Warren Buffett offers invaluable advice
A recent article by Rachel Adams in the New York Times covered an excerpt from Warren Buffett's annual letter that he authors at the same time as Berkshire Hathaway’s annual report is released.
A teaser of this letter was published and offered some invaluable advice for anyone in the property market. Mr Buffet’s advice centred around a pair of investments he had made.
“let me first tell you about two small nonstock investments that I made long ago. Though neither changed my net worth by much, they are instructive.”
Between 1973 and 1981 Nebraska and surrounds experienced an explosion in farm prices. This was attributed to the forecast for “runaway inflation”. However, the price hike bubble burst and those same properties were now valued at 50% or less. This was devastating for the farmers and the banks, many of which failed.
Buffet, in 1986 purchased a massive 400-acre farm, for a steal at $280,000 which was considerably less than one of the failed banks had loaned against the property a few years earlier.
Knowing nothing about farming, Buffett revealed that his son loved farming and he taught his father all the metrics around production capability and operating costs.
“‘I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.
Buffet understood that the investment could only prove to be profitable. He understood that there would be bad crops and bad years as well as some brilliantly productive years. 28 years on, the farm is worth 5x it’s original worth and the farm itself is running at 3x the productivity as when the investment was made.
Buffet attested to the fact that he only recently visited the farm for the second time.
Again in 1993 a property bubble had popped specifically in the commercial property market and Buffet was tipped off about a property for sale across from New York University. Again Buffet identified a property that was not meeting is maximum capacity yield and understood that with better management, the investment would pay off ten fold. Along with 2 other investors purchased the property.
“And manage it they did. As old leases expired, earnings tripled. Annual distributions now exceed 35% of our initial equity investment. Moreover, our original mortgage was refinanced in 1996 and again in 1999, moves that allowed several special distributions totaling more than 150% of what we had invested. I've yet to view the property.” he goes on to forecast that the investments will continue to be satisfactory holdings for his lifetime and for his generations to come.
Dudley Annenberg had the following to say:
What struck me about this article is that Buffet is as an astute buyer of property which he is not knowledgeable about but has the ability see a good deal as he is in buying businesses. He has the knack to see a good deal when it is offered to him.
He is not swayed by political events when making decisions about buying but the same cannot be said about buying property in a 3rd world country like SA. Politics in USA is hardly volatile.
It surprises me that he has so little exposure to property. He dispels the theory of one third in stocks, one third in property and one third in cash. He is 100% a stocks man bar 2 properties.
I agree that you should invest in what you know best. You will undoubtedly do better than spreading your risk among investments you rely on others to guide you. They end up making fees at your expense. Insurance policies are a case in point.
Andries Louw Added to Dudley’s comments:
In both the property purchases mentioned Warren got somebody knowledgeable or with experience in that type of property involved.
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When he bought the farm in 1986 he asked his son (who loves farming as stated) to give him advice and help him with the quantum to do the feasibility of the farm;
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When he bought the retail property in 1993 he partnered a group of friends that included an experienced, high - grade real estate investor.
Above is a perfect example of how one should "stick to your knitting" and partner with or get knowledgeable people involved when dealing in property. This is what we at Annenberg Property Group are called on to do every day.
And the newest director, Andrew Jefferson says:
Buffet has always applied the adage “If the stock markets closes for 10 years and you cannot sell for 10 years, would you be happy to own that stock?” The same should apply to investment grade commercial property.
Of course, this depends entirely on your reason for buying. Buffet only discusses purchasing as an investment, but the bulk of property sales are done to owner-occupiers. However, when buying property as an occupier, one should still look to the future. It is much easier to expand within your own property than to sell and move again. If it is possible to find a property that you can grow into without materially affecting your cash flow, this is always advisable as it will save you on long term expenses.
However, always remember (as in the NYU vicinity), location, location, location.