- \n
- Beginning at age 11, with modest savings from his childhood ventures in newspaper delivery and golf ball recovery, Buffett compounded his wealth over a lifetime of shrewd investments into a fortune totaling $80+ billion.<\/li>\n
- If you would have had the opportunity to invest $1,000 in Berkshire Hathaway in 1964, it would be valued at $15,594,000 today, a compounded annual return of ~19% sustained over a 50+ year period\u2014a record that other legendary investors don\u2019t even come close to touching.<\/li>\n
- While not widely known, Buffett has unique and expansive insight into the real estate industry through Berkshire Hathaway\u2019s ownership of HomeServices of America (residential real estate brokerage), Berkadia Commercial Mortgage (multifamily lender), Shaw Industries (residential carpet and flooring), GEICO (property insurance), Benjamin Moore (paint), Clayton Homes (manufactured homes), and Acme Brick (residential building materials).<\/li>\n<\/ul>\n
Buffett hasn\u2019t written a book on real estate, he\u2019s never sold any courses, and he hasn\u2019t (yet) appeared on the BiggerPockets Podcast<\/a>. But Buffett has recorded quite a few thoughts on investing. And his thoughts are very relevant for us real estate investors.<\/p>\n
We\u2019re all fortunate enough to have access to Buffett\u2019s musings through his annual shareholder letters<\/a>.<\/p>\n
Though Buffett rarely wrote about real estate, I\u2019m going to take a stab at translating Buffett\u2019s wisdom for BiggerPockets’ readers. This is one of several of what I hope to be a series of articles channeling his wisdom into the real estate arena.<\/p>\n
I\u2019ve written this article with the help of my friends and fellow BiggerPockets members\u00a0Bryan Taylor<\/a> and John Jacobus<\/a>. Bryan and John are great real estate investors and Warren Buffett fanatics. They make the trek to Omaha each year for Buffett\u2019s celebrated annual meeting. They\u2019ve listened to Buffett\u2019s interviews, read his letters, and tried to emulate his strategies in their own investments. I\u2019ve learned a lot from them, and there\u2019s a lot you could learn, too.<\/p>\n
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<\/p>\nSo let\u2019s get started. If you had a personal meeting with Mr. Buffett, what might he say to you first? How might he advise you in your real estate career?<\/p>\n
I think he might say this:<\/p>\n
To succeed as a real estate investor, seek out high quality, productive assets and let time do its work.<\/em><\/p><\/blockquote>\n
What Does Buffett Consider to Be a Good Investment?<\/h2>\n
In his 1991 annual letter to shareholders, Buffett encouraged investors to pursue durable, high quality \u201ceconomic franchises\u201d whose earnings are based on a product or service that:<\/p>\n
- \n
- is needed or desired,<\/li>\n
- is not subject to price regulation, and<\/li>\n
- is thought by its customers to have no close substitute.<\/li>\n<\/ol>\n
\u00a0“<\/em>The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.”<\/em><\/p>\n
How does real estate fulfill these criteria?<\/p>\n
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- Needed or desired.<\/em><\/strong> Shelter is a concept that has endured the test of time. Real estate will always be in demand, and no technology, cryptocurrency, government, or economy will change that.<\/li>\n
- Not subject to price regulation<\/em><\/strong>. For now, this is under your control. My firm doesn\u2019t purchase apartments in places like Oakland or San Francisco that impose rent controls. I know someone doing very well there, but I choose not to add in this variable to my firm\u2019s investment mix.<\/li>\n
- Thought to have no close substitute.<\/strong><\/em> Substitutes in real estate are generally based on price, location, and amenities. Our company focuses on owning Class B multifamily properties, built 20-40 years ago, in which rental units are offered at rates materially lower than recently built Class A multifamily units.<\/li>\n<\/ol>\n
Following this “no close substitute” approach protects us from a surprise introduction of substitutes in the market. Even if the markets in which we invest were to experience significant oversupply of new apartment units in a short period, we would remain somewhat protected from substitutes due to the relative affordability of our rental units as compared to Class A units.<\/p>\n
Following a similar approach but with a different type of multifamily housing product, Bryan and John pursue mobile home park investments, which have few substitutes because they are unrivaled in affordability relative to alternative housing options. This affords them the opportunity to price their rental units aggressively while still maintaining a substantial discount to alternative housing options.<\/p>\n
How do you further limit substitutes to your rental properties? This is largely under your control, Mr. and Mrs. Apartment Owner. Will you create such an amazing place to live that your tenants are eager to renew their leases? And tell their friends? And blast it on social media?<\/p>\n
Our company hires a community connection coordinator to facilitate community in every apartment complex. It\u2019s a fact that few apartment dwellers know their neighbors or feel like they\u2019re part of a real community.<\/p>\n
We are determined that residents in our communities will have to work very hard to remain isolated. Our coordinator delivers welcome baskets, plans community events, and is ready to help when someone has a health crisis or broken-down car.<\/p>\n
Our apartments may be three or four decades old, but our goal is to create an irreplaceable community for our residents. This is similar to what Apartment Life\u2019s CARES program<\/a> facilitates for multifamily communities across the United States. If you haven\u2019t seen them in action, you should certainly check them out.
\n
\nRelated:<\/strong> What Would Warren Buffett Do? 12 Quotes for Smarter Investing<\/a><\/em><\/p>\nIn his 1991 letter, Buffett also stated that \u201ca truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.\u201d Creating an amazing community is a way of creating a moat to protect your occupancy and profitability.<\/p>\n
Now that we\u2019ve gotten a taste of Buffett\u2019s wisdom, what else did he have to say?<\/p>\n
In Buffett\u2019s 2007 letter, he describes the enduring value of a modest investment in See\u2019s Candies:<\/p>\n
\u201cLast year See\u2019s [Candies] sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. …we have had to reinvest only $32 million since 1972 to handle the modest physical growth\u2014and somewhat immodest financial growth\u2014of the business. In the meantime, pre-tax earnings have totaled $1.35 billion.<\/p>\n
All of that, except for the $32 million, has been sent to Berkshire… After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See\u2019s has given birth to multiple new streams of cash for us. (The biblical command to ‘be fruitful and multiply’ is one we take seriously at Berkshire.)\u201d<\/p><\/blockquote>\n
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<\/p>\nSo, What Is Buffett Talking About?<\/h2>\n
Buffett often describes the ideal business\/investment as one that provides consistent earnings growth without the need for excessive amounts of capital investment to maintain that growth.<\/p>\n
Great businesses simply need time to generate earnings and reinvest those earnings at high rates. This compounds over time and rewards the patient investor. Buffett reiterated the importance of time and patience in the investment process when he shared this golden nugget in his 1989 letter: \u201cTime is the friend of the wonderful business, the enemy of the mediocre.\u201d<\/p>\n
Warren is consistent in his perspective that buying high quality, durable assets (businesses in his case, real estate in most of ours) and holding them for long periods is one of the best methods for building and preserving wealth.<\/p>\n
For example, his purchase of See\u2019s Candies has proven to be a home run because the growth in earnings has mostly come from raising prices every year as opposed to pouring additional capital into growth opportunities, such as new products or innovations. Chocolate (and real estate) has remained largely the same for decades.<\/p>\n
How Do These Lessons Apply to Real Estate Investing?<\/h2>\n
When analyzing real estate investments<\/a>, it\u2019s important to target opportunities where you understand how the forecasted earnings of the property can grow materially over the life of your investment without the constant need to inject additional capital into the property.<\/p>\n
This is where a ground-up developer can get in trouble. The development lead time, changes in the market, cost overruns, lease-up timing, and other variables can cause returns to deviate from the plan. Buying generally stabilized multifamily assets is usually a more predictable formula for forecasting earnings.<\/p>\n
Targeting properties located in markets with solid demographics, job growth, job diversity, and rising incomes may allow you to raise rents consistently over time without needing to implement significant capital improvements to the property.<\/p>\n
When analyzing multifamily assets, we are looking for properties located in markets with growing populations, new jobs in diverse industries, low unemployment, and rising household incomes. We also look for properties that are structurally sound and don\u2019t require significant capital to appeal to prospective renters.<\/p>\n
These factors are important to us because they lead to long-term, predictable growth in cash flow and provide us with an opportunity to redeploy our capital into acquiring more income-generating multifamily properties. Even if growth in these demographics is not perfectly predictable, look for markets where the direction and momentum are likely.<\/p>\n
Additionally, while value-add opportunities and light deferred maintenance can add to the appeal of an investment opportunity, tread carefully with multifamily assets that require a significant up-front capital injection or major ongoing capital improvements to remain appealing to renters. These can add risk, weigh on your returns, and act as a barrier to generating long-term wealth.<\/p>\n
How Else Might Warren Buffett Advise Us in Our Real Estate Careers?<\/h2>\n
To achieve success, investors should filter out complexity and focus on identifying the two to three factors that might have the greatest impact on a prospective investment.<\/p>\n
In his 1977 letter, Warren Buffett outlined a small set of simple factors that he uses to evaluate investments:<\/p>\n
\u201cWe want the [investment] to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.\u201d<\/p><\/blockquote>\n
New real estate investors can quickly become overwhelmed by the surface level complexity, analyzing dozens of factors that could potentially impact investment outcomes. However, the long-term results of real estate investments are oftentimes driven by just a few key factors.<\/p>\n
To achieve success, investors should focus on identifying those two to three critical factors and critically review the potential outcomes.<\/p>\n
For example, here are a few of the key factors that Warren Buffett might focus on while analyzing the prospects of a real estate investment:<\/p>\n
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- By how much and for how long do I expect rents to grow?<\/li>\n
- How likely is it that the market for affordable housing will remain attractive in this area?<\/li>\n
- How likely is it that the competition in the area will impact my ability to attract and retain residents?<\/li>\n
- Will this property retain its attractiveness to prospective renters? Is the location, proximity to jobs\/retail\/transportation, and atmosphere of the community appealing? How might this change in the short-\/medium-\/long-term?<\/li>\n<\/ul>\n
My company has found that about a full two-thirds of the success of any multifamily project is predicated on two important factors: (A) the selection of the market, and (B) our choice of a third party property manager. We spend a lot of time on these two issues, and we consider our success or failure on these two items as make-or-break for the acquisition of any multifamily asset.<\/p>\n
This reminds me of Buffett\u2019s strategy of buying great companies run by honest and competent people. This has made Buffett tens of billions, and it will work for us (and you), as well.<\/p>\n
- Not subject to price regulation<\/em><\/strong>. For now, this is under your control. My firm doesn\u2019t purchase apartments in places like Oakland or San Francisco that impose rent controls. I know someone doing very well there, but I choose not to add in this variable to my firm\u2019s investment mix.<\/li>\n
- Needed or desired.<\/em><\/strong> Shelter is a concept that has endured the test of time. Real estate will always be in demand, and no technology, cryptocurrency, government, or economy will change that.<\/li>\n
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