What can CRE investors learn from Warren Buffet, the greatest investor of all time?
Warren Buffet is the greatest investor, with his portfolio consistently crushing even top funds. Although most of his focus is in the stock market, we're able to learn a great deal from his insights on investing in general and how they can apply to CRE.
I've always learned a lot from Warren's advice, but these 2 quotes in particular resonate really well with CRE investors.
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Warren Buffet’s been quoted saying the 3 most important words when it comes to investing are: Margin Of Safety.
I really take this to heart when looking at properties, because what this means is what extra room did we leave for the unexpected to happen? Lots of times we see underwriting from other operators and they have really aggressive assumptions, which may not be a terrible idea if you really want the deal, but to us, no deal is better than a bad deal so we always lean on the side of safety.
An example of this is here in the Phoenix market, where in the last year we’ve seen a 16% rent increase, unheard of from any other point in time. To put that into perspective, generally, most operators will assume a 2% increase in rental income per year.
Now, we’ve seen people assume that this 16% growth will continue over their hold period, sometimes up to 5 years or more. For us, that doesn’t leave enough margin of safety, because what happens if in 2 years rent increases fall back into a typical range, or just don’t stay crazy high?
It doesn’t leave room for the market to adjust downward, and to us that’s too risky and we’d run the risk of overpaying for an asset and missing our projected returns.
We’ve also seen these in other categories where expenses are very low, assuming expenses can be taken down from 50 - 60% down to 30 or 40, without leaving any room for property tax increases, insurance claims & increases, or even assuming extremely low vacancy levels, because what happens if you miss your target of a 2% vacancy or if your expense cannot be driven down into the 30 or 40% range?
You’ll miss your projected returns or possibly even lose some money. So always leave room for the unexpected to come up, and build in a margin of safety.
It's better to buy a wonderful company at a fair price, than a fair company at a wonderful price
The second quote that Warren Buffet says is: It’s better to buy a wonderful company at a fair price, than a fair company at a wonderful price.
In real estate, we’ve adopted this thought process as well. In the beginning, we were looking at C- even D class neighborhoods, where incomes were really low, maintenance expenses were really high, it was dangerous to travel to the properties, and there really wasn’t any indication of a market upswing.
We looked here in the early stages because we were seeing some great prices and could notice some really high projections, but what we quickly learned was that these assets never perform as expected.
Expenses are always significantly higher than anticipated, tenant problems cause personal and financial stress, and great property managers and other contract workers won’t go to those areas.
While I do know people who make great money in these markets, that’s the payoff for taking on the significant risk with the tenant base and the lack of growth in these areas.
We’ve since elected to purchase wonderful companies at fair prices, and in this business that is exactly what we’re doing, we’re purchasing these buildings as a business. We’ve traded off some of that potential upside in exchange for much more security, less volatility, more predictability, and in the end, still hit some really amazing returns for our investors.
So what Warren Buffet tells us are two things: be conservative in your underwriting and always leave room for the unexpected, and it’s okay to sacrifice some potential upside for security and to acquire better and more stable assets.
I hope you found this episode valuable and if you’re interested in learning more about how multifamily investments fair against the stock market (unless Warren Buffet is running your portfolio) then download our free guide below.
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