This post highlights an area of our investment philosophy that goes against the grain of popular advice for real estate investors and investment firms: we don’t specialize in a single asset class. Read on to learn why Generalism is a key part of our mission to grow long-term wealth in real estate.
One of the most common instructions given to beginning real estate investors is to specialize in a single asset class. The justification for this approach is that specialization leads to a competitive advantage: if you spend all of your time playing chess, you should be able to beat someone who splits their time between chess, music, and sports. This competitive advantage in real estate shows up in both acquisitions (speed to purchase, knowledge of other deals, etc.) and operations (vendor relationships, tenant relationships, etc.). Many of the best real estate companies in the country are built on this philosophy, and many companies will continue to be successful following this approach.
What’s the downside? Your success is tied to the success of your asset class.
In a long-term investment strategy, you will go through multiple market cycles, and within those market cycles, different asset classes will perform differently. Take the below charts of REIT performance by asset class as an example:
Source: Nareit
In multiple years (including 2020), there was a spread of more than 50% between returns from the top-performing and worst-performing asset classes. Further, these national trends smooth over the even greater fluctuations between different markets. Think of the difference between owning an apartment complex in San Francisco, CA, and one in Austin, TX in the last year...
Yes, there will be overperforming and underperforming firms and locations within each asset class, but everyone will be subject to the tide of market cycles. This is a large risk that specialists must deal with.
The goal of generalization is to reduce this risk through separation from the market cycles of individual asset classes. Generalization allows you to be a disciplined, opportunistic, counter-trend investor.
Balancing these aspects – discipline and opportunism – is at the heart of the well-known philosophy of value investing, whose proponents include legendary investors like Benjamin Graham, Warren Buffett, and Howard Marks. If you specialize in a single asset class, and properties are trading at high valuations, you take on risk by continuing to acquire properties in that asset class. If you are open to investing in other asset classes, however, you can look across the street at the properties that aren’t popular in the current market and work to acquire assets with a higher likelihood of increasing in value as the cycles turn. To summarize, generalization allows you to take advantage of properties trading at a discount to inherent value, regardless of the asset class.
What’s the downside? You can’t beat good specialists at their own game. A skilled operator who specializes in a single asset class will probably beat you in acquisitions and operations within that asset class. That margin may be small, but it’s an advantage nonetheless. You trade the short-term advantage of greater expertise on a single asset for the long-term advantage of consistently buying assets at low values and selling them at higher values when cycles turn.
Side note: the emphasis above is on good for a reason. Specialization doesn’t guarantee competence, and it can hide incompetence for those lucky to “specialize” in an asset class at the right time (i.e. poor multifamily operators saved by cap rate compression over the last 10 years). There is no magic recipe for investing success.
If you want to build a portfolio or business around a long-term, multi-generational vision, you have to build something that can thrive in an unpredictable future environment. We expect markets, technologies, economies, laws, and even nations to change and fluctuate over the years. In each season there will be opportunities unique to that environment; there will also be opportunities of yesteryear that are no longer wise investments in that day. This is the impetus for a generalist approach to investing.
Back to the application for real estate investing – our goal is to be able to grow wealth for our partners in any market. It’s a tall order, and more of a constant mission to work toward than a box to check when we get there. To achieve this, we need to be able to:
Few firms have been able to do these four things well over an extended period of time. It’s tough. So why not structure your investment strategy to make it easier to achieve?
This is where generalism helps out. If you have processes in place to operate well (#3), generalism widens your funnel to acquire undervalued assets (#1) at the right price (#2) and builds a diversified portfolio which leads to more opportunities to sell overvalued assets (#4).
More importantly, these entry and exit points are the areas with the most impact on investment returns. There is no secret sauce to operations in real estate. I’m not saying, of course, that people don’t screw up here – it happens all the time. The point is that there are proven recipes to real estate operations that anyone with common sense, diligence, and attention to detail can follow. While large firms can use their economy of scale to boost returns in some areas, small firms (that make wise decisions) can use their agility and local relationships to save costs in other areas.
Purchasing and selling, on the other hand, are where you establish your ceiling for returns and realize those returns. And in a long-term strategy, selling determines the capacity you have to purchase more assets, which begins the cycle again. As Howard Marks put it, “The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst.” This is a simple formula to long-term success in investing.
Generalism – combined with disciplined, intelligent purchasing decisions – widens your view. It presents more opportunities to buy great investments and steer clear of the worst.