Joshua Kennon » Real Estate

One of the Mansions In Charlie Munger’s Secret “Mungerville” Up for Sale

Joshua Kennon — Sun, 05 Sep 2010 02:52:44 +0000

Given that I wrote about Charlie Munger so much this week (re-reading part of his biography caused him to be on my mind), I thought this was interesting …

Years ago, through a tiny property subsidiary called MS Properties (or something along those lines), that is a subsidiary of Wesco Financial Corporation, that is a subsidiary of Berkshire Hathaway, Charlie Munger decided to secretly develop a tiny bit of Southern California as a creative outlet. His friends called this “Mungerville” but to the public, it is the Sea Meadow development in Montecito, California.

Anyway, one of the houses in the development is now up for sale for just shy of $26,000,000 and it is beautiful. I wonder if the people in there have any idea their neighborhood exists because a very wise man wanted to create something and used the spare change around a Berkshire subsidiary to do it.

How to Avoid Financial Stress

Joshua Kennon — Mon, 16 Aug 2010 01:24:11 +0000

I was reading through the comments on an article about investing over at Yahoo Finance and a lot of people were whining about the fact that it is impossible to save money. Only those who inherit their money can be rich (which you all already know is false based on the evidence).

A gentleman named Frank replied to the commentators:

It is absolutely, positively true. Pay cash. Eliminate all debt. No mortgage. Save as much as you can. For a vast majority of people, that is the best advice possible. (There are exceptions, such as someone borrowing money by issuing 30-year mortgage bonds for a hotel company he owns and financing property acquisitions during a recession, for example, but these scenarios aren’t going to apply to very many folks!)

In fact, I have a family friend who is in her 70’s (I’ll call her Rose), who owns her house outright, has no debt, hundreds of thousands of dollars in the bank, and owns three or four rental houses in the neighborhood where she lives, all filled with renters paying her cash each month. For most of her life, Rose earned less than $50,000 per year. She just refused to buy things unless she could pay cash and when she took on a mortgage, she sent every extra dime she could safely part with into the bank to reduce the balance. It is fair to say she has zero financial stress.

Rose didn’t have an inheritance. She had no grand genius financial plan. It was simple, plain vanilla saving and debt avoidance so the bank paid her interest rather than her paying the bank.

Ozzy and Sharon Osbourne Certainly Know Their Real Estate

Joshua Kennon — Wed, 07 Jul 2010 18:53:17 +0000

When it comes to real estate, business acumen, and interior decor, Ozzy and Sharon Osbourne have my admiration. Not only are their properties flawless in appearance, they use them as cash generators.

According to one of my favorite blogs, Mr. and Mrs. Osbourne purchased this 4,500 square foot, 5 bedroom, 5 bathroom beachfront property in Malibu, California for $5,100,000 in March of 2003. Today, they rent it out for several months during the summer at $40,000 per month.

This is what separates those who are successful from those who can’t hold onto money, like former NBA stars. You must keep cash rolling in the door and the cash you generate must exceed the cash going out by a considerable margin each year after paying taxes. It is simple but that doesn’t mean it’s easy. Here, the Osbournes are having their cake and eating it, too.

But, then again, I’ve been in love with their real estate since seeing Ozzy’s closet on MTV Cribs several years ago. That, and knowing Sharon’s business acumen and I was won over even though my personal music taste runs to singer / songwriters instead of heavy metal and, to be honest, I don’t think I’ve ever heard a single one of Ozzy’s songs. Still, it’s so refreshing to watch people do things well.

The Joy of Cash Dividends

Joshua Kennon — Fri, 12 Mar 2010 19:12:17 +0000

If you owned $2,000,000 worth of Campbell Soup Company stock, you would receive $64,000 a year in cash dividends mailed to your home or office, or directly deposited into your bank account depending upon your preference. How did someone come up with the $2,000,000 to begin with, though, given that we know 90% of wealth is self-made in the United States? Here are some thoughts ...

Over the years, I’ve written a lot about dividends on the Investing for Beginners site at About.com. In fact, over the past few years it has been one of my absolute favorite topics to cover because through the Great Recession of 2007-2009, those who owned a collection of high quality dividends stocks were better able to ignore market fluctuations and avoid selling their ownership to pay their household bills.

It isn’t an infrequent thing I’ll hear people opine, “yeah, but who has money sitting around to invest enough to matter?” It’s then that I realize the wisdom of Solomon when he said, “Do not despise the day of small beginnings.” Most people don’t even try to begin collecting assets because the dividend checks start out at only a few dollars each quarter. But money is like a farmer growing a crop. It only takes a few seasons for the seeds you planted to begin to throw off enough seeds of their own for you to drastically increase your yield per acre.

Hard Work Isn’t Enough – You Need to Own Cash Generating Assets

It is almost exhausting reiterating this point, but let’s imagine that you owned $2,000,000 worth of Campbell Soup Company common stock. Regardless of what the stock price did, you would receive $64,000 a year in cash dividends mailed to your home or office, or directly deposited into your bank account depending upon your preference. That works out to $5,333 per month. Dividends are taxed at 15%, meaning you would only pay $800 to the government, resulting in $4,533 per month in cash income.

This money should come as long as Campbell’s products are still popular and generating profits, even if you don’t get out of bed in the morning. It is your reward for not spending the money and instead investing it in companies that create jobs and grow the economy. (After all, you could have taken the whole investment and gone to Vegas, or redecorated your kitchen, or bought new cars, installed a swimming pool, etc.)

Since We Know That Most Wealth Isn’t Inherited, How Do You Get the Money to Invest?

We know, from virtually every study ever done on wealth in the United States, that 90% of American millionaires did not inherit their money. They are first generation rich, with a vast majority coming from the middle class or lower class. Most put themselves through college, and most are married. Since they all started out exactly like you, how did they get the money to buy the $2,000,000 worth of Campbell stock? It isn’t like the tooth fairy just showed up and dumped a pile of cash on their doorstep.

The Millionaire Next Door Method (Good Defense)

The most popular way is the so-called “millionaire next door” that Dr. Thomas J. Stanley discussed in his books. These are people that never made a lot of money but played good defense – that is, they spent less than they earned and invested the surplus in stocks, bonds, mutual funds, and real estate. This route can certainly make you rich (but not super-rich, which we will discuss in a moment). It’s relatively easy, it just takes a long time to achieve financial independence this way. If you are doing what you love for a living, this won’t matter because you’re happy anyway and one day you wake up to find you are loaded.

Take someone who is 27 years old. If he were to cut expenses and save $1,000 per month (I have family members who are not college educated, in their twenties, and single parents that are capable of doing this so I don’t want to hear it isn’t possible – they are no better than you are, they are just making better choices), by the time he reached 65 and retired, he’d have $4,368,521 at a 10% rate of return. At a 4% withdrawal rate (this is the level most academic research shows allows you to never run out of money, even if we were to go through another Great Depression), this would bring in $174,741 in annual household income, or $14,562 per month. That’s an after-tax figure, by the way. If inflation runs 3%, this would have the same purchasing power as earning $4,736 after taxes each month today. You’d be in the same position as our Campbell Soup investor, plus you’d still have another couple of decades to live, statistically, and you’d have a huge pile of wealth to give to your children, grandchildren, or charity when you leave this world.

The High Earning Method (Good Offense)

One of the reasons we bought so many stocks during the Great Recession was because we knew that the dividends, which had been turned off in some cases to protect the company and build cash reserves to make it through the down cycle, would likely be restored for many of the stronger corporations. With General Electric trading at below $6 per share, for example, it doesn't take a rocket scientist to figure out that even if it took 5 or 10 years to get the dividend back to $1.24 per share, you'd make a hell of a lot of money when it was restored. It would work out to a greater than 20% dividend yield on cost!

Those with specialty degrees in medicine, law, engineering, or finance are often able to earn six-figure salaries (or better depending upon their skill and career path), allowing them to spend large sums of money, while still putting aside money for saving and investments. An interesting fact, though, is that very few high earnings show up in the millionaire rankings where they should. That is, they have far less wealth than one would expect.

The general consensus among those who study the affluent is this is the result of the psychological concept of social proof. Doctors, for example, very rarely have the emotional strength to drive a ten year old Honda. Instead, they feel pressure to drive what the other doctors are driving so as not to stand out from the crowd. (Hence my note that most people would rather fit in than be exceptional.)

The Business Owner Method

The biggest percentage of millionaires comes from those who own businesses and the vast majority of super-rich and billionaires also own businesses. The reason is something called earnings capitalization. If you are a doctor and you earn $1,000,000 a year, that’s it. You pay your taxes, you’re lucky to be left with $600,000 net, and if you die tomorrow, your family is out of luck.

If, however, you had built a plumbing business that generated the very same $1,000,000 per year in operating profit, you could sell it to investors or private equity groups. If the company has modest growth, you may expect a 10x multiple. In other words, these investors would be willing to pay you $10,000,000 for your company (as the founder, you own 100% of the stock), because that generates a 10% pre-tax earnings yield. If they think they can use their marketing skills or other holdings to increase profits further, they can make a lot of money themselves.

The same income, in other words, results in $0 in net worth for the doctor and $10,000,000 in net worth for the business owner (to be fair, let’s say $8,000,000 because you have to pay capital gains taxes). Same income, vastly different wealth.

This is precisely the reason that I chose to go into business ownership rather than law or medicine. God blessed me with an extraordinarily high intellect (for which I can take no credit), just like he blessed others with different abilities – some are athletic, some are extremely patient, some are natural leaders. I wanted to know how to get the most benefit for each unit of “work” I put in (as measured by total hours invested) and that would allow me to live the lifestyle I want – no demands on my time, total freedom to do what I want when I want, and still be able to afford the things I like.

The Super Rich Are Usually a Combination of the Three Methods

Take someone like Warren Buffett. He owned the general partner equity of his partnership, which entitled him to a big cut of the investing profits. This made him a de facto business owner. He rarely spent money, meaning he played great defense. As his stature rose, he sat on multiple boards of directors, earning millions of dollars a year in director fees and income, making him a good offensive player, as well. If you look closely, most of the super-rich combined all three methods into a hybrid that fit their personality. Even if they drop $10 million on a yacht, it represents a fraction of their net worth and is like you going out and buying a new Playstation 3.

In our case, we own businesses. When opportunities are attractive, we take the profits from the businesses and buy stocks. When stocks are overpriced, we’re open to selling them and buying real estate. We may take the cash dividends from our stocks to expand our wholly owned businesses. We are an integrated investment vehicle designed to grow our shareholders’ wealth. It just happens that right now, all of the shareholders are members of the Kennon and Green families, respectively.

The Housing Crisis Isn’t All Bad …

Joshua Kennon — Tue, 09 Mar 2010 19:26:42 +0000

For every $1 in home value lost by a seller, there is $1 saved by the buyer. No one is talking about this, but the housing crisis represents a massive transfer of wealth to the younger generation (35 years and under) from the older generation.

As Warren Buffett pointed out in this year’s letter to Berkshire Hathaway shareholders, for every house that falls in value and pushes one family into bankruptcy, another American family benefits from the lower prices as new households are created due to the younger generation graduating from college, settling down, and moving out of their parents’ houses.

So, the 50 year old that lost all of their home equity is in trouble, but the 22 year old getting married now has much more affordable housing options available, resulting in more cash in his or her wallet each month. As Buffett put it:

Prices will remain far below “bubble” levels, of course, but for every seller (or lender) hurt by this there will be a buyer who benefits. Indeed, many families that couldn’t afford to buy an appropriate home a few years ago now find it well within their means because the bubble burst.

No one is talking about that, though, because it’s somewhat harder to measure. This is my point when people talk about being at the mercy of the economy … I don’t buy it because there are always intelligent things to do. If you thought housing was going to fall years ago, you could have shorted the housing market index or construction companies. I read one account the other day where some of the nation’s top home builders sold everything they owned, approached the private wealth management division of UBS, and put their entire net worth in high-grade bonds. The newspapers were full every day of headlines screaming, “Housing hits new high!” How many people took advantage of it?

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The Kennon Retirement Insurance Plan

Joshua Kennon — Mon, 08 Mar 2010 18:30:16 +0000

One of the Things That Helped Me …

I thought of this "stupidity insurance" as writing my own self-insured retirement plan or insurance policy that would guarantee that by the time I was ready to stop working, I'd be able to take $21,422.71 per month after taxes WITHOUT EVER SAVING ANOTHER DIME after my 30th birthday. Anything else I built up - my businesses, my houses, my art collections, my brokerage accounts, my main retirement accounts - is extra (and, frankly, where the *real* money will be). The account should maintain its value of $6,426,814 over time, meaning that the whole sum could be left to my heirs or given to the family foundation for charitable purposes.

From time to time, you may come across reference to my “stupidity” insurance or my “reserve” fund. I’ve had a bunch of readers write me over the years and ask about various comments I’ve made so I thought it might be useful to explain it. My parents, siblings, and Aunt Donna have always known about my investing but virtually no one else did when I was a child (by the time I got into high school, though, it was all I talked about so hiding it was no longer an option).

For those of you who are older than 14, this isn’t going to do any good unless you have children or grandchildren that may benefit from some personalized version of it (which is why I’ve never written about it). By the time I was older, we had put almost all of my siblings on a modified system that helped to guarantee they would enjoy the same outcome in their own retirements. This plan has some resemblance to the dividend trust program I described in an article on student loan debt.

How the Stupidity Insurance Fund Came About

One of the first things I did when I was a child and figured out the time value of money, and how powerful it could be, was to create a plan that would ensure that no matter what I did or how successful I was, that I would retire rich. For years, I called this my “stupidity” insurance or my “reserve” fund because it was designed as a sort of self-written insurance policy that no matter how royally I screwed up or how bad things became in life, there was a huge “compounding machine” working in the background for me. I started toying with its development when I was in 4th grade in a tiny town called Savannah (before I was in 7th grade, I had lived in seven or eight different cities because we moved a lot). I think it came about because of the biographies I read where you’d have formerly successful business people that lost everything, or millionaire rock stars that ended up bankrupt and broke. My goal was to do everything possible to make that a virtual impossibility.

The program worked like this: If, starting at 14 years old (which was 4 years in the future at the start of the program), I could save $500 per month by working after school or doing side projects for people, and I could park the money at 5% until I was 30 years old, I would have roughly $141,945 in this insurance fund. I’d kick in the extra $55 to make it an even number, so let’s call it $142,000.

This $500 was my “insurance premium”, so I didn’t think of it as saving or investing because that is what my brokerage accounts were for – for all intents and purposes, this money didn’t exist to me. I treated it like an expense, or a car payment. I did everything possible to get it into tax-advantaged accounts such as a Roth IRA or SEP-IRA because I wanted the money to be able to grow tax-free when it reached what I called “the vesting date”, which was my 30th birthday. This was the date at which I would stop contributing money to the fund and split everything that had built up since I was a kid into different asset classes (stocks, bonds, mutual funds, real estate, options, etc.) and invest it in such a way that it could be passively ignored for years. In many cases, the law requires you to take distributions from your retirement accounts by the time you are 70, so that would be 40 years of compounding.

By putting money into assets that generate cash and grow in value over time, like businesses that are attractively valued, the money in this self-created retirement plan or retirement insurance policy silently compounds for decades in the background as we all go about our lives.

If this passive money earned 10% (I have a history of earning much more, and I planned on utilizing things such as self-directed IRA accounts that would allow me to actually buy an apartment building or hotel, for example, as the money grew but I’m keeping it there for the sake of conservatism; most people should bet on 7% to 8%), by the time I reached 70 years old, the “insurance fund” would have $6,426,814 in it. There would be virtually no taxes owed on this money because of the types of accounts in which I had placed the funds.

Most research shows that even in a Great Depression scenario, withdrawals of no more than 4% per year mean that you’ll never run out of money. At a 4% rate, I could take $257,072.56 in dividends out of the account each Christmas for the rest of my life. That’s $21,422.71 per month after taxes that I could live upon, simply because of money I saved from the time I was 15 to 30 years old without ever contributing another penny.

To put it another way: I would never have to save another penny beyond my 30th birthday, and anything else I built up such as businesses I started, retirement plans, brokerage accounts, home ownership, etc., would all be extra (and, if I did my job correctly, would dwarf the insurance fund in value at retirement). But if I utterly, totally, and completely screwed up life and blew everything I ever made and became a total profligate, I’d still retire with a monthly income of $21,422.71 after taxes plus any social security for which I qualified. That’s why I called this my “stupidity” insurance.

The Psychological Effect of Having Your Own Stupidity Insurance

Some psychologists and money managers have written about similar programs, which they call your “go to hell” money. They call it this because you know that no matter how bad things get, whether or not you lose your job, change careers, or get divorced, if you are unhappy, you can get up, walk out of the building, and tell everyone to go to hell.

The main benefit of the program is intellectual freedom to pursue what you want to do without fear. It could be argued that one of the reasons I launched companies after graduation, rather than take a job at Merrill Lynch or Goldman Sachs, was because I knew if I failed, I’d still end up rich and I could always get a job tomorrow.

What The Rich Really Collect

Joshua Kennon — Tue, 09 Feb 2010 10:17:54 +0000

Everyone focuses on the stuff the rich people collect. Yet, the biggest secret is that the rich are really collectors of rents, royalties, dividends, and interest. Whether song rights, hotel ownership, businesses, sales commissions, stocks, timberland, or patents, these are the things they truly amass. Instead, people read or watch television shows about the original works of art and the wine cellars, which are mere side hobbies that occupy very little time. Do not focus on what the rich buy for consumption, but rather, what they buy to generate more earnings streams. You'll often find that for every $25,000 watch they bought, they purchased an $800,000 apartment building and that the watch came long after the assets were in place. This single shift in thinking will greatly enhance the probability of you achieving the same ability to live how you desire.