Value Investing in Real Estate

Value investing in real estate requires more than identifying attractive properties; it requires understanding long-term fundamentals, market cycles, and downside protection. Columbia Business School’s Chris Mayer and David Sherman explore how investors evaluate real estate opportunities through cash flow, replacement cost, leverage, and changing market dynamics.

In this webinar recording, Chris Mayer, Paul Milstein Professor Emeritus of Real Estate, and David Sherman, Adjunct Professor of Business, discuss the application of Graham and Dodd's value investing principles to the real estate sector. They explore how to identify assets priced below their fundamental market value and replacement cost, particularly during late-cycle periods characterized by high valuations and slowing growth. The session provides a framework for distinguishing between relative and absolute value, the critical role of leverage, and strategies for finding resilient investment opportunities in a maturing economic environment.

Focus on Fundamental Value: While some investors chase relative value (beating a benchmark), value investors focus on absolute or fundamental value, which is determined by buying below long-term market norms or replacement costs to ensure downside protection.
Real Estate as a Long-Lived Asset: Buildings should be viewed as durable, cash-flowing assets that can last 30 to 50 years, with the underlying land or location retaining value even as technologies change.
The Danger of Late-Cycle Leverage: Many institutional investors mistakenly increase leverage at the top of a cycle to hit return targets; however, true value investing requires lowering leverage during these periods to survive potential corrections.
Volatility Comes from Appreciation, Not Cash Flow: Historically, the majority of real estate volatility is driven by price changes (appreciation) rather than the underlying cash flows, which often remain relatively stable even during downturns.
Strategic Late-Cycle Positioning: Investors can mitigate risk by focusing on non-cyclical demographic drivers (e.g., medical offices, senior housing) or less capital-intensive assets (e.g., apartments, industrial) that recover quickly after a recession.

Are we currently seeing an uptick in the use of leverage by real estate investors?
Thoughtful, long-term investors are currently deleveraging in anticipation of potential equity value drops. However, those attempting to meet arbitrary return benchmarks (such as 12% or 15%) are often increasing leverage, which is risky given the high valuations in the current market.

Is buying a property below its replacement cost always a winning strategy?
Buying below replacement cost is not a guarantee of success. It must be paired with long-term growth patterns and high barriers to entry. For example, properties in declining markets may trade below replacement cost for decades without seeing appreciation; true value is realized in growing cities like New York City or San Francisco, where zoning is tight and demand is durable.

How should investors view office space demand if a major tech intermediary like WeWork were to disappear?
Even if an intermediary like WeWork disappears, the underlying demand from the tenants does not. Investors should focus on fundamental demand drivers—such as which neighborhoods companies want to be in and how much square footage per person they require—rather than the specific middleman facilitating the lease.