Have you been looking for a great real estate mentor? There’s a lot of talk about finding a mentor, and I think I’ve found the perfect one.
How would you like to be mentored by Warren Buffett?
Warren’s been mentoring me for some time now, and it’s been inspiring.
But I’ve never actually spoken to him. He hasn’t ever called or emailed me… yet.
But Mr. Buffett has created a means for me—and for all of us—to get inside his head and learn how he thinks about investing.
“Hold on,” I hear you saying. “This is a real estate investor blog. And Warren Buffett isn’t widely known as a real estate expert.”
That is true. But wouldn’t most of us agree that the Oracle of Omaha is the greatest investor of our time (perhaps all time?)
Consider a few of his stats:
- 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.
- 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—a record that other legendary investors don’t even come close to touching.
- While not widely known, Buffett has unique and expansive insight into the real estate industry through Berkshire Hathaway’s 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).
Buffett hasn’t written a book on real estate, he’s never sold any courses, and he hasn’t (yet) appeared on the BiggerPockets Podcast. But Buffett has recorded quite a few thoughts on investing. And his thoughts are very relevant for us real estate investors.
We’re all fortunate enough to have access to Buffett’s musings through his annual shareholder letters.
Though Buffett rarely wrote about real estate, I’m going to take a stab at translating Buffett’s wisdom for BiggerPockets readers. This is the first of what I hope to be a series of articles channeling his wisdom into the real estate arena.
I’ve written this article with the help of my friends and fellow BiggerPockets members Bryan Taylor and John Jacobus. Bryan and John are great real estate investors and Warren Buffett fanatics. They make the trek to Omaha each year for Buffett’s celebrated annual meeting. They’ve listened to Buffett’s interviews, read his letters, and tried to emulate his strategies in their own investments. I’ve learned a lot from them, and there’s a lot you could learn, too.
So let’s 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? I think he might say this:
To succeed as a real estate investor, seek out high quality, productive assets and let time do its work.
In his 1991 annual letter to shareholders, Buffett encouraged investors to pursue durable, high quality “economic franchises” whose earnings are based on “a product or service that:
- is needed or desired,
- is not subject to price regulation, and
- is thought by its customers to have no close substitute
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.”
How does real estate fulfill these criteria?
- Needed or desired. 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.
- Not subject to price regulation. For now, this is under your control. My firm doesn’t 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’s investment mix.
- Thought to have no close substitute. 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, whose rental units are offered at rates materially lower than recently built class A multifamily units.
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.
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.
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?
Our company hires a community connection coordinator to facilitate community in every apartment complex. It’s a fact that few apartment dwellers know their neighbors or feel like they’re part of a real community.
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.
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’s CARES program facilitates for multifamily communities across the United States. If you haven’t seen them in action, you should certainly check them out.
Related: What Would Warren Buffett Do? 12 Quotes for Smarter Investing
In his 1991 letter, Buffett also stated that “a truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.” Creating an amazing community is a way of creating a moat to protect your occupancy and profitability.
Now that we’ve gotten a taste of Buffett’s wisdom, what else did he have to say?
In Buffett’s 2007 letter he describes the enduring value of a modest investment in See’s Candies:
“Last year See’s [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—and somewhat immodest financial growth—of the business. In the meantime pre-tax earnings have totaled $1.35 billion.
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’s 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.)”
So, What is Buffett Talking About?
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.
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: “Time is the friend of the wonderful business, the enemy of the mediocre.”
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.
For example, his purchase of See’s 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.
How Do These Lessons Apply to Real Estate Investing?
When analyzing real estate investments, it’s 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.
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.
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.
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’t require significant capital to appeal to prospective renters.
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.
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.
How Else Might Warren Buffett Advise Us in Our Real Estate Careers?
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.
In his 1977 letter, Warren Buffett outlined a small set of simple factors that he uses to evaluate investments:
“We 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.”
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.
To achieve success, investors should focus on identifying those two to three critical factors and critically review the potential outcomes.
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:
- By how much and for how long do I expect rents to grow?
- How likely is it that the market for affordable housing will remain attractive in this area?
- How likely is it that the competition in the area will impact my ability to attract and retain residents?
- 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?
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.
This reminds me of Buffett’s 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.
I’ve chosen to follow Mr. Buffett on a safe and proven path to predictable profits, steady growth, and the compounding of assets—with the goal of multigenerational wealth creation and propagation.
Owning and operating multifamily assets may not be the most exciting or most fantastically lucrative venture in the world. (I have three friends who made a lot more in Bitcoin last year.) But in many ways, it fits Mr. Buffett’s criteria for a profitable “economic franchise.”
Intelligently investing in multifamily properties in large and growing markets can provide real estate investors a Buffett-like opportunity. How?
- The demand for multifamily housing is predictably strong for as long as any of us will be on the planet.
- The capital expense demands for a multifamily asset are somewhat predictable and controllable.
- A stabilized multifamily asset can provide its owners with a predictable tax-advantaged income stream for years or decades to come.
- Refinancing multifamily assets provides tax-free cash to the owners to allow them to buy other assets. This fulfills Buffett’s belief in the biblical mandate to be fruitful and multiply.
- Multifamily owners can take many steps to create a moat around their assets, effectively increasing customer loyalty and ultimately profitability.
An acquaintance of mine approached me today with an exciting investment opportunity… in space travel. Wow. If it works, they will make a fortune.
Since I was studying Buffett and working on this article, I found it easier than usual to give him a quick and courteous “no.”
I’m staying on a secure and established path to wealth generation and accumulation through commercial multifamily investing.
What about you? How does Mr. Buffett’s advice speak to your real estate investing situation? How will you think differently about your next big investment decisions after considering Buffett’s wisdom?
Let’s talk. Comment below!