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Today’s gem is this article titled Investing in Software vs. Real Estate written by a friend of mine, Suthen Siva. He’s both a real estate investor & a software investor (via his role at Constellation Software).
The article is great comparison of the similarities between cash-flowing real estate and mature vertical market software. It’s a quick read, but to give you a summary:
- Rent Roll vs ARR
- Attrition vs Vacancy
- Product Stickiness vs Location of Building
- Product Management vs Property Management
- Software Rewrites vs Renovations
- Cash Flow & Returns
I started my investing career via multifamily real estate and it’s still a significant chunk of my net worth today. Real estate investing taught me lessons around cash flow, leverage, risk, valuation/forecast discipline, evaluating opportunities, and generating attractive returns.
Given my real estate investing background, it’s only natural that I started seeing similarities in vertical software companies. The same investing principles apply.
In real estate, high quality assets deliver a high unlevered yield on cost (UYOC). In software, high quality assets deliver a high return on invested capital (ROIC). But the calculation is really the same: the stabilized operating income divided by the total cost to acquire and stabilize the asset. The factors that Suthen laid out in his article help you assess what the UYOC/ROIC for an asset would be, and therefore, determine the quality of the opportunity.
Whether I am looking at real estate deals, or software acquisition opportunities (via Atlasview), I approach the underwriting in a similar manner. Conservatism on assumptions, inputs and forecasts and focus on cash flows, managing capex and risks.