Margin of Safety

[monkeyboy]

Ben Graham put it in Chapter 20 of his book The Intelligent Investor "Margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, nonexistent at some still higher price."

Regarding the Class A Office Building we failed to acquire 2 weeks ago, some of you may ask these questions

1. Do you really believe it is a $5M property?
2. Are your cost saving measures doable?
3. If the answers to question 1 & 2 are yes, why didn't you set max bid limit at $3.5m? If we don't get to make $1.8m, we can make $1.3m, it is still very decent profit, right?

Here is my answer to these questions and I believe other MC members share the same thoughts.

1. We truly believe it is $5.0M property, from property sales history and its ability to generate cash flow, it worth this price tag once its cost structure becomes similar to its comparable class A office building.

2. We believe it is very doable, it does not take a genius to implement these measures. All we need to do is NOT to over spend like existing management company. There is an incentive for current PM to over spend (1) this is REO, owned by bank, bank does not have experience operating CRE, they depend on PM (2) PM tends to over spend on improvement and renovation on REO, after all, it is not their money and owner (Bank) does not watch cost closely like TZLC Management LLC (3) PM charges commission, construction management fee, etc to let money flow to their pocket, that's the biggest incentive.

If we take out these over spending, saving 30% on maintenance cost and cost on general operations (snow removal is the largest ticket item) goes to normal, professional services (legal, accounting, etc) cut by 30% and everything else maintain current run rate, the expense ratio will go down to 50%.

This does not take a genius to do it. This will bring property value to $5.0M.

If we can acquire another tenant, the revenue will increase by another 15%, Current PM acquired a new tenant in late 2013. We can see revenue increased by about 15% in 2014 (first 4 month revenue annualized) from 2013.

Acquiring another tenant is likely to increase value to $6.0M.

3. Why did you still set max buy price to $3M+5%Commission?

We believe we have a chance to acquire at this price. More importantly, this is a price we will NOT lose money even if the things don't go our way.

Though we have great confidence in our ability to deliver, but in business world, the ultimate rule #1 is "do not lose money".

If things don't go our way and we have to settle with resale the property, with current operations condition, we don't have any problem to sell it at $3.2M-$3.5M.

What we are looking at is (1) if things don't go our way, we still will not lose money (2) like JY said many times, we can not risk investor's money.

I hope this can explain why we wanted to acquire this property and why we stopped at $3M+5%.

MC's job is to help our investors to earn high rate of return over the long term. And we don't see that if we pay more than $3.15M. There are deals with better margins of safety out there for us to put our money into.

[小心翼翼的小地主]

俺个人很欣赏你们谨慎的投资态度。

[ecbb]

顶猴哥和MC， good riskmanagement plan.

[千里66]

顶顶顶！！！
把投资人的钱当做自己的钱，谨慎，智慧地投资，值得投资人信任.