Margin of Safety and Private Investors

In business and in life we have what I call direct and in-direct mentors. Direct mentors are those who mentor you one-on-one, you build relationships with them and they help you grow and guide you. In-direct mentors, on the other hand, are those who you emulate in business, mostly through reading and watching. You may not know them personally, but their thoughts and actions impact you.

One of my in-direct mentors is billionaire investor Warren Buffett. For those that are unfamiliar with his career highlights, I'll give you a rundown:

• Started investing at age 7
• Millionaire by age 32
• Current net worth: $40+ Billion
• Shareholder gain: 20% annual compound (over 40+ years)
  
• Gave almost all of his net worth to Bill Gates' foundation

Not too shabby, huh?

I've been a Berkshire Hathaway shareholder for a few years now and have enjoyed the annual shareholder meeting in Omaha. It's a tremendous learning experience.

Reading and learning Warren Buffett's business philosophies have helped me a great deal in raising private money and building my real estate investment company. Even though Mr. Buffett is 80 years old, his principles are timeless and true.

What's important to note, however, is that Warren Buffett had mentors as well. He first studied under (at Columbia) and then worked for the man considered to be the father of value investing: Benjamin Graham. Graham's legendary books Security Analysis and The Intelligent Investor are considered seminal books for stock market investors. In my view, they should be considered mandatory reading for investors in all asset classes.

One of Benjamin Graham's most highly regarded and time-tested principles was what he called a 'margin of safety.' In Graham's terms, a margin of safety meant that you were acquiring an asset for at least 33% less than what you valued it at. In real estate terms, this means that if you value an apartment building at $1,000,000 dollars, you wouldn't pay more than $666,666,67 for it. Think it's a tough criteria? It is - and it's supposed to be. If you buy with a margin of safety, you can prevent adverse investment results in the event that you were wrong about the valuation.

Warren Buffett has extensively used Benjamin Graham's margin of safety principle in his investing career. He always states that he can't know the precise value of a company, so he always discounts his value and sets his max buy price lower than that value he determined. You may already be doing this with your real estate investments and not know it. You may find a property and determine it's value based on income or comparable sales and then offer much less than that amount. If you're doing this you are already putting the margin of safety principle to work.

Keep in mind, though, to include repairs and improvements in your number. If you ascertain the value of a building to be $1,000,000 and it needs $100,000 in improvements, you might have to adjust your new price point to ($667,666.67 less $100,000 = $567.666.67).

If you think this is nuts and that you can't buy anything that is good for that cheap, then you just aren't looking hard enough. Right now, especially in the current market, there are definitely bargain properties available. You just have to sift through more than one or two and realize that bank owned or bank short sale listing price is not necessarily a bargain in and of itself.

I think margin of safety is a principle that should be used in all types of real estate investing, whether flipping houses or buying mixed-use buildings. If you keep margin of safety in mind, you'll prevent yourself from getting burned by chasing prices up too far. Investors that used a margin of safety on their purchases would have largely avoided buying real estate for long term holds at the bubble inflated prices during the boom of 2002-2007.

But how does margin of safety apply to raising money from private investors? It's simple: you demonstrate and promote the margin of safety approach to private investors and they will be attracted to investing with you. In addition, you will be a much better steward of their investment dollars. You'll only swing at the fat pitches as they come down the middle of the plate. You'll be a breath of fresh air to people who have had the Wall Street establishment run rough-shod over their portfolios with no regard for the investors well being.

Warren Buffett himself started off his investment partnerships by raising money from private investors. He would approach certain people his community (some he knew and others he did not know but was introduced to) and they would place funds with him. Soon, he built a reputation and his existing investors would refer their friends and family members to invest with him.

All of these are things you can do when raising private money - you can copy Warren Buffett's formula in more ways than one.

Each time I sat in front of an investors or promoted my investment opportunity to a group of private investors, I brought up my company philosophy which has been borrowed from Warren Buffett. When I purchase real estate, I make darn sure I'm getting a bargain and I don't chase prices up. With each property I buy, I have multiple exit strategies (which are profitable) and I treat my investors as partners (even those that are lenders and don't share in the profits).

As Sir Isaac Newton said nearly 300 years ago: "If I have seen farther than others, it is only because I was standing  on the shoulders of giants."

What Newton meant by this was that he was able to build his magnificent work off some of the work of other scientists that had gone before him. In much the same way, you can stand on the shoulders of giants like Warren Buffett by learning their philosophies and adapting and applying them to your business.

Margin of safety is a timeless investing principle that will work to attract wealth to you (in the form of private money) and also help you accumulate a great deal of wealth through real estate investing. Put it to work right away and watch your results astound you.