Why Warren Buffett Didn't Want to Buy a House to Live In - The 5 Minute WrapUp by Equitymaster
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Why Warren Buffett Didn't Want to Buy a House to Live In

Mar 17, 2016
In this issue:
» FY16 not turning out to be great year for the auto industry
» US Fed decides to keep interest rates unchanged
» ...and more!
0.00
Rahul Shah, Co-Head of Research

It was 1955.

Warren Buffett was 25 and just starting a family. One of the first instincts of a young family is to buy a house.

But not Buffett:

  • In Omaha, I rented a house at 5202 Underwood for $175 a month. I told my wife, 'I'd be glad to buy a house, but that's like a carpenter selling his toolkit.' I didn't want to use up my capital.

So, it's not like Buffett didn't have the money to buy it. By that time, he already had US$127,000 - quite a large sum for the time. A good house would have cost about a fifth of that. But he still didn't bite.

His reasoning was unconventional. But the pure logic of it is striking - a completely rational calculation of what would lead to a better financial result. It's void of all emotion and pre-conceived notions.

Buffett reflected on his situation at the time. He knew he had the skills to multiply money at a lucrative rate. Given that, he didn't see the sense in blocking a big part of his capital in a house. He reckoned it would be wiser to rent a house instead, and use the money he saved to invest.

You might be wondering how Buffett's decision and his situation sixty years ago is even remotely relevant to you today.

They very much are.

You see, residential rental yields back here in India are among the lowest in the world. They stand at a measly 2% or so. That is the amount of rent you pay per year relative to the market value of that property. So, even if you had the money to buy a house, should you?

Looked at another way, renting a house is the equivalent of taking a loan at an interest rate of 2% per annum. For just Rs 2 every year, you get to use an asset worth Rs 100. You could use it to invest. Agreed that you probably don't have Buffett's skills and wouldn't be able earn the kind of return he did on that money.

But even a simple bank fixed deposit earns close to 8% today. Subtract the 2% rent you pay and that leaves you with a 6% surplus accruing to you every single year.

And if you are able to make investments that safely earn an even higher rate of return, your edge would be even larger than that 6%. Over the years, this edge can make a mammoth difference to your wealth.

Yes, when you rent, you may miss out on any property price appreciation that happens along the way. But relying on such appreciation for wealth creation is tricky. Who knows at what rate house prices will go up in the coming years? It could be a fabulous return, it could be mediocre, it could be nothing, or it could even be negative (yes, this too is a possibility).

Do note - my point of telling you all this is not to advise you on whether you should buy a house or not. Instead, it is to get you to be more thoughtful about this decision. For most, it's an emotional and automatic decision. It doesn't need to be.

Few make their decisions - including such personal ones - in the purely rational manner of Buffett. Is it a surprise that few achieve Buffett-like results?

What do you think are the factors to consider when deciding whether to buy or rent a house to live in? Let us know your comments or share your views in the Equitymaster Club.

*******************

P.S.: Buffett eventually did buy a house a few years later, which he lives in it to this day. Perhaps once he reached a point where the cost of a house would be a much smaller proportion of his networth, he became more willing to give in to the temptation. But doesn't stop him from ruing that decision even now: 'I would have made far more money had I instead rented and used the purchase money to buy stocks.'

2.42 Chart of the day

The auto industry is one of the many indicators of the health of the Indian economy. And if one were to look at the data for the eleven months of FY16, things do not look too good. Barring commercial vehicles (CVs), most auto segments saw tepid growth in volumes.

Growth in CVs was led by the medium and heavy CV segment (MHCV). Better freight rates and improvement in operations of fleet operators meant that they had more funds at their disposal to purchase MHCVs. Growth of light CVs (LCVs), however, remained sluggish.

The next best performer was passenger vehicles (PVs) and growth for this segment was largely attributed to new product launches by many players.

Two-wheelers struggled this year. The rural economy is a big market for two-wheelers. Thus, as poor monsoons wreaked havoc on crop production, farm incomes reduced and rural demand took a hit. And this impacted volume growth for two-wheeler players.

Exports growth was also subdued because of currency problems in certain markets of Africa and Asia. All in all, it was not particularly a great year for the auto industry.

Clearly, once the Indian economy picks up pace, volumes for most of the major auto companies are expected to ramp up.

Commercial vehicles shine in FY16

3.40

After the US Fed raised rates in December last year, all eyes were on the central bank and what it would do in the next monetary policy. Well, we now have the answer. The Fed has decided to keep interest rates unchanged. Not just that. An article on BBC highlighted the Fed originally expected to raise rates four times in 2016. Now it expects to raise it twice this year. We will not be surprised, however, if this too changes as the year progresses.

What it essentially highlights is this - The US economy is still sluggish and will take time to recover. A lot will depend upon whether is a significant improvement in the job market. Plus, global factors such as the health of Europe, China and the like will also influence the Fed's decision in the coming months.

What is difficult to take a call on how this will impact Indian stock markets. There is every possibility of fund flows remaining volatile. For the Indian investor though all this should not really matter much in terms of his investment decisions. Stock selection should be more a function of the inherent strengths of the business and healthy financials. Thus, volatility in the stock markets will be nothing but an opportunity to pick up quality stocks at attractive prices.

4.48

The Indian markets traded firm for the larger part of the trading session today led by sustained buying activity across index heavyweights. At the time of writing, BSE Sensex was trading higher by around 75 points. Buying was largely seen in oil & gas, IT, and metals stocks. The BSE Midcap and BSE Smallcap also did well to notch gains of 1% each.

4:56 Investment mantra of the day

"Some people seem to think there's no trouble just because it hasn't happened yet. If you jump out the window at the 42nd floor and you're still doing fine as you pass the 27th floor, that doesn't mean you don't have a serious problem. I would want to address the problem right now." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst) and Radhika Pandit (Research Analyst).

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13 Responses to "Why Warren Buffett Didn't Want to Buy a House to Live In"

Zulfiquar Singaporewala

Mar 21, 2016

Buying a house is to invest huge % of your hard earned money if you are doing service.
In India if you are holding big post in Govt. or either in Ltd company than every one ask still you are not having your own house means emotional blackmailing in the society or you are stingy.

Many people do not think about economic calculation and vision for future life. If you want to buy a residential area flat it cost more ( Say 45 to 60 lacs ) and if you buy a flat in comercial complex it cost less ( Say 40 to 50 lacs )If you rent a flat in residential area it will cost 15ooo/ month.
while comercial flat will cost more than 20000/ because it is generating money.
So best bet is to buy flat of comercial area and rent flat in residential area. This is real tricky adjustment in economy and I have done so and bought my house after 15 years when adequate fund is available with me.

Like 

Rajeev Bagra

Mar 20, 2016

Buying a house is a costly affair and means blocking a substantial portion of liquid cash which could otherwise be used for your business (if you are an entrepreneur) or unable to invest in other asset classes like equity or even investing in learning. So, if you are young and willing to work hard making best use of your skills, it appears you can postpone the decision of buying house for the greater interest of your life's pursuit.

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ramachandran

Mar 19, 2016

Buying a house or flat by an indian at first look is for safety and security and the idea of returns on investments were not calculated. Initially returns are less than 2% by way of lease, but the appreciation will be more or equal to investment in equity. But property has a drawback in that it is not that liquid. I cannot sell a part of my flat or house to raise money and I cannot buy it back when I have surplus like equities. Yes, I do agree, taking a house/flat on lease will be more easy than buying a house and protecting it. Transfer of equities to sons and daughters is more easy than transferring house/flat. This should be the biggest advantage of equities over owning a house.

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J S GOGIA

Mar 18, 2016

This decision was good in USA context, where the value of house property depreciate even today. It does not fit into Indian condition where escallation in house property was very high. The plot bought by me is worth 1000 time fold, Can the money grow in banks/ stock market like this. The plot original value of 4000 is worth Rs. 5 crore now. Free living plus rental earning is worth Rs. 8lac a year.

Like (3)

Subramanian

Mar 18, 2016

One of the key reasons people buy a house is for Security i.e they will not be asked to vacate and be on the streets. Whatever income stops, at least a roof over the head is there. With the way the prices have gone up in the last few years, people feel that reality is the place to invest. The problem with rental yield is that we take the current rent/current property price. But if you take the current rent/property price 10 years back then the yield will be higher. Also, as the rent keeps on increasing, one has to move away from the central location to suburbs if you are not one of the tenants not moving out.

Like (2)

Vuyyala Ravi Kumar

Mar 17, 2016

At the outset, I agree with what Mr Buffet did i.e. not to use his own money for purchase of a House.

Not everyone is in a position to buy a property with own funds. Buying a house involves own contribution @20% with 80% from Housing Finance Companies. The Loan ensures forced savings which with savings on rent & IT benefits creates a secured asset in 8 -10 years (as per HDFC most Housing Loans are closed in abot half the tenure) and Financial Security with option of reverse mortgage in last years of life if things go very bad.

It is difficult to invest in SIP/Equity investments with such discipline and that is the difference between buying a House & Equity Investments/MFs.

Socially also there are querries from Family/Elders/Well Wishers about when are you buying a House.

Regards

Ravi

Like (2)

G Darad

Mar 17, 2016

You may be surprised to know that the concept was there in my mind even before I knew Buffet or even before I turned an investor. The need to buy a house, especially in our kind of society, has been a purely emotional one, born out of insecurity. Culturally speaking, we have never been an enterprising people and so we have an inescapable psychological need to secure our future here and now. We do not have the confidence to approach the future with hope and optimism.The complex is further aggravated by our habit to introduce irrelevant and extraneous considerations into our thought processes, for example, our habit to relate ourselves to the socio-economic hierarchy without a dispassionate assessment of our own predicament.This complex is obvious when u discuss the idea even with supposedly rational people. I am sure, you will hardly find any takers for this idea, howsoever rational it may be. Investing and earning riches is based on professionalism and cannot be equated with buying a house which is pure emotionalism. For an investor like me, the idea however, is appealing and challenging, since it affords an opportunity to demolish the mundane and conventional mould.

Like (2)

Nandan Shah

Mar 17, 2016

You are only taking in to account rent. What about capital gain? That way even stocks earn 1.5-2% dividend. I have to protect against high inflation, the way to go is to invest in physical asset. You do not trust the currency & govt. Gold and property is another asset class that protects you against theft by the government

Like (3)

Utkarsh

Mar 17, 2016

I quite agree...As long as the IRR of the investment exceeds the IRR of property appreciation and its benefit is not offset by exorbitantly high rents i.e the FV of the rent whenever we assess the decision to buy/rent, always makes sense to rent

Like (3)

George K Naliyan

Mar 17, 2016

Great idea of Warren Buffet relevant eve today

Like (3)
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