is back” ONLY because interest rates are so low, real estate values have nowhere to go but up.  Think about it, if rates fall in half, theoretically, a person whose income has stayed the same would be able to buy a house double the value than what they were buying before because now their biggest cost of owning the home, the interest paid to the bank, has fallen in half.  

We haven’t had much real income growth over the past few years because of the economy with underemployment standing at 13.9% as of last month.  We have to get a lot more people to work and a lot less part time workers back to full time before we start to see some real income growth. 

When income starts to increase, you will start to see steady real estate value increases that aren’t caused by short term issues such as interest rates.  After all, when the Fed is printing the money they are printing, rates have nowhere to go but down and when they stop doing that, which they will sometime in the future, interest rates will increase and it will cost the same home to be worth less UNLESS there is a large enough increase in income to offset that interest rate increase.  

So the next time someone says “Real Estate is Back” ask them how the incomes in their area are doing. Because that really is all that matters.  And just like most people and investors, they claim to be long term oriented, but long term isn’t 1-3 years…it’s 10+ years, at least.  

Have We Forgotten 2008 Already?

Everyone has forgotten 2008. Anyone who wants to disagree with me can go right ahead and do so, but the way people talk about their “equity” investments and ignores all the obvious data for why we should be concerned shows me that the short term memory that John Galbraith talks about is very true.

We are sitting on an overbought market with high valuations that are still getting people to justify them. Just like in 1999. Just like in 2007. It’s happening over and over.  Everyone forgot that it just took a few months for reality to set in…then when buying was good again, everyone forgot that values don’t go down forever! Not many people thought it was the right thing to be buying in late 2008 and early 2009, but I was doing it. And now not many people think I should be sitting on the sideline…but I’m doing it.

“Financial planners” want their clients money to go up even though it is ridiculous. It’s just like a real estate agent making their clients happen by negotiating higher prices…it doesn’t make sense.  Unless you’re retiring very shortly, you should want lower stock prices.  And if you are retiring shortly, you shouldn’t even have your money in stocks! 

I beg of everyone to close their eyes and remember what it was like to lose 30%, 40%, 55% of your money back in 2008. I am not saying that will happen again, even though I do not think it’s out of the realm of possibility by any means. I am just saying that with valuations the way they are and profit margins at 80% higher than historical, now is the time for caution.  We are possibly in a new recession and Europe is just kicking the can faster than we are in the U.S.. We are in for a long and turbulent ride that won’t end as rosey as people think.  We have years to go before the words “secular bull” can be uttered by anyone with half a brain. 

This is not meant to sound alarming, but just to point out that we have to remember that during good times, we easily forget bad and vice versa.  I am here to just remind everyone that at the end of the day, all that matters is valuation.  If we ignore valuation, we ignore the most fundamental principle of investing.  You’re buying a busy and not just pieces of paper.  You have to look at equities as a stream of cash flows and future earnings to see what it’s worth.  If it makes $1, it’s not worth $200! I don’t care how cool the company is or how creative the founder is.  It just isn’t worth it.  

I can’t wait to see how many “financial planners” tell me, 3 years from now, that they saw how obvious the overvaluation were and got their clients out. Just like 2008.

Using the S&P 500 to US GDP Ratio

I am a big believer in looking at valuations to see where the stock market is currently at.  One of the big ones that Warren Buffett always discusses is the total stock market market cap vs GDP ratio. Being as it is a semi-difficult market cap to find, I prefer to just keep it simple and look at the S&P 500 because the index is based on total market cap of the top 500 companies in the country.

We take our data back to 1957 and go by quarters, since GDP is reported quarterly. Look at the chart I created below. The historical average is 82.44% ratio of S&P 500 to US GDP. We are currently at 94.18%, which is about 13.6% over historical average value.  I am not suggesting that this is the one metric to look at, I just want to point out some metrics that are used to look at market valuation.