Luis Belmonte is considered a legend by many in the real estate space. His mix of common sense and sense of humor made him one of the most memorable guest speakers that I had during business school.
I finally had the chance to read his book Get Rich Slowly: Invest in Real Estate which I have meant to read since I graduated in June. I learned a ton from this book. If you have any interest in learning more real estate, I highly suggest you pick up a copy. Most of us make very few real estate purchases in our lifetimes, and learning a bit more from someone like Belmonte is well worth the time.
Here are 10 lessons I took away from the book:
- Only an income-producing property (such as an apartment building) is an investment; your home is not. Belmonte calls a vacation home a “toy.”
- Look for barriers to entry when you are buying real estate. This is a similar point that Sam Zell has made (we have a post profiling him as well). In areas where it is easier to build (think Las Vegas or Denver for example) with lots of flat land, it is less likely that real estate will appreciate over time due to simple supply and demand. When times are good, developers can rapidly add supply to meet (and then often exceed due to developers’ tendency to overbuild) demand. Therefore, barriers to entry are critical. Belmonte says that geographic barriers (i.e. mountains or water) or political geography make it more likely that real estate values will appreciate.
- Pay attention to correlation. Another guest speaker in my real estate made this same point when she posted a chart that showed the tight correlation between San Francisco real estate prices and the NASDAQ stock index.
- Be honest with yourself regarding what you like/dislike and what you are good at. Each link of the real estate process takes a unique skill set. For example, Belmonte says that the best property managers care about the tenants – he watches the body language between the property manager and the tenant. He points out that most residents don’t leave a building; they leave a property manager because they are unhappy with the service.
- Publicly praise others, especially sales people. Belmonte points out that most sales people are treated poorly. If you treat them well and openly trumpet their achievements when they help you, you will be a preferred partner.
- Keep the numbers simple. Rather than fancy IRR formulas that require complex mathematical spreadsheets, Belmonte says to simplify the problem – advice that has been recommended by many great investors, regardless of whether they are buying stocks or real estate. The “perfect property” formula says the unlevered IRR = initial cap rate + rent growth assumption. So if the initial cap rate is 7% and the rental growth assumption is 3%, the unlevered IRR is 10%. Belmonte says to reduce the addition above the entry cap rate to just 1% to be more conservative and because properties are not perfect (i.e. there are transaction costs). Therefore, a good rule of thumb is that the unlevered IRR on a 7% cap rate property is 8%.
- At the bottom of the cycle, real estate often trades at a discount to replacement cost – that could present an attractive time to buy. This is similar to the point that Sam Zell made as well. Belmonte points out that true replacement cost, however, also has to include the cost of fixing the building up to a nearly new condition. Belmonte thinks investors can create a lot of value by buying up assets that aren’t perfect in decent areas when the market is tough, then fixing the property up to attract tenants and establish a consistent income stream that would be attractive to other investors.
- All markets have cycles. The point Belmonte makes here on lending is especially astute – “Lenders love facts…facts are wonderful things, but they are all in the past. Your project will be built, and leased or sold, in the future.” In tough times (when investors should put capital to work), the facts in the recent past look bad, so lenders don’t want to lend. However, in great times, the facts in the recent past look great, so lenders want to lend – thus contributing to overbuilding. When this overbuilding is apparent, developers see that there will soon be too many buildings, but because of X, Y, Z reason, their building is “special” and will be fine. This is the sign that the market is near a peak.
- Publicly traded REITs (real estate investment trusts) have advantages, but also several disadvantages. REITs have the advantage of being liquid assets, access to capital in tough times, and can be invested in for smaller amounts than a typical real estate property. Belmonte says to be wary if a REITs dividend is high (check the dividend coverage) because a well-run REIT should retain as much capital as possible to buy other properties. He also says that leverage levels should be reasonable. The downsides of REITs are that they tend to be less lean than private real estate corporations, and the easy access to capital can make them continually act as developers even when development should be curtailed late in the cycle. As Belmonte says, “Development is not a programmatic business; it should be an opportunistic business.”
- Work with the right people. The real estate business involves dealing with many people and counterparts. Throughout the book, Belmonte stresses the point to have great people on your side, whether it is a contractor to look at a property you may buy (to see how much it will cost to fix) to lawyers to brokers.