Tag: Investing

Real Estate Investing Framework

[This is an edited version of a talk I recently gave at a MOI Global event.]

I’d like to summarize some of the lessons I learned from helping to run a buy and hold real estate portfolio:

Lesson 1: Find a framework

Before my involvement, I had no prior experience in the real estate industry.  So I needed a framework.

As you might know, my main investing model is value investing. So I chose value investing as my framework. I stopped viewing it like an isolated real estate operation, and started to view it like a regular investment.

Lesson 2: The need for a simple valuation heuristic

My second problem was, that I needed a simple valuation method.

I discovered a very simple one: the rent multiple. Basically, it’s comparable to a Price-to-Sales (P/S) ratio. You take the price of a property, and divide it by the yearly rent revenue.
 
After that, I needed a heuristic of what is expensive and what is cheap. In the current market condition you often see multiples of 25, and even 30 or more. This is quite expensive. In more calmer market conditions you see multiples of 20 or less. A multiple of 15 is reasonably cheap and a multiple below 10 might be described as deep value.

There are two ways to calculate this multiple. First, you can calculate it based on the most recent effective numbers, or secondly, you might use what might be called an intrinsic value multiple, where you take the realistic gross rent you expect, once you take control and implement the obvious quick wins. Of course, it’s more conservative to use effective numbers vs. the projections. Personally, I like to use both, and also like to apply a margin of safety.

After that, I needed to decide on what I consider fair value. In the end, I’ve decided to use a multiple of 20 as a proxy for fair value. The reason why I don’t mark-to-market is that it’s a buy and hold portfolio, so the owners are not interested in market gyrations. This gives the framework a certain stability, and takes the speculation out of the equation.

Lesson 3: You need comparable metrics

My next problem was, that I needed useful metrics to aid our decision-making.

It turns out that the real estate industry uses quite fuzzy metrics. You hear terms like gross yield, net yield, or return on investment. People that use those metrics often seem to exclude very key elements, such as financing costs, taxes, or the fair value of the employed equity. My best guess is that the purpose of these fuzzy metrics is to help the sellers (and their agents) inflate their numbers and make them look better than they are. This is supported by my impression that there seem to be enough real estate investors that keep using those fuzzy metrics, and don’t make the effort to find better ones.

Okay, so what was the job to be done? My main goal for finding a metric was to compare the real estate performace with the performance of a public stock portfolio.
 
I ultimately decided to use the after-tax return on equity. I want to stress after-tax, as a lot of people in the real estate industry seem to keep using pre-tax numbers.

To calculate the after-tax return on equity, I first calculate the after tax free cash flow. Again, without adjustments, and without exclusions of key elements. 

On the equity side, I use my fair value proxy. A lot of real estate investors use their cost basis, because this boosts their returns. This doesn’t make sense to me, because I want to take into account the opportunity cost of the employed equity. That’s why I use my fair value multiple of 20.

So now, this allows me to compare apples with apples and have a useful framework for capital allocation decisions, especially between real estate opportunities and public stocks.

Lesson 4: What are the performance drivers of buy and hold properties?

The next question I had, was to identify the main performance drivers of buy and hold properties. Basically a simple checklist to help me evaluate new opportunities.

I see three main drivers of performance:

First driver: Untapped growth potential: the best buy and hold property is one with untapped growth potential, first in terms of development potential (e.g. turning unproductive spaces into new units) and second, untapped rent potential (meaning: that the current rent is below comparable market rent that you could charge).

Second driver: A reasonable purchase multiple: in the best case scenario, you want to purchase a property with a low multiple, which results in an instant capital gain when you mark it up to fair value.

Third driver: Leverage: the more debt you have, the less equity you have to employ, which of course boosts your after-tax return on equity. With debt, you also have a yield from paying back the principle. This builds up equity. But over time, this reduces your returns, so you might need to re-finance periodically to keep equity low. Personally, I’m not a huge fan of leverage. But if you operate with a large enough margin of safety, leverage makes sense and boosts your returns.

What’s important to note is that I don’t view price increases as a driver. For a lot of real estate investors, this is their main goal and their main performance driver. In contrast, my main goal is to grow the underlying fundamentals. When rent increases by 10%, the value increases by 10%, because I keep the valuation multiple constant. That means that I only consider value increases when there is a corresponding rent increase. If a value increase is not based on fundamentals, I view it as speculation and don’t consider it.

This change in attitude helps focus our energies on increasing the underlying value, and not on being distracted by the fluctuations of the market.


Posted on by Remo Uherek

Investing Lessons from Running a Startup

[This is an edited version of a talk I recently gave at a MOI Global event.]

I’d like to share some of the lessons I learned from being a startup founder, and how these can be applied to investing:

Lesson 1: I’m a better investor because I was a founder

As Warren Buffett famously said: „I’m a better investor because I’m a businessman. And I am a better businessman because I am an investor.“

This rings very true to me, and I can confirm it based on my own experiences.

I was in the middle of my startup, back in late 2008, when I discovered Warren Buffett and Benjamin Graham. My main takeaway for my business was that I realized how bad our gross margins were. At the time, our gross margin was around 30%, and we were burning money. Then, when applying this insight over a period of 3 years, we were able to double the gross margin to 60%, which helped us to achieve break-even and ultimately lead to selling our business. Without those gross margin improvements, it would have been much more difficult.

Lesson 2: “Creative accounting”

The second lesson is what I call „creative accounting“.

We were sending our investors monthly updates. But, brained-washed by the venture capital industry, and suffering from our own insecurities, we believed that everything that didn’t go „up and to the right“, was hurting our story. So we made a conscious effort to keep the story going, by applying what we called „creative accounting“.

We took advantage of the grey areas, and applied somewhat loose and not very consistent accounting practices. We played with the capitalization of certain expenses, to move them off the profit and loss statement. We recognized revenues in different ways, sometimes at the start of a project, sometimes in the middle, and sometimes at the end of a project.

In good months, we rolled over revenues to the next month, to have a head-start and create a cushion. In bad months, we scrambled to recognize everything we could, to avoid reporting bad news.

So based on these experiences, I’ve learned to become more skeptical of accounting statements, because there is always room for “creativity”: adjusted numbers, not expensing stock options, playing with accruals, playing with revenue recognition, and similar tactics.

Lesson 3: Seek owner-operated businesses

The next thing I learned is what it means to be an owner-operator.

I’ve been a founder of my own startups, but I’ve also managed startups that other people have founded. A founder is an owner-operator. He holds a large stake, and the whole responsibility lies on his shoulders. There is „skin in the game“ and a sense of „ownership“. It’s a different quality than managing someone else’s company.

When the company is mostly you, you cannot escape. You have to „go forward or go under“.  We had very tough periods in our startup. On multiple occasions, I was very close to giving up. But I didn’t, because I was an owner-operator. As a manager, you can quit much more easily. It’s a different situation.

That’s why in my investing today, I gravitate towards owner-operators. I’ve been one, and I understand them much better than hired managers. 

Lesson 4: Strong sales organization

Number 4 on Phil Fishers 15 point checklist is: “Does the company have an above average sales organization?“

I had to learn this the hard way. For the first two years, I was the only sales person in our company. It wasn’t working well. I had no prior sales experience, and I wasn’t enjoying the job. I realized that we need to build a sales team.

So I took a deep dive: I read sales books, went to sales seminars and hired our first sales manager. We ended up hiring 4 sales managers in one year, and quadrupled our revenues.

So today, I have a much better sense for what Fisher means by „above average sales organization“.

Lesson 5: Strong marketing & lead generation

A sales organization cannot be effective without a strong lead generation. If all you do is cold sales, you likely won’t get very far. You need qualified prospects and hot leads. 

Here we had an advantage. Because it was one of the areas we were above average.

Our core product was sponsored postings on blogs, what today is called influencer marketing. To not be misleading, we required every blogger to label their sponsored posts. And not only label them with something like „This is an ad“. Instead, we branded the label with our company name, and most importantly, included a link to our website. So each campaign for our clients, be it NIKE or RedBull or Disney, turned out to be a free campaign for ourselves. It was a marketing flywheel. And it was our #1 lead generation source.

So, in order to assess the sales capabilities, you need to be able to understand the whole marketing & sales funnel.

Lesson 6: The Flywheel Effect

Ever since reading Good to Great by Jim Collins, I keep thinking about flywheels.

I’ve learned that great companies have a strong, self-perpetuating and ever-increasing engines. Our viral marketing tactic was a one example. Network effects are another example.

So my lesson is: look for strong flywheels.

Lesson 7: Innovator’s Dilemma

The Innovator’s Dilemma describes why established companies have great difficulties to cannibalize and re-invent themselves, and why startups can be so disruptive.

It was one of the favorite business books of Steve Jobs, and he was a master of solving the dilemma. 

In times of ever faster technological change, it’s important to keep this concept in mind, and seek companies that have demonstrated that they have the courage and stamina to solve this dilemma.

Lesson 8: Certain things don’t show up in the accounting statements

I’ve learned that certain things don’t show up in accounting statements.
Hiring procedures, HR practices, company culture, early R&D experimentation all don’t show up at all, or only much later. 

As a startup, we had a strong company culture. It was a matter of necessity. We couldn’t afford to pay market salaries, and the job required every team member to put their heart & soul into the company.

Startups not for everybody, but if done right, they create a strong culture and a high level of productivity. If a company can preserve this startup ethos, it can be a huge asset. 

So the lesson is: don’t forget the soft factors.

Lesson 9: All eggs in one basket / Take something off the table

As a founder, especially a young founder who has no meaningful assets outside his company, you are not only concentrated, you are hyper-concentrated. All your eggs are in one basket, and as this would‘t be enough, the odds are stacked against you. 8 out of 10 startups fail.

It’s not a healthy situation, because you are over-exposed. That’s why it can be good to take a portion, say 10 or 20 percent of your stake, off the table, if you have the opportunity, to reduce the psychological pressure. Not right away of course, but maybe after 2 or 3 years, depending on how your startup develops.

So while insider buying is usually a good sign, insider selling doesn’t need to be bad. It could be prudent from a personal capital allocation perspective, and also a risk-taking perspective. If essentially your whole net-worth is tied up in your company, it might be hard to take the necessary risks to maximize long-term potential. So you need to understand the motive of insider selling before drawing conclusions too fast.

Lesson 10: Be a Learning Machine

Books have been super important for me. Whenever I faced a problem, I ordered the best books on a the topic, and tried to apply the best practices. That’s how I learned how to organize myself, how to build a sales team, how to build a positive company culture, and much more.


Posted on by Remo Uherek

31 Takeaways from START Summit 2019

My main motivation for going to START Summit 2019 was to meet old friends and acquaintances from the St. Gallen area, but also to learn from the talks. I was positively surprised. It ended up to be one of the best and most innovative tech/startup conferences I have ever attended. Check out the opening video as one of the details they nailed.

Here are my key takeaways:

#1: The University of St. Gallen (HSG) has a palpable entrepreneurship vibe. This event has been 100% student organized by 60 students. They had support of HSG’s Dean and the St. Gallen Mayor, both of whom came to the opening. I loved my time at the University of Basel, but looking back, I really missed the entrepreneurship vibe I felt in St. Gallen!

#2: St. Gallen wants to become the hub for eSports, similar to how Zug became the “Crypto Valley”. They started the initiative “Digital Sports Hub Switzerland” to push this forward. (Learned from the Mayor of St. Gallen.)

#3: There is no such thing as an “AI startup”. It always needs to be “AI plus x”, i.e. AI applied to a specific thing. AI itself is not a product, it’s a technology, similar to electricity. (Learned from Richard Socher, Chief Scientist at Salesforce.)

#4: How to build an AI startup: (1) Pick a very specific niche/problem. (2) Collect as much structured data as possible in this niche. (3) Create specialized algorithms that create value. (Learned from Richard Socher, Chief Scientist at Salesforce.)

#5: Ask yourself regularly: “Where can I have the biggest impact, given my personal skills and resources?”. I have added this question to my quarterly life review. (Learned from Richard Socher, Chief Scientist at Salesforce.)

#6: “Essentialism” is a better term than “Minimalism”. It’s not about the number of possessions, but how essential/important they are to you. (Learned from Cédric Waldburger, Entrepreneur and Essentialist.)

#7: Quick tips on how to start with essentialism: (1) For everything you add/buy, remove/give away one thing. (2) Put things you haven’t used in the past 90 days in a box. Then wait another 90 days to see whether you go back those things. If not, give away the box. This battles your loss aversion and the instinct of “I might need this one day”. (Learned from Cédric Waldburger, Entrepreneur and Essentialist.)

#8: “As an investor, it’s important to cut your losses. As an entrepreneur, it’s important to keep going. So there is a difference in mindset.” (Learned from Daniel Aegerter, Investor and Entrepreneur.)

#9: Dragon = a company that returns >1x the whole fund (compared to Unicorn = Startup valued at >$1 billion.) Recent European dragons were Spotify, Adyen, Supercell, Delivery Hero, Just Eat. (Learned from Nenad Marovac, Investor.)

#10: Logitech transformed itself from a PC peripherals company to a Cloud peripherals company. Now multi-brand, multi-category. Vision: Become a Nestlé or Unilever type company. (Learned from Bracken Darrell, CEO Logitech.)

#11: Best team size is a team of 2. Reason: You only have 1 relationship to manage. Team size of 3 = 3 relationships. Team size of 16 = 120 pairs of relationships. That’s why Jeff Bezos at Amazon focuses on very small teams (“two pizza teams”). (Learned from Bracken Darrell, CEO Logitech.)

#12: Large organizations have only one advantage: scale and resources. But one huge disadvantage: complexity and bureaucracy. Startups have the advantage of small teams and less pairs of relationships. That’s why startups can move much faster than the big guys. (Learned from Bracken Darrell, CEO Logitech.)

#13: Logitech CEO has 25 direct reports. This is a wonderful number. As he cannot micromanage them all (because they are too many), he needs to give them responsibility, so they can work autonomously. It’s not a 25 people team either (with 300 individual relationships). It’s 25 single pairs, i.e. 25 subsets of two people. This is manageable. (Learned from Bracken Darrell, CEO Logitech.) [Want to know how to calculate the number of relationships for a given number of people? I did. Here is formula with n representing the number of people: (n*(n-1))/2 e.g. for 25 people it’s (25*24)/2 = 300 pairs of relationships]

#14: Give each new employee this task: “after 30/60/90 days send me a note with things that are broken. What obviously broken/ineffective/inefficient things can we improve?” (Principle: Fish don’t notice water anymore). Logitech CEO meets with each new employee and gives her/him this task. They have implemented many suggestions already. (Learned from Bracken Darrell, CEO Logitech.)

#15: Logitech sees itself as a design company. Why did Bracken Darrell join Logitech as CEO? Because he wanted to be part of a design company.

#16: Pick a very specific niche. How did Scalable Capital (soon €2 billion assets under management) get started? They focused on a very particular target group. Super exclusive. Focused on people with a university degree in business or computer science (i.e. people with a high degree of numbers literacy.). (Learned from Erik Podzuweit, Founder of Scalable Capital.)

#17: California Privacy Act 2018 (CCPA) is coming. It’s similar to GDPR, i.e. everyone who has users in California needs to comply. (Learned from Lisa Gradow, Co-Founder of Usercentrics, a Consent Management Platform).

#18: Privacy = freedom from unauthorized intrusion. Cyber Security = measures taken to protect a computer against unauthorized access or attack. (Learned from Lisa Gradow, Co-Founder of Usercentrics).

#19: Archlet.io won the startup pitching competition. They use machine learning algorithms to make value chains more efficient. They implemented one project so far, and achieved cost savings of 3% for the client.

#20: A great business model for hackers is to become ethical hackers and sell their know-how to companies. Edwin van Andel (Hacker & CEO of Zerocopter) believes that 60% of all hackers could be converted to ethical hackers, applying responsible disclosure principles.

#21: How to fix your security issues? Apply the Security Knowledge Framework. (Learned from Edwin van Andel, Hacker & CEO of Zerocopter.)

#22: “There is no way to happiness. Happiness is the way.” — Buddha (Learned from Daniel Graf, Uber Advisor.)

#23: Kilian Wagner, Co-Founder of VIU Eyewear won the HSG Founder of the Year 2019 award. The other nominees were the founders of Avrios, FELFEL and Globegarden.

#24: N26’s first product was “pre-paid cards for teenagers”. They spent all money, it didn’t work, then pivoted to the current product. (Learned from Valentin Stalf, Co-Founder N26.)

#25: Most of N26 customer service is done via chat. Their new chatbot reduced 20% of customer service requests. (Learned from Valentin Stalf, Co-Founder N26.)

#26: In the real estate space, a lot of digital low handing fruits are still available, e.g. remote signing of contracts with DocuSign. Lot’s of other innovation/disruption potential in this industry! (Learned from Dustin Figge, Founder von Homelike.)

#27: Don’t underestimate the power of mentors. Look for somebody with the same values, who is 10-15 years ahead of you. Don’t do it half hearted. Create a project and systematically reach out to specific mentors! #mentors That’s what I will implement, to find 1-2 additional mentors.

#28: Sennheiser, a 3rd generation family business, was founded in 1945; born out of necessity (needed food for his family, founder was scientist before); started with voltmeters, microphones; today 3000 employees (50% in Germany, still near the farmhouse where the company started); invented the first headphones in 1968; built a new innovation campus; CEO is here in St. Gallen to see what is going on, to not become complacent; the big opportunity is to create audio solutions for iphone/ipad. Video of those devices is great, audio still shitty. (Learned from Daniel Sennheiser, CEO of Sennheiser.)

#29: Audio & video are the future (Podcasts, YouTube videos etc.). If you are not good at it, then hire freelancers to help you! Lack of action is not an option.

#30: “Only do what only you can do.” Always ask yourself: Where is my edge? Then 100% focus on this area. All other things: Outsource them, find partners, or don’t them at all. (Learned from Daniel Sennheiser, CEO of Sennheiser.)

#31: Freigeist Capital investment criteria: How big is the market? Is the team right? Can this have a huge impact? Traditional KPI’s are not important (cashflow etc.). (Learned from Frank Thelen, CEO at Freigeist Capital.)

Conclusion:
If you are interested in the Swiss and European innovation and entrepreneurship scene, you should definitely consider adding START Summit to your schedule in 2020! I will be back for sure. 

Related links:
– My Photos (many pics of slides!)
– My Tweet summary
– My LinkedIn summary


Posted on by Remo Uherek