What all great investors have in common

Australian investors are well versed in the long list of ways to invest in commercial property. This explains why the commercial property investment sector is so large. The value of unlisted property trusts is estimated at $227 billion, while the listed property trust sector is valued at $144 billion (Property Council of Australia). Despite the commercial property sector’s fund raising success, few investors are aware of the emerging options to invest in funds in the residential real estate sector.

Read on to learn why this emerging investment class is gaining traction and whether now is a good time to consider investing.

Change is afoot in the residential real estate investment universe

The name of the change afoot in the residential real estate universe is equitisation.

Equitisation is when a fund invests in a portfolio of properties and the non-debt ownership is split between the fund’s equity investors. It’s been the name of the game in commercial property for decades, and has enabled the significant listed and unlisted fund inflows the sector has attracted.

Residential real estate has been slower to the equitisation party. However, there are a number of emerging managers with unlisted residential real estate funds up and running who are aiming to change that. These players have good reason to be optimistic. For an asset class which has historically required a significant amount of management effort per dollar invested to deal with setting up loans and managing tenants, the concept of large-scale passive residential real estate vehicles could open up the asset class to a much wider group of investors.

As with all investment opportunities, savvy investors will be assessing the growing list of residential real estate funds in terms of the expected returns on offer versus the risk involved.

The big carrot: solid residential real estate investment returns

Benjamin Graham lost around 70 per cent of his wealth in the Wall Street crash of 1929. Despite that, nearly a century later, he’s still regarded as the father of Value Investing.

To provide some perspective, Graham fared better than the average punter. Within three years of ‘Black Thursday’ in 1929, the overall market had fallen by 89.2 per cent. Fortunes had been lost, and the Great Depression was well underway.

It wasn’t until 1954 that the Dow Jones index recovered to the 1929 peak.

Graham was still a young man when he turned his back on a promising academic career, picking up a job on Wall Street instead. His talent was obvious early – at the age of 25, he was reported to have been earning $500,000 annually.

Lessons from the Wall Street crash

Causes for the crash are many, but most historians point the finger at rampant speculation fuelled by easy credit. It didn’t help that the securities industry was largely unregulated. A Senate enquiry in 1933 heard that financial institutions deliberately misled customers, and that fraud and insider trading were everyday business practices.

The Securities Act of 1933 introduced some structure to the industry, and for the first time, legislated that investors must receive truthful financial data about shares offered for sale. Until then, companies hadn’t even been required to lodge regular financial statements.

Prior to the Act, anybody could – and did – give stock recommendations. Legend has it that John F Kennedy’s father, on being given some hot tips by his shoeshine boy, sold his entire portfolio just before Black Thursday.

Graham also learned some lessons from the crash. He’d spent years formulating his thoughts into a coherent strategy, and in 1934 he co-wrote Security Analysis, considered by some to be the Bible of modern financial analysis.

Security Analysis

Graham, in his later book The Intelligent Investor, articulated the basis of his investing philosophy.

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

The key expression here is thorough analysis. Graham is arguing that selecting investments shouldn’t be based on a hot tip, newspaper recommendation or market movements. Instead, it should be the result of a comprehensive study of original documents, aiming to find new information.

Prior to the 1929 crash, that wasn’t possible as few companies posted regulatory returns, and the few that did weren’t trustworthy.

After the Securities Act of 1933 was implemented, that all changed. Graham spent countless hours at the regulator’s office poring over quarterly company reports, looking for information that others didn’t have.

Over the next two decades, Graham’s average investment performance was 20 per cent per annum. Over the same period, the broader market returned 12.2 per cent per annum. It was during this period he took on a young Warren Buffett as an apprentice, who after adopting Graham’s methods had some success as an investor himself.

What all great investors have in common

The answer to that is simple. It’s information, or more completely, access to information. As Graham suggests, an investment operation follows a thorough analysis, which will provide as much relevant information as possible.

In the case of shares, that might include company history, historical financial statements, management, market position, competitors, and an evaluation of the company’s products or services. Warren Buffett is on record as saying it takes months, not days, to obtain enough information to seriously evaluate an opportunity. Even then, it could be months (or years) before he acts.

It's possible to take shortcuts, of course. Relying on a recommendation is one. But for that to work, the person making the recommendation still needs to have done the research…

And the less information a person has considered when evaluating an investment, the less robust any investment decision will be.

Insider trading

Let’s make a clear distinction between access to information and insider trading. Australia’s Corporations Law requires companies to act with transparency, and provide a great deal of information to the market. As it’s then in the public domain, this information is available to all investors (although most won’t investigate it fully).

Insider trading relates to information, which is not in the public domain, that could potentially affect the price of a security. An example might be the CEO of a company who is aware the business is about to collapse. If that information hasn’t been disclosed to the market and the CEO sells his shareholdings, he would be guilty of insider trading.

Despite being glamourised in movies like Wall Street, insider trading is not an investment strategy. It is a crime punishable by imprisonment.

The future

The internet has revolutionised share trading. It has also made access to information easier. Much easier.

A generation ago, stockbrokers were the gatekeepers of company information. Yes, it was possible to obtain hard copies of company reports to research, but just as it was in Benjamin Graham’s day, it was a slow and time-consuming process. Instead, most people relied on recommendations from financial professionals.

Today, you’ll find almost limitless information about potential investments online. Some will be reliable sources (annual reports, ASX announcements) and others less so (blog posts, internet chatrooms and social media influencers).

Benjamin Graham’s investing philosophy is as valid today as it was in 1933 – perhaps more so. Potential investments still require that thorough analysis of information. But were he alive today, I suspect Graham would add an extra step to his process – a thorough analysis of the source, and reliability of information. The great investors of the future will be experts at both.

Disclaimer: This article is prepared by Tom Ellison. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.