This post is ultimately going to be about real estate, but bear with me for a minute. In Warren Buffet's 1989 letter to shareholders, he describes something that he refers to as the "cigar butt" approach to investing. This has been talked about a lot since this letter, but the general idea is that if you buy a company cheap enough, it doesn't matter that there may only be "one puff left." Your low cost basis will make that puff all profit.

This has a logic to it, but Buffet goes on, in this same letter, to call this a "bargain-purchase folly." You may think you're getting a good deal and an enviable discount to market, but if the company sucks, you're likely in for a rough ride at some point. This lesson learned is what resulted in his famous adage that it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Now, let's consider something that Howard Marks wrote in the memo that I cited yesterday. He calls it one of his guiding investment principles and goes like this:

"There's no asset so good that it can't be overpriced and thus dangerous, and there are few assets so bad that they can't get cheap enough to be a bargain."

Interesting. I agree with the first piece. It doesn't matter how good an asset may be -- and we can now start to turn our minds to real estate -- there's of course a way to pay too much. But is this second part entirely or at least mostly true? I'm not so sure. It might be a cigar butt.

One of my own rules for real estate is that just because an asset is cheaper than it was before, it doesn't necessarily mean that you're getting a good price. And that's because I have seen "bargain prices" drop even further. In fact, when it comes to real estate, including development land, sometimes the value that you should be willing to pay might even be negative or less than zero.

What this means is that someone would need to pay a rational market participant in order to take on the asset or development project (usually this comes in the form of a subsidy and it means the market isn't functioning on its own).

"Buying below market" and "buying below replacement cost" are commonly sought after features in the real estate industry. And indeed, buying well is critically important. But I do think that it's important to be just as worried about overpaying as you are about buying a shitty asset. Buying too cheap can also be a problem, assuming the market is pricing the asset accurately. It means you probably don't want to own it.

Cover photo by Simone Hutsch on Unsplash

As many of you will know, I very much enjoy reading the investing memos of Howard Marks. And buried somewhere in one of them is an analogy about the kind of investors who try and time the market and/or who constantly chase the next hot thing (whatever asset class that may be).

It goes something like this: If you're trying to catch a bus and you're running from bus stop to bus stop trying to perfectly time the arrival of the next one, there's a chance that you might never catch a bus. But if you patiently wait at one stop, eventually a bus will come and eventually you'll be able to get on it.

I like this analogy because you see this jumping around in every industry. In tech, a lot of people have moved from the crypto bus stop to the AI bus stop and, in real estate, we've seen it, and are seeing it, with industrial, student housing, and other in-demand asset classes. Capital wants its yield.

Now, it's obviously important not to ignore macroeconomic shifts and fundamental changes to your sector. If your bus route has been cancelled or rerouted, you don't want to be waiting patiently at that stop. You want to be on the move.

But if the long-term fundamentals in your sector haven't changed and everyone else is distracted by what's new and shiny, hanging out can be a powerful strategy. And this brings me to something that Marks recently wrote about in a memo called "On Bubble Watch." In it, he talks about the three stages of a bull market.

Here's how he describes stage one:

The first stage usually comes on the heels of a market decline or crash that has left most investors licking their wounds and highly dispirited. At this point, only a few unusually insightful people are capable of imagining that there could be improvement ahead.

In my view, this is broadly the stage we are at in the commercial real estate industry. It's tough out there. But at some point in the future, we will move past this stage and go from "a few unusually insightful people" to "most people" and then finally "everyone." These are the exact words used in his 3 stages.

But here's the thing.

There's lots of opportunity if you can be among the "few unusually insightful people." It gives you the chance at being right about something that "most people" are overlooking. But that means you need to hang out at the bus stop that you have high-conviction around, which can be hard if everyone has left you in search of another one.

Yesterday, the City of Toronto announced that it would be "unlocking" 7,000 new rental homes -- including 1,400 deeply affordable homes -- by doing two key things:

• Waiving development charges on rentals

• Providing a 15% reduction on property taxes

And by their estimates, the value of these benefits would be roughly $58k per new rental home:

Great news, right?

But wait, there's a catch. If you read the details, you'll see that in order for a project to be approved under this program, there is also a requirement to deliver at least 20% of the homes as affordable rentals.

So let's look at what this could mean.

Here is a chart comparing a market rental suite at $3,000 per month to a more affordable one at $1,500 per month:

Both are assumed to be 600 square feet. In the case of the market suite, the per square foot (PSF) value is estimated at $933 psf, and the affordable suite is estimated at $467 psf. This represents a halving of the value (which makes sense because I halved the rents).

On a per unit basis (again, we're assuming 600 sf), this is a loss in value of about $280k. But since only 20% of the units would need to be "affordable", I multiplied this number by 0.2. The result is a per unit loss of approximately $56k.

What this means is that we're basically doing a whole bunch of stuff to get right back to the same place. Like, hey, we're not building enough rental housing and we're certainly not building enough affordable housing -- because the development margins are so dangerously thin -- so here's a credit of $58k per unit. But at the same time, here's a bill for $56k per unit.

What's the point, besides making it sound like we're doing something to create more housing? This program will do absolutely nothing to spur the creation of new rental housing.