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

I admire Warren Buffet's humility:

In the physical world, great buildings are linked to their architect while those who had poured the concrete or installed the windows are soon forgotten. Berkshire has become a great company. Though I have long been in charge of the construction crew; Charlie [Munger] should forever be credited with being the architect.

This is an excerpt from his recent letter to Berkshire Hathaway shareholders, which, this year, he opens up with an obituary to his late partner, Charlie Munger.

I don't agree with everything Warren says and writes. He, for instance, doesn't seem to like crypto and streetcars. Though, surely, he'd really dig my CryptoParisian.

That said, I never miss his letters and his thinking has been broadly instrumental in how I tend to think about real estate.

If you take his description (same letter) of what Berkshire does, and replace businesses with properties, this is what you get:

Our goal at Berkshire is simple: We want to own either all or a portion of [properties] that enjoy good economics that are fundamental and enduring. Within capitalism, some [properties] will flourish for a very long time while others will prove to be sinkholes. It’s harder than you would think to predict which will be the winners and losers.

This is a good way to think about real estate.

At the highest level, I agree with the premise of this tweet from The Real Estate God. The overarching argument is that one's main criteria for selecting a real estate market in which to enter should be "the place with the least competition." And the reason for this is that less competition equals less price discovery, which then equals more mispriced assets and more opportunities to generate outsized returns.

Going even further, the argument here is that you're actually taking on less risk by buying mispriced assets in less competitive markets because you can model reality (things like in-place cash flows and market rents) as opposed to betting on the future (things like rental growth and/or cap rate compression). Said in a different way, it's easier to find deals and "make money on the buy"; and, once again, I would mostly agree with this.

But in my mind there's a very important caveat. And it's akin to the advice that the late Charlie Munger supposedly gave to Warren Buffet: "Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices." While it is true that you might find wonderful pricing in less competitive markets, there remains the question of whether you're also buying wonderful real estate.

And I think that's an important consideration.