5 Keys to Buy Real Estate Like Warren Buffett - Part 1

Warren Buffett is the gold standard in the investing world. He has outpaced his contemporaries with eye popping returns and a simple approach. So when I started investing I naturally sought to understand and emulate the Warren Buffett investment philosophy.

I devoured everything that I could find on his strategy, process, and principles. He is famous for an annual letter he wrote to shareholders. His annual letters outline his investment approach, key wins, mistakes, and his evolving worldview. So I read every shareholder letter since the 1960s. I was a fan, but there was just one problem.

I HATE STOCKS

Warren Buffett built his early career by buying publicly traded stock that anyone could buy. He spent countless hours reading annual reports and researching industry publications. I liked evaluating companies, but I hated the lack of control and visibility that comes with being just one of a million shareholders in a large company. On top of that the stock market is fairly efficient most of the time. It is also dominated by enormous investors with deep pockets and more access to management than I could reasonably expect. I had a great strategy, but limited information and no defined competitive advantage.

Instead I turned to real estate in 2007. What I found was the perfect market to execute Buffett's investment philosophy. An oversupply of properties, limited buyers, and plenty of motivated sellers. A value investor’s dream. I have spent the past decade executing the Buffett playbook and refining his investment philosophy to fit real estate investing. I've boiled it all down to five key principles for consistently successful real estate investing.

MARGIN OF SAFETY

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” - Warren Buffett

So I’m not naïve. Some small percentage of readers won’t make it through the whole article. It’s sad, but true. With those folks in mind, I decided to start with the most important rule for successful real estate investing. Never Lose Money!

Sounds great, but how the heck do you do that? For that I direct you not to a rule, but the first principle…Margin of Safety. With any successful investment you need a conservative, reliable, and defensible margin of safety.

Simply put, a margin of safety is the extra cushion that you build into your analysis of any potential real estate purchase. This covers all those what-ifs.

WHAT HAPPENS WHEN...

• Rehab costs exceed your contractor’s estimates?
• The market is bad when you need to sell?
• Your new tenant loses her job?
• And the myriad of other things that can go wrong with real estate investing

If you are looking to flip a home, the standard margin of safety is a 30% cushion between the expected After-Repair Sales Price and the Total Expenses (Purchase Price + Rehab + Closing/Holding Costs).

The margin of safety required for buy-and-hold rental property will vary a bit more by the neighborhood that you are investing in. A new, affordable home in a desirable neighborhood likely needs a smaller cushion than an older home in a lower-income area. As a general rule, the riskier the investment, the bigger your margin of safety should be.

Here are a few of the factors that I consider when evaluating the appropriate margin of safety

• Worst case vacancy
• Potential eviction costs
• Unexpected Repairs

For my properties in Detroit, I conservatively estimate all my expenses will eat up 6-8 months of annual rent. That leaves a 4-6 month margin of safety. In good years that's my profit. In bad years it's my safety net.

SUMMING IT ALL UP

Margin of Safety: Unless you like losing money, always build in a healthy cushion. When you're just starting off you're guaranteed to make mistakes so build in an even bigger margin of safety

The best investment strategies are simple to understand, but difficult to master. You want double-digit investment returns? Learn to master the basics.

This is the first of a five post series where I highlight the 5 key principles from Warren Buffett 's investment philosophy that I use to achieve consistent, above-average investment returns with real estate. Check back next week or follow me on BiggerPockets to automatically be alerted to future articles.