Warren Buffett is America’s greatest stock investor, but his philosophy changed over time from “cigar butt” to value investing – and that transition is when his profits soared. In this Mobile Home Park Mastery podcast we’re going to overlay Buffett’s theories on trailer park investing and spot the similarities and differences.
Episode 311: Buffett, Cigar Butts And Trailer Park Investing Transcript
Warren Buffett is one of America's greatest stock investors, but he is also a great storyteller. He gives a lot of down home observations that are very easy to grasp, and one of his best quotes is, "A cigar butt found in the street that only has one puff left in it, may not offer much of a smoke, but the bargain purchase price will make that puff all profit." This is Frank Rolfe, from Mobile Home Park Mastery podcast. We're gonna talk about the concept of Buffett's concept of Cigar butt investing, as contrasted with his... In concepts of value investing, and then see how that overlays onto proper mobile home park investing. So I think we all understand this idea. With a cigar butt, you basically are buying something or getting something virtually for free. And even though it's not of a whole lot of value, you paid very little or nothing for it.
So therefore, it seems like a really good deal, a very profitable deal. And that's how it was back with Berkshire Hathaway when they started out. They bought a failed textile mill. Why? Because it was cheap, and then it was doing awful. And they kept buying more and more similar businesses and stocks, which basically all looked similar. They were situations where the business could be had at a penny on the dollar, but yet it didn't have that much potential. And then later, Buffett and his partner, Charlie Munger, changed course. They came to a new revelation that what they should have been doing was they should have been doing value investing, and they defined value investing as buying high quality assets with a sustainable competitive advantage that they buy at a fair price, basically buying good companies at a reasonable price. Now, what is Cigar butt investing with mobile home parks?
Well, it's when you buy a mobile home park for very low cost, or perhaps you buy it with zero down non-recourse debt, typically from a seller. And then it's often revolves around buying bad locations, bad property condition, bad occupancy, failing private utilities, permitting issues, including complete illegality. And I engaged in my early career, certainly in doing some cigar butt mobile home park purchases. One of my early parks was a 15 space park with a brick house. And I bought this thing for $65,000. I put down $5,000 and the seller carried the balance of $60,000. So I had almost nothing in it, only $5,000 in it. And this park was such an unbelievable pig of a park. All the homes were pre-HUD in horrible condition. The thing was a basic thicket of overgrown brush. And the seller did not even have a rent roll. In fact, he didn't even know the names of the people who lived in the mobile homes.
It was that rough, but still it was that cheap. And then later I bought a 180 space mobile home park in San Angelo, Texas that had only one resident in the entire park. And I bought that entire park for $240,000. That's right, just a little over a $1000, a space with zero down and non-recourse seller debt, another cigar butt of a deal. And both deals made me money in the end, but only because I bought them so insanely cheap. So that's what cigar butt investing is all about. It's about buying things that are super cheap, don't have a lot of potential, nothing you're proud of, but you can say, "well, but that still made me some money." But a better plan as Warren Buffett would tell you, is to engage in value investing. So let's break down Buffett's concept of value investing in his own words regarding mobile home parks.
First, you wanna buy a high quality asset. Totally you'll agree with that. So you wanna buy a mobile home park that has excellent infrastructure, density and location, and you want two... By virtue of buying these trades, have liquidity. You can sell that thing again in a moment 'cause everyone wants it. And you have the ability to attain institutional debt, which has the lowest possible interest rates, typically non-recourse in the longest loan terms. Next Buffett says you wanna be in businesses with a sustainable competitive advantage. Going to another Warren Buffett saying that means you want a business with a giant moat. Because the moat is what protects your investment from your enemy, which is competition. And the mobile home park industry has not one, but two giant moats. One is the fact that the mobile homes never leave the property. Part of that is physical. You can't really move a pre-HUD home one built before 1976, because it doesn't have a HUD seal, so you can't bring it back in anywhere.
And also, homes that are older than the '90s typically shouldn't be moved because they may be just too fragile to make the transport. But most importantly, people in mobile home parks rarely ever leave. They have a typically a 14 year tenancy because they like living there so much. They have a detached home with a yard at an insanely low price, and nothing can compete with what we do. Apartments are attached, they're not detached and they can't match our pricing. And if you wanna a detach dwelling, a single family home in the US averages $400,000. But that's only moat number one. Moat number two is you can't build any new mobile home parks in the US.
There's... In any given year, they estimate 10 or fewer mobile home parks built new, but about a 100 that are torn down for redevelopment. So basically, mobile home parks are an endangered species. Cities and people who live in cities hate mobile home parks. So they have banished them. You cannot obtain the zoning to build anything new. So when you own a mobile home park, you don't have to worry about one being built across the way or down the street like a self-storage facility, but instead, you know you have got a monopoly, no one can build anywhere around you. And then finally, Buffett would say that in value investing, you're buying this good business at a fair price. And in that regard, mobile home park buyers have a huge advantage over Warren Buffet because mobile home parks typically have lots of room for improvement. It's really hard for Buffet to probably find businesses to buy these days 'cause they're all horribly overvalued.
The price to earnings ratio in the US typically was considered to be, if it was not 10 or lower, a bad buy. Now they're 20 and above. But with a mobile home park, you have all these additional things you can fix pretty quickly after purchase. You can raise rents to market levels. You can fill vacant homes in lots. You can sub-meter and build back water sewer, which is our single largest cost item. And you can often reduce manager cost. So in this way, the concept of value investing is much easier for mobile home park buyers than it is for Buffet. Although nevertheless, Buffet has pulled it off time and time again with large investments in such great businesses as Coke and GEICO and the list goes on. But is value investing really superior to cigar butt investing? Some people might say, well, let's think about that for a minute.
Number one, cigar butts are harder to find. It's a whole lot easier to go down to the store and buy a real cigar than it is to scrounge around the streets and the curbs and the gutters looking for that cigar butt that has one more puff left in it. And as Charlie Munger told Buffett when they changed their investing system, that if they wanted to scale, if they wanted to be anything, if they wanted to be big, they would have to give up cigar butts, which they could not find frequently, and instead change over to value investing. But another bigger item is that cigar butts rarely have huge profits. Look back at my early cigar butt deals, that deal that I bought for $65,000, you might say, "Wow, what a deal". I ended up selling that thing for 125,000. So even though it was a very large return on investment, the numbers were still extremely small in scale. And that's the problem. Most of those cigar butt deals that you see out there from mobile home parks are small. They're small in size, they're small in dollar value. So it's hard to make a real home run.
It's hard to really attain huge amounts of wealth off of cigar butt deals. And also, cigar butt deals are inherently risky because you're buying problem properties and you know that you're buying them when you buy them. And one problem with a problem property in some cases is it can chase after you even after you sold it. If you're buying a property that's environmentally contaminated or has a private utility, it has to be remediated. These kinds of things can go after you even after the sale is complete. But that's not to say that cigar butt deals don't have their spot in mobile home park investing, because many smaller investors find the cigar butt deal as a stepping stone to attain capital to actually do value investing. They understand that they really would like to buy that really nice looking 100 space mobile home park, but for the time being, they're gonna stick with that 20 spacer.
Why? Because it's cheap and they can afford it. And then eventually, after a series of successful cigar butt deals, they will then move on into buying bigger and better stuff. That's how Berkshire Hathaway did it. They went from their early origins of cigar butt buys and textile mills that were failing to become the monolithic enterprise it is today. I went from my early cigar butt 15 space park into the portfolio that I'm involved in today. So Maybe the real key is to know the difference between value investing and cigar butt investing. And to acknowledge that sometimes cigar butt investing is correct based on your budget and what you're trying to attain. But the goal should always be to upgrade, to always take that capital created through those cigar butt transactions and instead put that money into the larger, more quality value investing. This is Frank Rolfe, from Mobile Home Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.