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Welcome to the Commercial Real Estate Mastery podcast, where you'll learn the correct way to identify, negotiate, perform due diligence on, renegotiate, finance, turn around and operate real estate in today's market -- a market in which volatility creates opportunity, and sound principles defeat fads and bubbles. And your host is a 25-year commercial real estate veteran and co-owner of over $1 billion in real estate assets, Frank Rolfe.
The late Charlie Munger was Warren Buffett's business partner for most of Berkshire Hathaway's existence. And while Warren Buffett was the instigator of the concept of the conglomerate, which ultimately became one of the largest investment vehicles in American history, Charlie Munger was his common sense, horse sense associate who was constantly giving pearls of wisdom to Buffett to better direct his investment, career, and their partnership. And if you read the early books on Warren Buffett, when he started off Berkshire Hathaway, he was buying things that were simply cheap. That's why he bought Berkshire Hathaway. It was a failing textile mill.
He would buy assets that pretty much nobody wanted that were all worn out, and he'd buy them really cheap. And he tried to squeeze that last little bit of money out of them. And Charlie Munger once said to Warren Buffett, viewing the portfolio and its performance, "You know what, Warren? You gotta quit doing this cigar butt investing." He said that these companies we're buying are like cigar butts you find on the street. So, sure, they're cheap, they're free. They're just laying there in the gutter, and you light them up and you might be able to get one puff off of it or maybe two puffs of cigar smoke, and then you have to throw it back in the gutter again. We gotta quit messing around with that kind of stuff. We gotta buy better quality assets that are around for the long term.
This is Frank Rolfe with the Commercial Real Estate Mastery Podcast. We're gonna talk all about cigar butt investing, why it's not really the best idea if you want to be successful. And let's go over why that would be. Because you would think that buying things that were cheap or free would be a good way to make money. But here's the issue. Typically when you're buying a cigar butt deal, you're buying something that has very high risk, but it requires very low capital. I don't know about you, I wouldn't pick up a cigar butt in the street. I don't know what germs are on that or who was smoking it. We don't even know what brand of cigar it might be. And the same is true in real estate.
So typically, a cigar butt deal in real estate involves a property which has very, very low occupancy, all the way down to no occupancy, or maybe failing infrastructure. Maybe the water lines and sewer lines are breaking, or the roof is about to fail, or the whole foundation is shot, or sometimes it's things that have very, very poor appearance. They just look terrible. Or maybe they're in a terrible location, the wrong side of town, an area so scary you're afraid to even walk up and go inside the property. But you're drawn to that deal because you can buy it very, very cheap. And you assume, therefore, since it's very, very cheap, it's very low risk. At the same time, it's probably not even financeable, it's in such poor condition. But all of us are drawn like moths to a flame when we see things that are cheap. We get this desire to get involved in it because, gosh darn it, it's cheap. But the alternative asset to the cigar butt is a reverse of all those things.
So that would be a property that has very, very low risk, but it has higher capital needed to do it. Now, those kinds of deals have different attributes. Number one, stabilized occupancy, 80% occupancy, 90% occupancy. Revenue coming in the door, that's a good thing. And a very, very strong location, one that people are proud to own. Very, very nice appearance from the street and something that would qualify for debt, whether it's bank debt or CMBS debt or Fannie Freddie debt. Regardless, an asset that's very liquid because at any given moment we could sell it or we could get a loan on it. So then if those are the two types of assets, the cigar butt and then the very nice quality asset, which is the better deal?
Well, there's a thing in real estate called risk-adjusted returns. Because if you look at a CD that pays three and a half percent or a stock that pays three and a half percent dividend, which is riskier? Well, clearly the stock. The stock could go to zero, the stock could stop paying the dividend. But the CD is not going anywhere. It's backed by the FDIC. You're gonna get paid your interest on that one. So when we look at life and we look at assets and we look at properties, the big issue not only is the money side of it, but the risk attribute to it. Because that cigar butt deal is inherently extremely, extremely risky. And that quality deal, it has much lower level of risk.
Now, some people get into cigar butt deals because they just don't have enough capital to buy anything of any quality. And I've done that before. My first mobile home park I ever bought was wrong side of town, terrible condition, half empty. But I bought it because it was super duper cheap. 400 grand with only $10,000 down. Ludicrous, two and a half percent down, seller carrying the debt on it. And I've done a lot of deals like that. I understand the whole attraction to cigar butt investing, but you have to know what you're buying. And if you want to be successful doing cigar butt deals, you have to be very good at evaluating where you can take that asset.
When I bought that cheap mobile home park on the wrong side of town with everything in the world wrong with it, I did have a few things that I knew that would hold my value. I was right on the freeway. I had a very unique permit for a mobile home park. So even though I was buying as though it was cigar butt, I knew it really wasn't a cigar butt, that I could make it into something better. So if you want to do cigar butt advertising... Or not advertising, real estate deals, the key item is you have to be a good shopper and not buy something that's really literally just junk, but that you can build into something better. That's being a smart cigar butt investor. And on the flip side of it, in the low-risk investments, perhaps if you want to play in that arena, the concept is you may need to get a capital partner.
I would much rather own 50% in a partnership of a great quality asset than 100% of a poor quality one. But of course, like anything in life, there's a gray area. There's many deals out there that are not cigar butt quality, but yet they're not of the highest level. They're somewhere in that big gray area in between the two. And that's where most people typically are shopping. Those deals out there where they're navigating their investments, trying to buy things which are great quality but don't look great quality to most people, but yet they're not completely free, but yet they're very reasonably priced to meet with their capital constraints. Now, if you look at Berkshire Hathaway, of course, when they got out of cigar butt investing, that's when Berkshire Hathaway really took off. And their annualized return over all those decades was 19.8% per year on average, which was the best return anyone has ever had.
But they did mix in quite a bit of cigar butt things at the onset, which they then used to build into the bigger Berkshire Hathaway we know today. So maybe another way to look at it is that a cigar butt deal, maybe that cigar butt is the baby steps you need to get into better quality properties. Because you can still learn a lot from a cigar butt deal. And maybe if that's what it takes to get you in the door is finding a real estate property that's very, very, very inexpensive, then maybe that's not a bad thing. Maybe that gives you the practice and the experience and the confidence to then move up to the next step. This is Frank Rolfe with the Commercial Real Estate Mastery Podcast. Hope you enjoyed this. Talk to you again soon.