How to use Buffett/Kiyosaki intrinsic value.
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Intrinsic value is a term used by two key investors, Warren Buffett and Robert Kiyosaki, so it is obviously worth thinking about. I shall go through their four elements and then add one of my own specifically for Bed & Breakfast. They look at intrinsic value as separate from price although both would see price as important upon purchase of an asset as price determines the return. Kiyosaki in particular would say that the price of a property cannot be controlled and could go three ways: up, down or stay the same. As a variable, the price of real estate is uncontrollable because it depends on cycles, population growth, popularity of location etc.
Intrinsic value on the other hand is value that can be controlled because it is within the business and can be mined further. To be able to spot this when you buy as well as develop the intrinsic value during your time with the B & B will give you an added advantage over those who just buy because the property looks pretty. The four parts of intrinsic value are:
Income (cashflow): should be a positive cashflow after all expenses are paid including the business/home loan i.e. revenue should be higher than total costs;
Depreciation (phantom cashflow): depreciation appears as an expense and is shown as an expense by your accountant according to a depreciation schedule. It can also be seen as income which comes from a tax break. It is phantom because it is income you do not see;
Amortization: payment of your home/business loan by your tenants/guests. I use the term guests as per the usual hospitality protocol although guests could be seen as tenants of your rooms on very short term agreements, who are paying off your home/business loan during their stay;
Appreciation: your tariffs will rise over time because of inflation and should anyway, if you add to the guests’ enjoyment with depreciatory expenses such as en suites, air conditioning, jacuzzis etc.; you can refinance and borrow your appreciation out as tax free cash i.e. returning to the bank with the figures demonstrating an improved bottom line which will encourage them to loan you further money for more development. Your guests pay for the amortization of the new loan during their stay and provide a further tax free cashflow.
And now to my contribution:
A fifth source of intrinsic value unique to B & B is a virtually free roof over your head when you live on the property. You will often see separate family accommodation advertised as part of the deal when buying a B & B in Australia. Separation from the guests leads to greater happiness for both your family and the guests as both of you need your own space. You will only have to contribute a fractional amount to rates, electricity, telephone etc., the fraction depending on the size of your living quarters as a ratio to the size of the guest quarters; the remainder of the bills will be classed as business expenses to be claimed against tax. Breakfast and dinner (if you offer it) are yours for free because you just help yourself, plus an unlimited supply of tea and coffee. This cuts down everyday household expenses considerably, particularly when you buy in bulk.
References
Trump, D.J. and Kiyosaki, R.T. (2006). Why we want You to be Rich. Rich Publishing: LLC.