What Real Estate Can Teach Us About Investing

Real estate investing is often incorrectly scoffed at in the stock market investing world.

On this episode of Industry Focus: Financials, Gaby Lapera and John Maxfield interview Tim Leigh, founder of real estate company Hoff & Leigh in Colorado Springs, about how the business works. Listen in to learn about how the company makes its money, how it uses market cycles and research to find good investments, why real estate is a solid investment strategy for individuals and businesses, and how to get started in real estate investing if you don't have the start-up capital to buy a location yourself.

A full transcript follows the video.

This podcast was recorded on Jan. 11, 2016.

Gaby Lapera: What it takes to build a $100 million business and how to identify a promising real estate investment. This is Industry Focus, financials edition. Happy Monday, everyone! I'm Gaby Lapera. John Maxfield, our senior banking specialist, joins us over Skype. And we have Tim Leigh, who is the founder of Hoff & Leigh, which is a multifaceted real estate company based in Colorado Springs, Colorado, to help us talk about a topic that we don't normally cover. We are normally all about the investments. This is also a type of investment but different from stocks. We're going to be talking about real estate today. Welcome, Tim! Thanks for taking the time to join us.

Tim Leigh: Thanks for calling. I'm looking forward to talking about one of my favorite topics, real estate.

Lapera: Fantastic. So, just before getting started, I wanted to put out there that we've got a couple reader questions about successful businessmen, people who self-started themselves, and Tim is a fantastic example of that. Do you want to give our listeners a brief overview of Hoff & Lee? Your elevator pitch? What does it do? When did you found it? Where do you see it going in the next 10 years? Do you feel like you're being interviewed? Because you are.

Leigh: Sure. I was a law school dropout who became a door-to-door life insurance salesman. One day, I was calling on a young guy who is leasing commercial property for a living. Back in the day, I didn't even know you could earn money leasing commercial property. I'm from a small town, so I wasn't even aware that was an option. I became so interested in what he was doing, and became determined that it was something I could do at a high level, so I quit selling life insurance and became a commercial real estate leasing agent. And I knocked around for a couple of years with companies as an employed broker.

Then, in 1987, my former partner, Bob Hoff, and I founded Hoff & Leigh. When we opened our doors, our attorney told us that he would be dumbfounded if we lasted a year. But since then, we've become the longest-continuously running commercial real estate brokerage in our market, and now we're on our way to building a national brand. Over the years, we've developed systems and processes to make our job more scientific and predictable and easier to execute. So, what we do is pretty simple to understand. I like to tell people we list, lease, sell, manage commercial property and we invest for our own account and we lead other investors.

John Maxfield: So, Tim, one of the things that Hoff & Leigh has really doubled down on since the financial crisis, in my understanding, is owning and operating commercial real estate. Can you talk a little bit about your investment philosophy in this regard, as well as what you perceive to be your competitive advantage when doing so?

Leigh: Sure. We've been successful investors because we watch the business cycles, and we watch real estate cycles, and we buy when the party's over and the chandelier's crashed to the floor, and all the dancers are running for the exit. The implication is that you have to have a great amount of courage, and you do, because we buy when everybody else is selling. And that's not an easy thing to do. I can remember after the last crash, we had a lot of heartfelt conversations around the kitchen table trying to figure out if the market was ever going to recover. And, markets always recover, they always have. The last crash was so bad, we were pretty fearful, but we stepped up to the plate and made a lot of good acquisitions, and it has proved to be a pretty successful strategy.

Really, what we do, I would say, is counterintuitive. We really don't chase markets. We try and do a little bit of market timing. We really watch what's going on in the larger business world and the world in general and try to buy when we see there, maybe, some opportunity. Philosophically, it's kind of my belief that most transactions occur because of greed and fear. And because that's the case, most folks make bad investment decisions. My experience has been that most folks invest, really, because of the adrenaline rush that comes from investing and they continuously chase the last best horse.

And what we do is different. We look for boring investments that pay us money every month. One of our really strong competitive advantages is that we're brokers, and we're on the ground floor and because we get a first look at good deals. And the implication for the average investor who might be listening to this podcast is, they need to find a trusted broker who has successfully invested for their own account.

And, by the way, that's not just a broker. That's somebody who has successfully invested for their own account, so the listener knows that person has good experience. And they either need to partner with him or her or develop a relationship where the broker knows the investor's needs and abilities, and then the investor has to be ready for the day the broker calls and says, "Hey, send me your money." Because, the fact is, good deals are picked up quickly, and therefore, that trust relationship and the availability of the investor's liquidity allows the average investor to play at what I would consider to be the A level, and be able to take advantage of markets that normally wouldn't be available to them.

Part of our national franchise model was designed around the idea that all real estate is so local, and because it is, and because we wanted to have a diverse market opportunity across the country, we figured out that having brokerages at all these markets put us on the ground floor with those folks that are in those markets. So, it's not unusual for us to get a call from one of our network offices and say, "Hey, you guys need to fly out and take a look at this deal, Salt Lake or Akron or Jacksonville or something like that." And if we didn't have a network, we would never get a chance to look at those deals.

Maxfield: When I hear you saying this, what really comes to my mind is one of Warren Buffett's most famous sayings: "You want to be greedy when others are fearful, and fearful when others are greedy." Buffett is talking in the context of buying whole companies, like Berkshire Hathaway does, or in the context of stocks, you want to act countercyclically. So, I guess what's interesting is, you're saying that you see, as both a broker and an owner of commercial real estate, that same exact type of behavior in the real estate market that we see in the stock market.

Leigh: Oh, yeah. I think without question. At a high level, good real estate is sold by a call for offers, which is a pretty interesting concept, as opposed to a stock, where it's a free-for-all and you go in and try to buy it at the market. But what we do that's maybe different than what a lot of folks might think of commercial real estate brokerages do is we have a real market orientation, so we don't chase after large institutional real estate as an investment. What we do is the stuff that the every man could do. We work what I like to call the bottom 80% of the market, and we look for value opportunity. And there's a lot of that out there, but you've got to really pay attention to what's going on in the overall economy.

So, the implication might be, for example, the China market melts off like it did last week, so that causes some person in Colorado Springs to get scared and decide to sell a building, maybe at a discount. We come along, we're not so afraid of what's going on in China, because we understand what's going on, and we say, "We'll buy that property, because we're going to be able to buy it below prevailing markets, and create some value for ourselves." We work in, again, what I call the bottom 80% of the market, which is where the typical investor is at. The top 20% is the large institutions, and that's a whole different conversation. So, we're kind of blue-collar, lunch-pail commercial real estate brokers that go out into local market and find what we figure to be really good real estate investments.

Lapera: I heard you mention that you were expanding, and you mentioned a bunch of different places. I think you said Ohio and Utah and Florida. I was wondering, how did you pick those markets? What is driving your strategy behind expansion?

Leigh: Well, at the end of the day, what really drives it is just relationships. We need somebody and we build a relationship and grow the business that way. But the strategy was always to recruit new network offices in markets where Southwest Airlines flies directly from Denver. The theory is Southwest did all the heavy lifting, and if the market's strong enough for them, we believe it's probably strong enough for us. Additionally, we look at tertiary markets. So, we look at SMSAs that are between maybe 300,000 and 1 million population, which, in our world, is a market that's overlooked by large existing national franchisers.

So, we're not interested in butting heads with existing large commercial brokerages in LA or Washington or New York City, for example. We believe there's great profit in the Omahas of the world. We believe we're the alternative of those large, existing brokerages. We're a family business. My daughter, Holly, and her husband, RD, now lead the executive team. And under their leadership, we've grown from a one-market boutique real estate company to an emerging national franchise brand with a unique model. What separates us is the simplicity of our model.

Our model is designed by high-producing commercial real estate brokers for high-producing commercial real estate brokers or for those other brokers who want to take their sales career to the next level. So, we offer no start-up cost, a high payout, and provide an entire backroom operation that comes with any nationally scaled company. For example, the guys in Ohio? We answer their phones. The guys in Jacksonville? We answer their phones. We answer every broker's phone in every market in our Colorado Springs office. And we can literally put a new broker in business inside our network within 24 hours of contracting, with a fully developed website and fully complemented marketing team at no cost to the new broker.

You could say our primary focus is not the technology, really, that everybody has. It's our relationships and the development of a culture of success, which includes, in our case, emphasis on family and loyalty and entrepreneurship. And as to the scaleability of Hoff & Leigh, technology and the Internet and the cell phone allow us to grow our network without limitations. So, we can be as big as we want to be, except for the limitations of finding quality folks to join us. That's the big trip: finding the quality folks. Also, the limitation of time, because we're not a huge organization. We're growing, but we're so small, so we can only do what we can do.

Maxfield: Tim, sorry to interrupt, but we've talked in the past, and one of the things that I found so interesting in those conversations was that, when you're in the stock market world, real estate, from the perspective of an investor, gets a really bad name. And it's based largely on Robert Shiller, who's a professor at Yale. His observation that over the last 100 years, on an inflation-adjusted basis, real estate -- and I think he's talking specifically about current residential real estate -- has appreciated something like 1%. I don't know what the exact percentage is. But we're talking in basis points, not like 100%. But there's really more to the story than this, isn't there? Specifically, if you buy, say, a second house with a mortgage, your return, assuming it's leased out, is going to be more along the lines of 6%, right? Your mortgage plus presumably some type of small premium. Can you dig into this a little bit and to dispel this notion?

Leigh: I'll give you an example to consider. My daughter bought a house. She bought it to live in it, but then she fell in love and moved in with her boyfriend. She paid a couple hundred thousand bucks for the house. Her house payment is $1,200 a month. She collects $1,450. Right there, she's making cash flow. So, you would measure her return based on the cash flow compared to her investment, and her investment wasn't the $200,000. In her case, I think she paid $10,000 down. So, coming out of the gate, she's making $3,000 in cash flow against that $10,000 investment. That's not bad. Her house is probably going to appreciate in our market, even as bad as it is. Probably it's going to go up about 2% per year. That's another $300 something a month. Then, she gets the tax benefit of depreciation, and that's probably another $350 a month. So, you add those three elements -- the cash flow, the appreciation, and the depreciation, which are real benefits that you get -- and she's probably making somewhere around $900 a month in value.

Maxfield: And then, over the course of that -- so, she puts $10,000 down. Presuming she holds that as a conventional mortgage, 30 years, she holds it for the entire 30 years, assuming on an inflation-adjusted basis, it still appreciates, but let's say it even stays even, you're still looking at a not-illegitimate return, right? You're not looking at a zero return, because you're not just looking at the appreciation. What you're saying is that you have that appreciation, but you also have the depreciation, and you also have that cash flow and you put those three elements together.

Leigh: Sure. Let me say, too, one of the things I didn't mention was the amortization of the loan. So, let's just say, in this case, take a number, it doesn't matter. Say the amortization is $150 a month on this loan to begin with. Over time, somebody else is going to buy that property for her. That's a huge benefit. So that $150 amortization for a stock investor buying a mutual fund on a dollar-cost-average basis, there's $150 deposit going into a mutual fund. It's the same equivalent, except that they have the other benefits that we just talked about: cash flow, depreciation, and appreciation. So, I get a kick out of folks who want to debunk real estate as an investment. I own stocks for my own account, I own highfliers and lowfliers.

I've never known real estate to go to zero, because there's intrinsic value to the physical, tangible asset. So, real estate, in my mind, is a great investment. One of the things that people used to always say was "It's not a good investment because it's highly illiquid." And I would say, "To the contrary. Real estate can be highly liquid with a simple credit line that's attached to the property." So, you could literally write a check for whatever cash you have in terms of the equity. I think, John, one of my philosophies has always been, if you want to beat the statistical average, which says that when you reach retirement age, you're either dead or dead broke, simply to beat that average, I've always said, you buy one house, pay for it, that's the (...) you live in. You buy a second house, you pay for it, and that provides you with money every month. And if you just do those two things and forget about everything else, I would argue, you're probably in the top 5% of all savers and investors at retirement.

Lapera: Wow. This was a very comprehensive show. I don't think we have that much time left, but I just want to give our listeners a summation. Ultimately, real estate is a lot like investing, and a lot of the same lessons can be taken away from both. You want to be patient, look for long-term investments. You don't want to grab something and sell it right away. The chances of you making your money back on that are probably not as high, just like with the stock market. I also want to emphasize the importance of doing research, both locally and globally. Part of the reason that Tim can be so successful is that he understands both the local market and what's going on in the larger global economy at the same time, which allows him to take advantage of any downturns in the market, as we also encourage here at The Motley Fool.

Also, two things that stood out to me are, he looks around him for opportunities just like investors can. So, things you're familiar with, things you know about, things that maybe haven't quite caught on everywhere else, maybe you can catch that locally and ride the wave as it gets bigger. Most importantly, buy things that you believe in. Just like Tim makes sure to invest in people he believes in and spreads in the cities that he believes are on the up and up, on the rise, you can do the same thing with stocks.

Now, if you're interested in investing in real estate without actually buying your own properties, because that can be a hassle or maybe you don't have the start-up capital, one thing you could look at investing in are real estate investment trusts, or REITs. We've done shows about them. We write a lot about them on The Motley Fool. I really encourage you to go out there and learn about them. I think that's it, unless anyone else has anything to say.

Maxfield: We really appreciate you joining us, Tim.

Lapera: Yeah. Thank you again, Tim, for joining us. Keep an eye out next week, when I'm joined by Jordan Wathen to discuss business development companies. It'll be a very exciting show if you like business development companies. As usual, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program.

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