Do Warren Buffet's Principles Apply to Real Estate Investing?

[Mark Hulsey]

While reading an article on The Motley Fool last weekend about Warren Buffett’s sage advice on investing in the stock market got me thinking. Like most investors, I’m always comparing “the market” to real estate investments. There are strong arguments to be made for each investment path, but I’m a real estate guy. However, that’s not what I want to talk about today.

Instead, Mr. Buffett’s words of wisdom made me wonder if they applied to real estate investing. Fundamental business principles are often relevant to many different industries. We can learn a lot by remaining open-minded to all business growth ideas. It’s too easy to get caught in same small circle of thinking – just like in life.

A few quotes from Mr. Buffett to consider as we apply them to real estate investing:

“Our goal is more modest: we simply attempt to be fearful when others are greedy and greedy when others are fearful.”

This aphorism is a natural for those of us with an inherent contrarian attitude. If everyone is heading in one direction, the contrarian is heading in the opposite. His quote about greed and fear brought me back to the irrational exuberance regarding real estate leading up to the Great Recession.

My fellow real estate pros would often ask me questions like, “…but Mark, the numbers just don’t make sense on this property my investor is looking at! What am I missing?” My answer was nearly always the same, “Nothing.” The numbers work or they don’t. Sure, there can be investment components that sweeten the deal that are not obvious, but when you need to dig hard to find them, it’s probably a lousy investment.

In those days, the herd was heading to the cliff. Sadly, many real estate investors took a hard fall – often life-changing. Some were new, but many seasoned. Many were very smart and plenty were not. Investment failure spanned the gamut. Easy money was just too enticing. While leverage is one of the principles of real estate investing that makes it so incredible, over-leverage is a killer. Remember, folks tapping into their home equity like an ATM spitting out cash, investors buying multifamily properties on stated-income programs, or throwing money at half-baked, residential developments that fell flat on their face?

Clearly, the many months leading up the Great Recession was the time to heed Mr. Buffett’s wise words about greed. The cats sitting on the sidelines holding tight to their cash won that game. Those cash-laden vultures swooped in to get some deals-of-a-lifetime upon the magnificent market crash. While the masses were thinking of greed with their unabashed enthusiasm, they sensed fear. Their instinctive investment senses served them well.

“Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price.”

This quote resonates with me. I look at every income producing property (asset) just like a small business in and of itself. Each small business needs love & care to thrive and most real estate investments require the same. It helps to know this right out of the gate instead of learning the lesson the hard way.

So, what’s a good correlation to Mr. Buffett’s statement relative to real estate investing? How about a good building in an outstanding location at a sensible price? It plays perfectly into the classic real estate axiom, “Location, location, location!” This overused cliché is one of the most important factors for all real estate anywhere in the world. It was true 50 years ago and will be true 50 years from now. The building itself may not be an outstanding property, but the location should be.

When an investor “buys location,” they have mitigated the investment risk substantially from the very beginning. Location always wins – right? It does, but only at a sensible price. That’s the kicker. That’s why every investor rightly asks, “What’s a sensible price?” Fortunately, real estate valuation methodologies are well defined and there’s ample sales data to quantify any acquisition these days.

Buying decent properties in solid locations at a sensible price is pretty straight forward. Then, we let time, leverage, and tax benefits do their thing. Bargain prices are not always necessary even though we know we make our money on-the-buy. I’ve witnessed many wannabe investors cursed with “analysis-paralysis.” It’s fine to be conservative in your investment strategy, but often it stops many in their tracks. I can’t tell you how many times in my career I’ve endured someone telling me, “Mark, I could have bought that property 12 years ago for $750,000. I don’t know how it could be worth so much today!” That’s what appreciation-over-time is all about.

“Risk comes from not knowing what we’re doing.”

This classic quote from Mr. Buffett has been recited thousands of time. But, these simple words should not be taken lightly when it comes to real estate investments. There’s huge value in understanding the risk-versus-knowing connection. It’s why investors stick with what they know. It’s why investors surround themselves with very smart & experienced advisors. It’s why investors understand that due diligence is the name of the game.

I’m dumbfounded by the number of situations we step into where an owner purchased a commercial property and did not understand the risk. They did not know what they were doing. Their advisors did not either. Simple stuff, like buying a commercial building to use for something that is not zoned for that permitted use – even with a CUP. Or, not realizing that upon a sale, the property taxes are going to zoom through the roof and ruin the return on investment. How about factoring the true cost of vacancy, reserves, or tenant improvements? The list goes on and on. Real estate investing is a complicated and costly game.

How about this? Like the doctor who must deal with the patient who perfectly self-diagnoses per their Google search. Suddenly, they’re the medical expert. Maybe it’s the gentlemen that’s owned three or four houses, so he knows all he needs to about real estate or worst yet, commercial real estate. Seriously, we see it far too often. In today’s culture, everyone’s an expert at everything, right? Most investment risk comes from not knowing what we’re doing – plain & simple.

There’s a reason many people often half-joke that the older they get, the less they know. It has nothing to do with their knowing. It has everything to do with their wisdom. They are finally old enough & wise enough to know there’s just too much to know. That’s why a great real-property attorney, CPA, banker, or real estate broker is worth their weight in gold. They not only protect their client, but they nearly eliminate the risk by simply knowing what they are doing. Experience indeed pays.

Thank you, Mr. Buffett. Your words of wisdom are truly timeless, even for real estate investing.

[Henry Clark]

@Mark Hulsey

Greetings from next door to Omaha.  Don't know Mr Buffett, never seen him, haven't read his thoughts.  My wife and son go every year to the Berkshire stockholders meetings for the gadgets. 

Two thoughts, one business and one entertaining.

Commercial-  We do Self Storage, 8 locations, 5 towns.  That is our lane.  Saved 4 acres road side on our latest project and built the storage in back.  Zoned Commercial.  15,000 per day road count. Between Council Bluffs and Omaha.  Planned to build Contractor rental units.  100 x 400 building.  Split 50 foot in the middle and in 25 foot widths.  14 foot tall by 12 foot wide doors.  Etc, Etc.  Numbers work.  Different customer and risk pattern than we are used to in Self Storage.

Based on the wisdom above and your background, do we build ourselves or sell the land (appraised $600,000).  We have $100,000 into the land.  All hookups are at the front, storm pond already installed, zoned, fenced, land leveled, just need to build.

"Curve" questions for the above.  Mr Buffet's advice only holds true if you generally speaking know where you are on the "Curve".

a.  Where are we on commercial land price curve?  Nationwide primarily.

b.  Where are we on Contractor rental buildings curve?  Local decision.

c.  Where are we on our personal Risk/Reward curve.  Financial risk is fine.  Its the knowledge Risk difference between Self Storage and Commercial Contractor rentals.  Only plan to do this one time.

Where do you think we are on the Curves?

Entertainment:

Mr Buffett is walking down a sidewalk.  As usual he has another 3 people following/with him.  There is a dollar bill on the sidewalk.  Doe he stop to pick it up?

- Economic efficiency- his time, the three peoples time, and cutting his next meeting short 1 minute while he picks up the dollar; is it worth it. Time- checks the dollar out, determines its clean and puts it in his wallet; takes a minute.  He decides not to pick up the dollar.

- trained by parents coming out of the 30's depression.  Picks the dollar up.

- Ego- both ways.  Doesn't want to be seen picking up the dollar, some things are too small.  Does want to be seen picking up the dollar, nothings to small.  Every dollar counts.

What is Mr. Buffett's and/or your thought process, on picking up the dollar?