Has Donald Trump Underperformed in the Real Estate Business? (Forbes)

[S. Misanthrope]

Hi all! I’ve mired myself in the fascinating world of anti-Trump hysteria, particularly among Objectivists and libertarians. One of the more desperate attacks is that Trump isn’t actually any good at business. I thought I’d sit down and write a proper response to one of the more seemingly reasonable arguments on this topic. I’d love to hear people’s thoughts and suggestions for improvement!

 

Article Link: http://www.forbes.com/sites/forbesleadershipforum/2016/03/03/has-donald-trump-underperformed-in-the-real-estate-business/#1c1e92a05506

 

Full article text is pasted below my response.

 

I came across this "evidence" that Donald Trump is a "lousy" investor via Robert Tracinski. Let's take it point by point.

 

“A large body of finance literature evaluates mutual and hedge fund managers relative to their peers.”

 

Interestingly enough, this “large body” of literature does not include a single study, paper, or article, peer-reviewed or otherwise, by Professor Griffin on this topic. This non-peer-reviewed Forbes article is the first time Griffin chose to undertake this type of measurement.

 

“Certain investors, like Warren Buffett, stand out as having produced outstanding returns over long periods, and they are judged winners, who have superior skill. Those who don’t measure up are politely called underperformers.”

 

There are two types of people: people who think a link is a source, and people who actually follow the link. The comforting blue of Warren Buffett’s name merely links to his profile page on Forbes, which contains no analysis of his performance, let alone an analysis similar to the one Griffin performs here. Now there’s no question Warren Buffett’s net worth is higher than Trumps, and there’s similarly no question that he started out in life with less than Trump did. But the rhetoric here is misleading in that it’s designed to set up a false dichotomy in the reader’s mind, namely that you’re either as successful as Warren Buffett, who is possibly the most successful investor of all time, or you’re a loser. Further, since Griffin never even offers evidence of Buffett’s performance, he’s merely playing into popular mythology, where “everyone knows” that Buffet is the heavyweight champion of investing.

 

“In this short essay, I will try to evaluate the investment return of Donald Trump by the same standards. I will do so in an academic manner, relying only on substantiated facts.”

 

The “same standards” as what? No basis of comparison for the methodology used is provided. In fact, at no point in the article is Trump’s performance actually compared to that of any other individual, which is what we usually mean when we talk about a peer analysis. As for Griffin’s “academic manner” and “substantiated facts,” that’s empty posturing. Academics use peer review, provide complete sources, and generally produce analysis in their area of proven expertise. Griffin does none of that in this article.

 

“The calculation requires just a few pieces of information: (1) starting and ending wealth, (2) the investment asset class, and (3) the benchmark returns for that asset class.”

 

Right off the bat, it’s obvious that this methodology has some challenges, to put it mildly. Let’s continue and see how things like “starting and ending wealth,” “asset class,” and “benchmark returns” are defined and used in Griffin’s analysis.

 

“For accuracy, we want the earliest date with a verifiable number.”

 

Why? Why on earth would we want this as our standard? I can verify for you that at age 4, I was the proud owner of $95.97. At age 21, my net worth was approximately -$200,000 (thanks, student loans!). Given my current net worth, I’m a better investor than Warren Buffett!

 

“Trumps (sic) was the son of a wealthy real estate investor, and he both began in and inherited his father’s business. A November 1, 1976, New York Times article quoted him as saying his net worth was then “more than $200 million.” For consistency, I will first use this self-reported round-number figure and compare it to Trump’s self-reported round-number figure of his current net worth, which he claims is in excess of $10 billion. I will then look at independent estimates.”

 

And here we see the biggest problem with the approach: “wealth” is defined as “personal net worth.” An example will illustrate the issue clearly. Let’s say I have a net worth of $300,000. I take $100,000 and purchase a house. A year later, the house has doubled in value. During that year, I’ve also sent a kid to college at a cost of $200,000. So my net worth at the end of the following year will be $200,000 (300K – 100K + 100K x 2 – 200K). By Griffin’s analysis, my 100% return on my real estate investment is actually a 33% loss!

 

With two divorces, a pile of kids, a deliberately lavish lifestyle, and two Presidential campaigns, it’s not hard to imagine where the Trump cash outflow might go. Further, in the case of multiple privately held businesses, simple restructuring would have a significant impact of Trump’s own net worth. If he started out in 1976 (that’s hardly the start of his career, so so much for the claim that Griffin is interested in the “earliest possible” figure) with 100% ownership, and over time he transferred shares to others, both within and outside of his family, his net worth would go down even as the value of the company he runs goes up!

 

No attempt is made in this “academic” analysis to capture or even acknowledge any of these basic methodological issues. Those who are getting some TL;DR feels are free to walk away now as this significant flaw invalidates the whole analysis.

 

“2. Asset Class [some fancy-sounding babble signifying nothing]”

 

To what extent was Donald Trump’s personal net worth of 1976 invested in the asset class described from 1976 through 2015? Blank out.

 

“3. Returns [blahblahblah]”

 

Anyone with a financial background understands that ROI isn’t everything. Investors are always balancing return against volatility. I think there’s a reason why Griffin’s links to sources sudden drop off when he starts addressing the benchmark he used. Just take a look at the Annual Index Value Returns in the Excel file here: https://www.reit.com/investing/index-data/annual-index-values-returns

 

As you can see, Real Estate Investment Trust (REIT) returns are notoriously volatile. Similar to the start-up world, most ventures completely fail while a few experience wild success, at least for a time. This volatility makes it very difficult to compare performance across different investors, especially in the long-term. In general, if you’re still around and making returns anywhere near the long-term average, you are extremely successful.

 

“Other Considerations… A Businessweek evaluation reports that Mr. Trump was worth $100 million in 1978. If one compounds this estimate from December 1978 to December 2015 using the index’s return, then his fortune would be worth $8.6 billion. Forbes, meanwhile, independently estimates his current net worth to be $4.5 billion. In other words, independent sources point to an underperformance of 48%.”

 

This is part where Griffin postures at fairness. Nowhere is there an acknowledgement that $8.6 billion is less than Trump’s own estimated net worth, implying superior performance under Griffin’s methodology. Instead he waves this away by applying Forbes’ estimate of Trump’s current net worth on the flimsy justification that Businessweek in 1978 and Forbes in 2015 would be a fair comparison due to their “independence.” Did they use similar estimation methods? Are they really independent when Trump is to some extent their competitor in media? Did anyone bother to ask whether the Editor-in-Chief of Forbes magazine might have a tiny conflict of interest considering his own bids for the Presidency?

 

I’ll try to maintain the patience for one more.

 

“The REIT equity funds have current leverage ratios around 36%, while Trump is documented (in The Young Entrepreneur’s Guide to Starting and Running a Business) to have been levered to 69%. If one were to lever the REIT returns at Trump’s rate, then the index’s performance would be considerably higher. Not only is the $13.2 billion a potential understatement of Trump’s underperformance, then, but also it seems he needed to take on a market-exceeding amount of risk in order to achieve his underperformance.”

 

Trump was at one point leveraged at 69%, according to the book cited, but the book does not claim that Trump is always that highly leveraged. That Griffin is so unwilling to admit how much he doesn’t know about Trump’s finances (his companies are privately held and until his Presidential bid, he never had to disclose anything publicly), and yet he’s eager to latch onto the potential for his lack of knowledge to suggest that things could be even worse for Trump, well! That lays his bias pretty bare, in my opinion.

 

In short, Griffin’s methodology is crap, his approach is dishonest, and his internal logic inconsistent. I grade this professor an F.

 

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Has Donald Trump Underperformed In The Real Estate Business?

This article is by John M. Griffin, the James A. Elkins chaired professor in finance at the University of Texas–Austin.

 

A large body of finance literature evaluates mutual and hedge fund managers relative to their peers. Certain investors, like Warren Buffett, stand out as having produced outstanding returns over long periods, and they are judged winners, who have superior skill. Those who don’t measure up are politely called underperformers. In this short essay, I will try to evaluate the investment return of Donald Trump by the same standards. I will do so in an academic manner, relying only on substantiated facts. The calculation requires just a few pieces of information: (1) starting and ending wealth, (2) the investment asset class, and (3) the benchmark returns for that asset class.

 

1. Starting and ending net wealth: For accuracy, we want the earliest date with a verifiable number. Trumps was the son of a wealthy real estate investor, and he both began in and inherited his father’s business. A November 1, 1976, New York Timesarticle quoted him as saying his net worth was then “more than $200 million.” For consistency, I will first use this self-reported round-number figure and compare it to Trump’s self-reported round-number figure of his current net worth, which he claims is in excess of $10 billion. I will then look at independent estimates.

 

2. Asset class: Commercial real estate is the Trump family business and has always been how he says he has made his fortune. For this reason, I use the FTSE NAREIT All Equity REITs Index. FTSE (Financial Times) indices are carefully constructed, readily available, and reach back into the 1970s. This one tracks the performance of real estate investment trusts (REITs) that invest in various types of commercial real estate (offices, hotels, apartments). The index is broad and diversified, and, importantly, is and has been open to investment by any ordinary investor. Hence, evaluating an investor against the index gives credit for picking certain types of real estate relative to the benchmark and will thus evaluate that investor’s ”active skill” relative to the market index of publicly traded real estate.

 

3. Returns: The index has averaged 14.4% arithmetic (13.0% geometric) per year from December 1976 to December 2015. Note that this is slightly higher than the 12.3% that one might have earned in stocks using the Center for Research in Security Prices value-weighted index. Using the year-end value of the REIT index, an investment of $1 in December 1976 would have yielded $116 by December 2015.

 

Calculation: An investment of $200 million in 1976 in the FTSE NAREIT All Equity REITs Index would have compounded to $23.2 billion by year-end 2015. That is considerably above Mr. Trump’s recent self-reported net worth of approximately $10 billion. Mr. Trump has underperformed the real estate market by approximately $13.2 billion, or 57%.

 

Other considerations: Although the use of self-reported wealth at both the start and end of the period is consistent, these values may differ from independent estimates. A Businessweek evaluation reports that Mr. Trump was worth $100 million in 1978. If one compounds this estimate from December 1978 to December 2015 using the index’s return, then his fortune would be worth $8.6 billion. Forbes, meanwhile, independently estimates his current net worth to be $4.5 billion. In other words, independent sources point to an underperformance of 48%.

 

Another potential factor to consider is that the investment return to the REIT is net of fees to the investor. A private investor (like Trump) who invested in these assets, on the other hand, could have earned the before-fee return and kept the management fees. Since the average REIT management fee is currently 1.03%, REIT managers of a $23.2 billion real estate portfolio would accrue a sizeable consumption allowance, but we do not have sufficient data to compare the amount relative to Trump’s actual consumption.

 

A more important consideration is leverage. The REIT equity funds have current leverage ratios around 36%, while Trump is documented (in The Young Entrepreneur’s Guide to Starting and Running a Business) to have been levered to 69%. If one were to lever the REIT returns at Trump’s rate, then the index’s performance would be considerably higher. Not only is the $13.2 billion a potential understatement of Trump’s underperformance, then, but also it seems he needed to take on a market-exceeding amount of risk in order to achieve his underperformance.

 

Conclusion: In the finance literature, investors who have outperformed are said to have skill, or talent, and those who do not are called underperformers. Using both independent and self-reported estimates of his net worth, Donald Trump has underperformed his real estate investor peers by 48% and 57%, despite taking more risk. Donald Trump is obviously a skillful presenter and a talented entertainer, but in terms of his investment skills, he is a clear underperformer.