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What Makes a Good Business

As I have the opportunity to talk to many of you (as well as many new investors) each week, I have started to see themes in the questions you ask and the topics we discuss. One of the key themes of late has been diversification and the sustainability of multifamily asset values. Next month I’ll delve into diversification, and whether it’s the best wealth-building strategy, but today I want to talk about inflation.

I heard a simple but profoundly true statement the other day, “The definition of a good business is one where you can pass inflationary costs onto your customers. The definition of a bad business, is one where you cannot.”

As a consumer, you’ve no doubt been on the receiving end of that equation, whether you’ve seen a significant increase in your grocery bill, tried to buy a house, do a remodeling project, or purchased a vehicle. While those are the topics most dominant in the news, they are not the most important to us as a group, or to you as our investment partner.

In all likelihood, you’ve read or heard of Robert Kiyosaki’s book Rich Dad Poor Dad and are keenly aware of the importance of acquiring assets that produce income rather than liabilities that generate expenses. It’s another simple but powerful principle that when thoughtfully applied, will change your financial life. The trick is to determine the best assets to acquire that will consistently generate cash flow for the foreseeable future and pace with (and ideally outpace) inflation. 

Tuned into generic news sources, one might think that the lumber business is a fantastic place to be right now as we’ve all been barraged with stories of prices being five times what they were a year ago. However, what we’re currently experiencing in the lumber market is most likely a temporary, somewhat fanatic spike in prices, driven, not by a fundamental shift in supply and demand, but by a labor shortage and supply chain disruption driven by the COVID-19 pandemic.

This chart shows the actual price of lumber over the last 43 years:

This is the consumer price index (CPI) over the same period:

Lumber, it turns out, is not a great business to be in if you intend to pass on inflationary costs to your customers.

What about multifamily real estate? How have those asset classes performed over time? 

At PassiveInvesting.com, we’re buying businesses and partnering with you in the process. Multifamily real estate has been and will continue to be a “good business” because we can pass on those inflationary costs to our customers. A “great business” can be defined as one where revenues significantly outpace inflation. All projections for the next several years point to inflation at just shy of three percent, rent growth is expected to average over seven percent. Clearly, we’re in the right business, and we’re glad you’re in it with us.