What property investors can learn from the movie ‘Moneyball’

The 2011 hit “Moneyball“, starring Brad Pitt and Jonah Hill, was as much a movie about economics and statistics as it was about baseball. The film, adapted from the book by Michael Lewis (in my opinion the book is much better), follows the story of Billy Beane (Brad Pitt), the General Manager of the struggling Oakland A’s baseball franchise. In a break from tradition, Beane chooses to engage a data guru (Jonah Hill, Based on Paul DePodesta) to help him craft a player development and recruitment strategy which would allow them to compete with the bigger, more cashed up teams. It allowed the A’s to uncover some players that they believed were undervalued, and to put together a team that had a chance to compete with the larger franchises. Without giving away the entire story line…it worked out pretty well for him. It’s a great movie, even though it does leave out a few critical details.

The key difference to how Beane chose players, compared to other teams, was his reliance on certain base stats to inform him of a player’s likely contribution to the overall team. His strategy was to value players based on an objective, rather than a subjective, approach and was quite different to the way scouts traditionally analysed potential players. He set about creating a framework to help him answer one key question: “How can I best buy runs?”. In order to find players that would score runs, he and his team analysed past games to discover what were the leading indicators that determined a player’s ultimate ability to score runs. They decided to adopt a singular focus on finding players that had the greatest chance of making it on base.  The way in which they did so didn’t matter as much as the fact that they did make it onto base. This was in contrast to how baseball recruiting was traditionally done, which involved a lot more reliance on averages such as home runs and RBI’s. It allowed Beane and his team at Oakland to look for players that fit their system. Seeking players that were undervalued by other teams was key.

So, given this is a blog about property, you might be asking exactly how is this relevant? I think there are quite a few lessons property investors can take from the story of the Oakland A’s, and how they took an out of the box approach to data and understanding the game of baseball, and applied it to their advantage.

Applying “Moneyball” thinking to property investing

In the same way that the Oakland Athletics created a framework to understand how they could find players that had the greatest chance of scoring runs for the lowest cost, I believe it is possible to employ a similar approach to property investing. Billy Beane focused on the key question “How can I best buy runs”. The parallel in property investing is to answer the question “How can I best buy capital growth?”. I’m a big believer that the ultimate goal of property investing is to secure capital growth. To do so, we need to understand the key drivers of capital growth, and how we can find areas that include enough of these drivers. We also need to do so at the lowest holding cost possible. Is it possible to develop a framework to help us find these properties, and to also seek out value that others might have missed? I certainly believe so.

So, how do we find undervalued areas and undervalued properties? In a similar way to the A’s focusing on the on-base percentage of batters, I also have a number of key metrics that I look at. However, I don’t rely on any single stat, rather I look at a number of key pieces of data to help me understand if a property (or an area) is worthy of further investigation. Of the more than 20 types of data that I look at, some of the key ones are listed below, broken up into those which help you select an area to invest in and those which help you select a property, once you’ve selected an area.

Selecting areas to invest in

The below are the main location related datum that I look at, as part of my overall property research. In keeping with the Moneyball tradition, these are the ones that relate to objective data. There are other things I look at as well, such as lifestyle activities and signs of gentrification, once I get on the ground. The below provides a good start however, to help find areas that show promise.

• Vacancy rates
  • There are a number of places to find vacancy rate information, but I prefer using SQM Research. I find their approach is more rigorous than some others, and the granularity of data that they provide is much better. When I’m looking at vacancy rate data, I’m focusing on areas with a sub 2% vacancy rate. More important that the individual monthly number, however, is the trend in vacancy rates. I’m looking to find places that have displayed a consistent downward trend over recent months, indicating a tightening of rental demand. Vacancy rate data is only one piece of information, but in my experience it’s an important indicator of where the rental market is at any point in time.

• Stock on market and days on market
  • Again, you can use the data available at SQM to give you an indication of how much stock is currently on the market, and how that compares historically. In particular I look at the stock above 180 days and the stock under 30 days. The former gives me an indication of long-term listings that are struggling to sell, and the latter can give an indication as to the appetite of vendors to put their property on the market, if they expect prices to rise. Again, just like the vacancy rate story, we’re interested in trends, and not an individual month in isolation.
  • It’s important, however, not to just look at these numbers in isolation. I’m also a fan of looking at plans for future developments in the area, and trying to work out what the potential future supply might look like for a property that I’m looking at purchasing.

• Economic activity
  • Unlike the above two measures, there isn’t one central source of information on economic activity by region. Rather, I ensure I’m across as many different data sources and news outlets as possible. The ABS provides a plethora of information about economic activity in Australia, regularly publishing reports and indices. National publications such as the AFR provide important commentary regarding the economy, and regular property market updates. At a more local level, local councils and trade associations provide data and information about investment in particular areas, however it’s important to remember these are often as much about PR and marketing as they are about information provision. Excellent data is also available from the .ID website, which publishes council/city level economic information, as well as summary Gross Regional Product data.
  • I’m keen on finding areas that are economically vibrant with strong future prospects. This means I don’t invest in any single industry towns, very small towns (a rule of thumb for me is below around 20,000 population is too small unless it is very close to a larger town) or towns that rely on industries that I don’t believe will perform well into the future.

• Population, demographics and income data
  • Websites such as the ABS and .ID provide excellent, accessible information about population movement, demographics, income levels and unemployment data.
  • When looking at this type of information, I’m focusing on finding areas that are experiencing or forecast to experience population growth and are likely to benefit from higher wages and salaries in the future. Income growth is an important consideration when looking for capital growth focused properties, so I spend a lot of time looking at information such as this. New employers, expanding industries, and access to new transport infrastructure that allows the local population to more easily access higher paying jobs are important things I look for.

Selecting properties to invest in

Once I’ve found an area that shows promise, I then look more closely at the actual properties available there. The below are the main property related things I look at.

• Yield
  • As an investor, I’m predominantly focused on capital growth. However, I need to ensure that the properties I purchase don’t put undue stress on the weekly budget and don’t cost too much to hold. In that regard, yield is a key measurement that I follow closely. Yield is important not only for the properties I’m buying, but also for the local market in general. I’m focused on finding properties that are going to have a strong yield to start with, and the requisite drivers to also see an increase in rents per week over time. In essence, I’m looking for factors that will make the area I’m investing in more appealing to both owner occupiers and tenants. In a future article I’ll dive deeper into understanding the role of yield in property investing.
    

• Operating costs
  • I really like to find out what’s driving costs, and to seek to minimise them wherever possible. In high level terms, this means I tend to focus on certain types of properties where I’m confident the ongoing running costs are manageable.
  • Some operating costs are more controllable than others. It’s true that we can’t do much about rates and utilities, but savvy investors can look to minimise certain aspects of running a property:

• • • Land tax-Considerations around ownership structure as well as diversifying your investments around the country can help to reduce or eliminate land tax costs. Decisions of this nature should only be undertaken after consulting your accountant and financial planner.

• • • Property management–By working with your property manager to ensure you select quality tenants and stay on top of any issues, it’s possible to reduce your operating costs as they relate to property management. Every time a tenant leaves you face costs associated with re-letting and potential vacancies. It’s often far better to pro-actively manage your property to ensure the tenant remains happy, sometimes accepting a few dollars less per week in order to minimise tenant turnover, and thus reduce overall costs.

• • • Maintenance-Depending on if you own a standalone house, or part of a strata complex, there are steps you can take to pro-actively manage maintenance, which can result in an overall lower cost in the long term. It’s said that prevention is better than a cure, and this is definitely the case with property maintenance.

• Land to asset ratio
  • One Moneyball type approach that I’m particularly keen on relates to understanding the land to asset ratio for a potential property. Many property commentators and investors are fond of saying “only buy houses, you need the land content”. However, rather than just focusing on the sheer size of a parcel of land, I’m more focused on the land value of the property. As an example, an art-deco apartment within 5-10km of a major capital city can have substantial land value, even though its actual land content is relatively low. At the same time, a new build house and land package on the outskirts of the same city could conversely have a relatively low land value, even though it sits on a substantially larger block of land compared to the apartment. By understanding the land value and comparing it to the purchase price, I’m able to calculate the land to asset ratio. I do this for every property I look at, and it helps me to understand which types of properties in which areas are worth considering further.

• Property type
  • A critical part of approaching the selection of a particular property, once you’ve selected the area, is understanding the actual type of property that is in demand in that particular suburb or area. In some areas, freestanding houses are the norm, and there’s very little demand for dwellings such as villas, townhouses or apartments. In other areas it’s the complete opposite. If you’ve found a promising area that ticks all the boxes, it’s important that you also spend some time researching how local residents live. This can be found, at a high level, from ABS Quick Stats, as well as by speaking to local listing agents and property managers.

Using the above ideas, what I’m looking to do is find areas and properties that have either been mis-interpreted by the general market, or where an opportunity isn’t immediately obvious. It’s less about access to data, and more about how I use data to understand opportunity. The second thing it allows me to do is to act very quickly. For every area I invest in, I’ve basically formulated what I believe the ideal property looks like. In some areas that might be a standalone house with plenty of land, and in others it might be a two bedroom walk-up unit that needs a cosmetic renovation. Each ideal property type is chosen based on the type of investor and strategy that it would suit. I regularly revisit this, to ensure that I’m ready to pounce as soon as a property comes online or is made available to me. That generally means getting the property under contract on the same day it’s made available. Speed is of the essence, and having access to reliable data, and knowing how to use it, is key. In the movie Moneyball, Billy Beane is portrayed as a generally patient person, who is able to quickly make decisions when opportunities present themselves. This is a critical lesson for property investors, who would be wise to set themselves up to be ready to move quickly once an opportunity becomes available.

Use data, but understand its limitations

Just as Billy Beane discovered, you can’t rely entirely on data to base your decisions on. In the case of property investing, data has a very important role to play in helping investors understand which areas have potential, and which property types and opportunities they should be focusing on. However, especially with an asset class like real estate, which changes hands so infrequently and is so heterogeneous, data should be used as just one part of the research process.

The longer you spend researching property, the more examples you’ll find of data being misinterpreted. A classic example is month to month published growth rates. These can show extreme spikes, particularly in suburbs that are seeing a rapid re-development, where older houses are being knocked over and replaced by new properties. In a thinly traded suburb, a single large development can skew property values, making them appear higher in the year when the new development sells, and then less in subsequent years, if there are no similar developments coming on line. Data is important, but it needs always to be understood in context. The greater the variety of different data points you can gather, the better. The wider the range of data providers, the better. Finally, the more you’re able to place data against a trend, the better. All of these measures can help minimise the risk of taking an individual piece of information and incorrectly drawing conclusions from it.

Understand the end game

Just as Billy Beane was ‘buying runs’, property investors are essentially buying access to future cash-flows, by way of regular rental income and the potential for capital growth in the future.  I’m always looking at how I can approach the two key questions “How much am I willing to pay to get access to this rental stream?” and “How much am I expecting this property to grow, relative to how much I need to invest in it?”. The latter includes the upfront investment and any ongoing investments over time.

Understand risk

At its heart, the strategies employed by the Oakland Athletics were all about minimising risk. They sought to use data to best understand the type of players to draft and the types of players to avoid. Bringing in a player that doesn’t live up to his price tag carries a significant risk, not just financial but also in terms of opportunity cost. It’s no different in real estate. If you have a finite amount of money to invest, then any misstep can set you back substantially. It’s even more pronounced with real estate, as the transaction costs are so high that it’s difficult and costly to unwind a mistake. Hence, investors often hang on to poor performing properties, hoping for a turnaround. Opportunity cost is a cost that is overlooked by most investors, but unfortunately it’s one of the biggest reasons that many investors fall short of their goals. I talk more about the idea of opportunity cost in this article.

I pay particular importance to the idea of risk management, and look to de-risk the purchasing decision wherever possible. So, how do I help clients manage risk in property investing? One way is to make sure that they’re buying properties that the banks are keen to finance. Others relate to things mentioned above, such as buying the right property type, finding areas that are economically vibrant, looking for value add opportunities, and focusing on areas that are in high demand from owner-occupiers. If you’re looking for more information on this, I’ve put together a free short-video series on this, which you can access here.

Employ portfolio thinking

In the movie, there’s a general narrative of how players fit in, based on their historical stats, to the expected performance of the overall team. Successful property investors employ a similar approach, adopting a portfolio approach to investing. I like to treat investing in property as if I were investing in a portfolio of individual businesses. Each property must make sense as an individual business, but it also must complement the rest of the portfolio.

Get your team aligned

Beane relied heavily on his analytics team, but wasn’t afraid to step in to move people on if they couldn’t see the ultimate vision. It’s no different with property. Find good people that you can work well with and that you trust, but remember that ultimately, you’re the one in charge and the one who has to make the tough calls.

In summary

Moneyball was a great movie, which provided an example of someone who stepped outside the generally accepted principles of baseball, to seek ways of doing things better. Property affords the same opportunity to smart investors who are prepared to do the work. I don’t believe in blindly following the masses, nor do I believe in relying only on abstract data to find your next investment. But I firmly believe that there are opportunities for investors to use data and information to help steer them toward areas and properties that show promising fundamentals. It allows you to make decisions based on a framework, not just on gut feel.

Property commentators are particularly prone to exaggerated, or mis-informed, statements. Some of the things I regularly hear are “Only buy houses, not apartments as it’s the land that appreciates”, “Affordable housing outperforms blue chip property”, “Cash-flow is king, you should only invest in positive cash-flow properties”.  Blanket dogmatic statements such as these are the reason that taking a Moneyball approach to real estate investing can work. If everyone else gets caught up blindly following one particular narrative, they fail to take a step back and really understand what’s going on. If you’re prepared to do the leg work, you have a good chance of separating yourself from the crowd and generating better than average returns.

 

Please note: the above information and analysis does not constitute financial advice in any way, and it should not be relied upon. It’s important that you seek guidance from licensed professionals, who can provide advice based on your individual needs. No investment decision or activity should be undertaken on the basis of this information without first seeking qualified and professional advice.