Bear with me as I explain my thought process for valuing an investment. I'll tie it back to my reason for real estate. The key to investing is to determine the intrinsic value of an asset and pay less than that number. How do you do that? Well, you can figure out what something's worth by estimating the future cash flows of it then discounting it back to its present value. For example, let’s say I had a crystal ball and I knew a particular investment would generate $100,000 in free cashflow over the next 5 years. Knowing the exact amount of cash that will be generated allows me to put a precise dollar amount to the true value of the investment. How much should you pay for an investment that generates $100k over 5 years? The answer is: it depends. It depends on the yield you demand for that investment. The less you pay, the higher the yield. For the example above, say you decided to pay $500k for the investment. It is expected to generate $100k in profits over the next 5 years. Let’s do the math: $100,000 / $500,000 = 20% return That’s a great return, but that’s not taking into effect the time value of money. The 20% is earned over a 5-year period so the annual return would actually be much lower than that. Annualized Return = 20% / 5 years = 4% annual return. Not so great. What does this have to do with my reason for investing in real estate? Well, discounting cash flows back to their present value to arrive at a price is quite simple to do. It’s a simple concept with simple calculator math. As with many things in life, it’s much easier said than done. Let me explain. The hard part is being able to accurately forecast said cashflows. Without an accurate forecast of the future cash flows, you are flying blind. The reason I chose real estate is because the only other option I considered was stocks of public companies. Let’s compare the two: Public Companies: To determine the value of a company, I need to forecast the future cash flows of said company. Public companies are usually big and complex. They are often multinational. They have many moving parts. They have thousands of employees. They have many product lines, markets, and competitors. Trends go out of fashion. Bad managers replace good ones. Competitors try to kill your business. Innovation is always necessary. The point I am making is that the task of predicting future cashflows for a public company is vastly more difficult than a simple residential rental building in Portland. In real estate, I felt I could gain an edge in my ability to accurately predict cash flows due to the simple nature of the real estate business. There aren’t a whole lot of income or expense inputs that go into a real estate investment. You have rents and fees on the revenue side. Then, you have property tax, insurance, and maintenance. You also have utilities and a few other things on the expense side. That’s it. Easy math. I learned something from the great Charlie Munger. In investing, added difficulty doesn't earn extra credit. I admitted to myself that I cannot confidently forecast a public company's cashflows. Very few can. But, I can forecast a real estate asset's cashflows. That's why I chose real estate as my primary investment vehicle – because I like to play games I know I can win.

This is such a common question. Many people believe a single-family property is a great investment and their investment strategy is nothing more than the fact that it's real estate. It is their contention that real estate is a great investment because “real estate always goes up over time." I’m sorry to be the bearer of bad news but “real estate always goes up” is not an investment strategy, it is a speculation strategy. I’m not saying there is anything wrong with speculating on price appreciation, I just want to point out the difference so you are aware which game you are playing. Yes, real estate has historically gone up over the long term. Yes, it’s possible it continues to do so over the next 30 years. Yes, it’s possible for prices to fall. Yes, it’s possible for prices to be stagnant for a long period of time. We can’t predict the future, we don’t know where interest rates will be, and we don’t know what we don’t know. The way to determine if a single-family property is a good investment is by running the math on it as an investment. If you had to rent out the property, how much rent can you demand? After accounting for expenses, how much Net Operating Income (NOI) are you left with? Given your NOI, what yield does that equate to with respect to the amount you invested. Is it a satisfactory yield? Therein lies the answer to the question of whether a single-family property is a good investment. Many folks who ask this are asking in the context of a primary residence they want to buy. I put the purchase of single-family properties into two buckets: 1) primary residence/personal consumption OR 2) investment purposes. I want to make it clear that I’m not saying buying a single-family property is a bad decision. I’m a fan of buying a single-family property for your primary residence, even if it’s not a great “investment”. Reason being there are many non-monetary reasons that can justify the purchase. For example, it’s a great place to raise a family, establish your roots, make memories, pass down to your kids, etc. Those are reasons that can be used to justify buying something for personal consumption, even if it is not optimized for investment returns, so long as you can comfortably afford it. The key is to be aware of the two and make the decision that’s right for you. If you are looking for a primary residence, don’t assume by default that it’s a great investment. It may be the perfect property for your family, but not a great investment. It can also be a perfect property for your family and ALSO a great investment (should you choose to rent it in the future), so they're not mutually exclusive.