Wednesday, March 12, 2014

The lessons Warren Buffet wants to teach you about real estate.

The world’s third richest man has something he wants to tell you.  He’s practically imploring you to listen as he dispenses a parcel of the wisdom that’s made him the third-richest man in the world.  We hardly need to check his resume to convince us to listen, but the billionaire Chairman of Berkshire Hathaway and Svengali of investing has this message for you:

Buy real estate.

Of course it goes deeper than that, as there’s a right way to buy real estate and a lot of wrong ways.  Thankfully Buffet, always generous with sharing his philosophies, has left enough breadcrumbs for us to decipher his formula.

The biggest breadcrumb recently came in his annual letter to Berkshire Hathaway shareholders; a highly anticipated forum to pick his brain about the year’s fortunes, the market, and always-general advice about money the average person can chew on.  In this year’s letter, Buffet makes no mystery about his thoughts on real estate, "Home ownership makes sense for most Americans, particularly at today's lower prices and bargain interest rates."

So let’s pretend we had Warren Buffet in front of us and could ask him the basic questions about real estate and finance most Americans have.  I’ve assembled his answers from his annual letters but also interviews and articles.

Why buy now?
He’s oft quoted as to why now is a great time to buy, "It's a way, in effect, to short the dollar because you can take a 30-year mortgage and if it turns out your interest rate's too high, next week you refinance lower. And if it turns out it's too low, the other guy's stuck with it for 30 years. So it's a very attractive asset class now."

Is it better to buy real estate now or stocks?
"If I knew where I was going to want to live the next five or 10 years I would buy a home and I'd finance it with a 30-year mortgage... It's a terrific deal."

How about buying rental properties?
"If I was an investor that was a handy type and I could buy a couple of them at distressed prices and find renters, I think it's a leveraged way of owning a very cheap asset now and I think that's probably as an attractive an investment as you can make now." He’s also said, "If I had a way of buying a couple hundred thousand single-family homes I would load up on them."

What should we be cautious of when buying rental properties?
In this year’s shareholder letter, Buffet tells the story when he was a young man and bought a recently foreclosed 400-acre farm in north Nebraska.  He knew absolutely nothing about farming but had a family member who did ready to step in, and he did know about money.  What he understood was that there was value to the property as an asset because of the goods it could produce, and that those goods would increase in value as time went on.  He factored a humble 10% profit but the real boon was long term.  Now, the property is worth 5 times what he paid and profits have been much higher than expected.

So “focus on the future productivity of the asset,” Buffet advises.  In terms of real estate, that equates to the inherent value of the property in the market, not how much the property price will change in the short term.  “I thought only of what the properties would produce and cared not at all about their daily valuations,” Buffett said. “Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard."

With all the changes in the economy and the recession, is real estate still a sound investment?
Buffet still lauds home ownership as delivering on its basic benefit: that homes increase in value over time, and insists that still applies, in fact, more than ever.  "It's a totally sound premise that houses will become worth more over time because the dollar becomes worth less," he said at a Congressional hearing on the financial crisis.  But that doesn’t mean there won’t be fluctuations, and the recent real estate bubble was caused by overconfidence that prices would never go down, the ease of getting multiple homes, loans without proper income documentation, and no-money down loans, leading to greed in every sector that eventually serves as the pin that popped the bubble.

Is it better to wait cautiously for the perfect time to buy real estate?
If there is one thing Buffet teaches us it’s that there are micro markets within any market, and always deals to be had so there is no wrong time to buy, but there’s definitely a right time to buy.  Starting back in 2008 he admitted that buying when prices are low always feels risky and unpredictable because no one can tell what prices will do in the short term, but that’s exactly the best time to get in.  Once consumers wait until there’s some stability and predictably to the price curve, the bottom – and the best deals - are already over.  Luckily, we’re still in an ideal buying environment as prices are still low and interest rates are great, but that won’t last for long.

"If you wait for the robins, spring will be over," says Buffet.

Should people stretch to buy their dream home?
That’s the perfect formula for failure, according to Buffet.  Too often during the financial crisis homeowners spent more than they could afford, with volatile adjustable payments and stretched to every dollar of their income just hoping for short-term gain.  That’s the recipe to lose money.
"A house can be a nightmare if the buyer's eyes are bigger than his wallet and if a lender -- often protected by a government guarantee -- facilitates his fantasy. Our country's social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford."

So what three factors are most important when buying real estate?
Warren Buffet believes the three most important elements to buying a home as a great investment are: a fixed mortgage, affordable payments, and holding on to it for the long-term.  By keeping payments affordable (and stable) and looking to keep it for the long haul, you basically allow the asset to bear fruit for you.  "If home buyers throughout the country had behaved like our buyers,” Buffet says, “America would not have had the crisis that it did."

Does he practice what he preach?  
Warren Buffet, The Oracle of Omaha, is worth around $50 billion dollars according to recent Forbes estimates, but still lives in the 5-bedroom home in Nebraska he bought 52 years ago for $31,500.  That sounds to me like a he takes his own advice!

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