O - Charlie Munger Believed Cash Is King And So Do I

2023-12-04 07:00:00 ET

Summary

• Charlie Munger emphasized the importance of cash and having money set aside for investment opportunities.
• Munger's strategy of keeping a significant amount of cash allowed him to amass a fortune of $2.6 billion.
• The article recommends two REITs with strong balance sheets and ample cash reserves for potential deals.

The recently deceased Charlie Munger, Warren Buffett’s long-time business partner, had hundreds of quotable quotes during his almost 100-year lifetime.

Life.

Investing.

Capitalism.

Government.

Taxes.

Risk.

Reading.

He talked about it all. But for today’s article, I want to focus on one particular topic, and that would be cash.

Here are a few of his soundbites on that subject:

• “It takes character to sit with all that cash and do nothing. I didn’t get to be where I am by going after mediocre opportunities.”
• “Live within your income and save so that you can invest. Learn what you need to learn.”
• “You want to fish where the bargains are. [It’s] that simple.”

Summed up, all three of those statements say the same thing: Cash is king . If you’re not spending money on unnecessary items, you’ll have more to spend on moneymaking, and money-growing opportunities.

Munger amassed a fortune of $2.6 billion by living how he lived.

That made him the world’s 1,182 richest person, according to Forbes, when he died – a far cry from Warren Buffett’s $118.9 billion but still much more than you or I have.

What would you do with all that money?

I can tell you Munger’s answer, and it goes right along with the other three above:

“The way to get rich is to keep $10 million in your checking account in case a good deal comes along.”

I’m living proof of that concept being true – even if on a much smaller scale.

One Absolutely Biddable Opportunity

I wasn’t always the most intelligent man with what I spent my money on.

In fact, I was downright foolish too many times to recall.

But I always did my math when it came to making sure the properties I invested in should return my money and make me more.

That’s how I was able to amass a multi-million-dollar empire that funded a very profitable lifestyle for me and my family.

Right up until the housing market crashed and I lost just about everything, that is.

That failure is a story for another day though.

Right now, I want to tell you about the time I learned of a foreclosure in Gaffney, South Carolina. I already owned a few properties there, so it was an area I knew well.

Maybe that was why I decided to check it out.

Honestly, foreclosures weren’t something I usually did.

I was too good at finding other opportunities that were worth my time.

Still, I decided to check it out after reading the auction notice in the paper. (Yes, that was back when newspapers were still in relevant physical circulation.) In order to even put a bid down, you were supposed to have a $100,000 check in hand.

The sale was set for a Monday morning, and I learned about it the Friday before. So I got a cashier’s check before the weekend hit, then set out early the next workday to see what I could see.

I’m not sure what I was expecting.

But whatever it was, it involved a lot more bidders.

When I arrived, there was one person in the room. One. And he was the Master in Equity (foreclosure Judge), prompting me to ask if I had the right location.

But I did.

And so I stayed.

An Amazing Opportunity

The “bidding” began at $500,000, so that’s what I offered. And since there was no one else to counter my bid, it was going…

Going…

Gone.

Cherokee Plaza, a 100,000 square-foot shopping center, was mine.

For $500,000.

In case I need to clarify, that’s $5 per square foot, an otherwise unheard-of bargain. Basically, I bought the whole kit and caboodle for the cost of the land.

I went right to work after forking over my $100,000 check, spreading the word about the newly available retail space.

It had once featured a Walmart, leaving plenty of room for a Big Lots to move in. Other spots went to Dollar General, Goodwill, Check Into Cash, Papa Johns, and Tractor Supply.

I wasn’t done yet though after all those successful lease signings. I also created an outparcel property and sold it to Kentucky Fried Chicken.

Do you know how much I sold it for?

Think $500,000, which paid off my entire purchase in one shot while still leaving me with plenty of rent checks coming in every month.

I’m not telling that story to brag.

After all, there was a large amount of dumb luck involved since nobody else showed up at the auction. That was an enormous factor completely out of my control.

What was in my control was having money set aside specifically to utilize should a worthwhile opportunity arise. That’s an enormous component of any successful business you’ll see on the stock market today.

Cash is king . And if you want to enjoy the benefits of such a reign, you need to know what to look for.

What real estate investment trusts, or REITs, have hardcore balance sheets with lots of cash on hand? That’s the question we’re exploring today.

In his annual letter to Berkshire Hathaway shareholders released in 2010, Warren Buffett says more "major" acquisitions are needed to maintain growth in the company's non-insurance businesses at a "decent rate." He explains,

"We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy."

At the end of 2010, Berkshire had a lot of ammunition for that elephant gun: $38 billion in cash.

That’s precisely why I’m recommending these two REITs – all with “fortress” balance sheets and ample dry powder “in case a good deal comes around”.

Realty Income ( O )

Realty Income is my largest holding and once the Spirit Realty ( SRC ) deal closes, this net lease REIT will represent around 10% of my total portfolio.

Why?

In Q3-23 Realty Income had cash on hand of $344 million and net availability on the credit facility of $3.4 billion which represents $4.5 billion of total liquidity.

That’s a healthy amount of cash, but of course the balance sheet is in the best shape ever: A3/A- credit ratings with debt to annualized pro forma adjusted EBITDA of 5.2x and fixed charge coverage of 4.5x.

In Q3-23 Realty acquired over $2 billion of net lease deals leased at a 6.9% initial cash yield.

In addition, the Spirit Realty deal valued at $9.8 billion is expected to add over 2.5% to annualized FFO with no external capital required to finance the acquisition.

More recently Realty announced a JV with Digital Realty ( DLR ) that will encompass $200 million invested in two data centers (for an 80% stake) that are 100% pre-leased to an S&P 100 investment grade client (I assume it would be Amazon, Google, Meta, Microsoft or Apple).

These properties are expected to generate a 6.9% initial cash lease yield upon lease commencement in mid-2024 and they're subject to a 10-year initial lease term with extension options and 2.0% annual rent escalators.

On the latest Q3-23 earnings call, Realty Income’s CEO, Sumit Roy, said,

“Notwithstanding the challenging capital markets backdrop, AFFO per share grew 4.1% from last year to $1.02 per share. Combined with our dividend, we are pleased to have delivered an annualized total operational return up approximately 9%.”

So even in this choppy market, Realty Income was able to acquire $6.8 billion of investments (through Q3) with investment spreads realized of over 100 basis points when calculating the WACC on a leverage-neutral basis.

Do you see the chart below?

In 2013, the Fed announced future tapering of its quantitative easing program (first arrow to the left), and then in the end of 2015, the Fed began to hike rates (middle arrow) and finally in March 2021, the Fed signaled the first increase in its short-term policy rates (after Covid).

The pattern here is obvious.

Realty shares always get hit when rates increase because Mr. Market thinks this net lease REIT is a bond….and shares improve whenever rates fall.

Although REIT cost of capital has increased alongside the rapid rise in rates, Realty Income is still able to transact and grow earnings and dividends.

Going back to Munger’s quote, “the way to get rich is to keep $10 million in your checking account in case a good deal comes along.”

In the case of Realty Income, the company has a lot more than $10 million in its checking account…something like $4.5 billion at the end of Q3-23.

As seen above, shares are now trading at $54.60 with a P/AFFO multiple of 13.7x. The dividend yield is 5.6% and we’re recommending an overweight allocation in the stalwart REIT that we forecast could return 25% per year.

Mid-America Apartment Communities ( MAA )

MAA is becoming a larger position in my portfolio.

Similar to Realty Income, MidAmerica is also A-rated and ended Q3-23 with $1.4 billion in cash and borrowing capacity under its credit facility.

The apartment REIT’s leverage remains historically low with debt-to-EBITDA of 3.4x and a low average interest rate of 3.4%.

MidAmerica is in a great position to put its fortress balance sheet to work. With a WACC (weighted average cost of capital) of around 5.5%, the REIT can drive earnings and dividend growth by cherry-picking high-quality communities and generating upside via the highly scalable operating platform.

MidAmerica has historically outperformed its apartment REIT peers during the latest downturn and recovery periods.

The reason for this is due to the company’s capital markets discipline and superior geographic and technology-enhanced business model.

Also, like Realty Income, MidAmerica has weathered multiple cycles, as evidenced by the fact that the company has never suspended or cut its dividend.

As seen above, there are rare opportunities to capitalize on such a “wide moat” REIT. Shares traded at 9x in 2008, 14x in 2020, and 15.4x today.

Shares traded at an average of 18.5 from 2010-2019. The dividend yield is 4.4%. We are accumulating shares in MAA based on our annualized total return forecast of 20% per year.

Who has $10 million in their checking account?

Charlie Munger knew that most folks don’t have $10 million stashed away in their checking account; however, he was pointing out that intelligent investors should always have some “rainy day” fund money to take advantage of opportunistic deals like the one I mentioned earlier.

In addition, investors should always conduct the necessary due diligence in advance, like I did when I purchased Cherokee Plaza.

I had already owned properties in the market, so I knew when it was time to pounce, it was a “no-brainer”.

I did not even think twice about writing a $100,000 check, because I knew that it could turn into $1 million or more, which leads me to my latest quote by yours truly on “X”.

As always, thank you for reading, and Happy SWAN investing!

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