Who Says Warren Buffett Doesn't Invest In Real Estate? - The 5 Minute WrapUp by Equitymaster
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Who Says Warren Buffett Doesn't Invest In Real Estate?

Jul 16, 2016
In this issue:
» Number of LBOs in Last Decade Highest Since 1991 Reforms
» More questions on China's future growth rate
» Roundup of world markets
» ...and more!
00:00
Rahul Shah, Co-Head of Research

Warren Buffett is all about, and only about, investing in stocks. At least, that's what world thinks.

But that is not at all what Buffett is about. And I want to prove it to you.

Let me take you to 1993. Few know that, in that year, Buffett made a 'small' personal investment in a commercial real estate property. Yes, you read that right. That's the king of stocks doing something no one thinks he does.

But the most interesting bit here is not even his choice of asset class. It's the analysis he did before making the decision. And here's the whole story...

That year, an acquaintance told Buffett about a retail property in New York adjacent to New York University (NYU). Now a bubble in commercial real estate had recently come to its sorry conclusion. And an institution called 'RTC' had been created to sell the assets of failed local banks whose generous lending practices had fuelled the erstwhile bubble.

At this point, here's what Buffett was thinking. He found that the annual rent income from the property was 10% of its sale price. But that's not all. The RTC had been undermanaging the property and several of its stores were lying vacant. Leasing them out would mean an immediate bump up in that 10% annual yield.

What's more, the largest tenant, who was occupying about a fifth of the property's space, was paying a paltry rent of about US$5 per foot. This when the other tenants averaged US$70. This lease was to end a good nine years later, but would provide a major boost to the yield.

And then there was the property's amazing location. You probably already know that NYU is widely considered among the top universities in the world. And it wasn't going anywhere.

Buffett, together with a few others, bought it.

Fast forward two decades and here's what happened. As old leases expired, income tripled. The annual rent Buffett now enjoys from the property exceeds 35% of the price he paid for it. Moreover, as interest rates went lower, interest paid on the loan taken to buy it substantially reduced, allowing extra earnings totaling more than 150% of what he had invested.

Obviously, he made a lot of money on the property. But anyone in their right minds who would have come across such a deal at the time would have bought it right? Not really. In fact, there were probably many such deals available at the time, and few takers. How come?

Well, at that point, things being the way they were at the time, most were thinking that property prices would fall further. Could they have fallen? Of course! And people were busy obsessing over the where the price of the property was headed. This had made them invest in these very properties when prices were skyrocketing, and now at these significantly lower prices prevented them from snapping them up even at the cracking deals they were available at.

Buffett, on the other hand, was busy focusing on the factors that could be reasonably analysed. Those were the ones that were truly important. And not on vague notions of where the price of the property was headed. Contrary to popular belief, he never knows before buying an asset where its price is headed next.

And his thinking when buying stocks is exactly the same.

I'll say it again: Buffett is not about investing in stocks. Nor real estate or anything else in between.

Rather, he is about arriving at an honest and intelligent judgement of what an asset can produce for its owner, and buying it when its price looks good in relation to that.

Everything else is noise.

What factors do you focus on when investing? Let us know your comments or share your views in the Equitymaster Club.

02:18 Chart of the day

Indian businesses are perceived to be less risk tolerant than their counterparts in the West. But if the data on acquisitions are anything to go by, the risk appetite of Indian Inc. has gone several notches higher in the past decade. In fact, data since 2007 shows that companies in India acquired businesses with the help of huge debt. The number of such acquisitions in last 10 years have been the highest since 1991 reforms.

Number of LBOs in Last Decade Highest Since 1991 Reforms


One would recall Indian companies fetching the MNC tag with the likes of Tata Steel, Hindalco, Tata Motors and Indian Hotels going in big ticket acquisitions in 2007-08. The fate of most of the acquisitions did not turn out as expected. Other than Tata Motors the profits of none of the other companies are anything to write home about. The Tata group has in fact been restructuring its business to shed debt and get rid of the acquired assets.

However, the desire to grow and diversify with debt does not seem to have faded.

The latest instance of mid-sized detergent company Nirma acquiring huge cement capacity with debt is a case in point. While this certainly reaffirms the growth potential of smaller companies in India, it does not always serve the interest of shareholders. Therefore such high debt acquisitions must draw concern about the cash flows of the company post acquisition. And if not satisfactory, investors must avoid getting carried away by the growth and diversification prospects.

03:35

Given the challenges that China has been facing of late (the stock market crash and the depreciation of the yuan), many believed that growth would take considerable beating. So far, that has not happened. As reported in The Economist, China's GDP grew 6.7% YoY in the second quarter of 2016. This is not too bad and at par with growth reported in the first quarter. So while growth is not as strong as it was in the past, it has not nosedived either so far.

What has led to this growth? Infrastructure investment has risen, the property market has been pretty strong in the first half of the year, and consumption has also been relatively robust.

But there are problems. First, China's growth continues to be investment-led. Not only does it account for nearly half of GDP but is also entirely fuelled by the state. In other words, there has not been much contribution from the private sector. This might work for the country in the medium term, but is not likely to be sustainable from a long term perspective. Moreover, growth seems to have come about at the cost of efficiency and productivity. Indeed, many of the state owned companies are quite indebted and are run much less efficiently than their peers from the private sector.

Of course, it only follows that a revival in the private sector will go a long way in bolstering China's growth. But that's easier said than done because the private sector is grappling with its own set of problems. Lack of reforms, and bloated capacity are some of them. From the looks of it, it does seem that China's GDP growth for the time being will largely be state led. How long this can go on is anybody's guess.

04:15

Major Asian markets ended the week on an encouraging note. Stock markets in Japan and Hong Kong ended the week higher by 9.2% and 5.3% respectively. Stock markets in Japan surged on hopes of more stimulus measures. Further, the stronger-than-expected election victory by the country's ruling coalition also lifted the markets.

Stock markets in Europe too ended the week on a positive note. Stock markets in Germany and France ended the week higher by 4.5% and 4.3% respectively.

Talking about UK, The Bank of England surprised investors by holding off on cutting interest rates despite the hit to the British economy from last month's vote to leave the European Union. Further, Theresa May was appointed as the new Prime Minister of UK. Stock markets in UK ended the week higher by 1.2%.

Stock markets in US ended the week higher by 2%. Dow Jones Industrial Average closed at an all- time new high during the week.

Back home, Indian indices too ended the week on a positive note. BSE Sensex ended the week trading higher by 2.6%. The ongoing earnings season will be a key trigger for the markets going forward.

Performance During the Week Ended 16th July, 2016

04:56Investment mantra of the day

"Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of 'Don't just sit there, do something.' For these investors, liquidity is transformed from the unqualified benefit it should be to a curse." - Warren Buffett

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

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1 Responses to "Who Says Warren Buffett Doesn't Invest In Real Estate?"

Thirumurthy. R

Jul 16, 2016

The clarity of thought that goes into any investment decision, possible only when there is neither greed nor panic, is seen in Buffet's real estate venture.
Full marks for the lucidity of your writing.

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