Legendary investor Warren Buffett shared several choices investing tips at the annual Berkshire Hathaway general meeting on the first weekend of May. While devised for stocks, his investment philosophy can be easily tailored to fit a real estate audience.
If you’re a real estate agent who works with investor clients, you can apply Buffet’s five most important principles to your clients’ performance-focused property investments for a profitable future.
Buy and hold, forever
Buffet famously likes to buy assets “for life.” That makes him very different from investors who buy and sell frequently in search of quick gains or better opportunities. “Stick with big easy decisions and eschew activity,” he said.
Buffett believes it’s hard enough finding just one high-quality asset to acquire at a discount. If your clients manage to do so, advise them to hold onto it indefinitely. Selling it means they’d be left having to find another rare asset to invest it.
Another downside of frequent activity is the accumulation of transaction costs, which are often high and consist of taxes, commissions and closing expenses. Buying and holding a great asset keeps your client’s transaction costs to a minimum. This keeps money in their pockets and out of yours, true, but it builds client-agent trust, which means they’ll continue using your services for future investments. It’s a win-win.
Time is your friend
Buffett rightly points out that time is a friend to wonderful company, but an enemy to the mediocre. Similarly, a great investment will generate both cash flow and capital gains over the years, while a mediocre one won’t. Your clients can reinvest the value gained to create even more gains, over and over. Buffett calls those repetitive gains the gold standard.
When your clients are sitting on a cash-generating investment, the passing years mean higher compound earnings for them.
Prep for the bad years
Buffett also believes investors should prepare for what he calls “economic discontinuities.”
Adapting this approach to real estate investing is easy as long as your clients remain realistic with an eye on the long-term view. In any market, there will be periods of growth and contraction. Real estate investors need to know that being protected from disaster during a bad year is more important than earning a little bit more during the good years. Their long-term returns will be much higher.
This is why Buffett’s taste for debt is very low. He likes to say his aversion to leverage has dampened his returns over the years, but that it helps him sleep well. Buffett said it is “insane to risk what you have and need in order to obtain what you don’t need.” That is, it is crazy to over-leverage the quality assets you already own just to speculate on further acquisitions.
For property investors, Buffett’s advice means keeping debt low enough to be manageable even during adverse periods, such as when credit is expensive or difficult to obtain.
Of course, your clients can still use equity from their existing assets to fund new investments. You might say Berkshire does something similar when it uses the float from its insurance companies to buy stocks, bonds and companies. But property investors should avoid the risk of being forced to sell an asset at a discount because their debt is too big to service.
Buy durable competitive strengths
Buffett looks for acquisitions with durable competitive strengths. For real estate investors, this translates into purchasing properties with features that will make them relatively valuable, no matter how the market is performing. Such features can include: a desirable location, access to transit, proximity to good schools, easy access to job centers, low operating costs and water views.
Many investors are lured into buying properties in marginal neighborhoods where prices may be growing more quickly than in more established locations. But Buffett looks to buy valuable assets that he can hold onto for life, not to time the market by hoping to take profits before the market reverses in a fast-growing but marginal area. These are the first locations to lose value when the market turns.
Following Buffett’s strategy would mean looking for safe value rather than risky gains.
Pay a sensible price
A key tenet for Buffett is to buy only when you can obtain a sensible purchase price. He always measures price against value, not against the current market average.
By acquiring assets at a price below their true value, property investors give themselves a “margin of safety” that helps ensure the success of those investments. “You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple,” Buffett said.
Buffett famously kept his money in his pocket when the stock market was roaring to record highs and valuations. He felt assets were simply too expensive when compared to their true value — the margin of safety wasn’t there. By being patient, he managed to have billions in cash available when the crash came, and he swooped in to buy good assets priced below their true value.
Buffett has beaten the stock market for 53 years. In fact, he has more than doubled the wider market’s compound annual gain. A $1,000 investment made with him in 1964 would be worth almost $16 million today.
It is true that real estate has unique characteristics with no counterpart in the stock market. However, I firmly believe we can all improve our own results by considering how a legendary performer like Buffett might do things.
I encourage you to consider these investment tips and share with your investor clients those that you think will benefit them.