Food for thought:
"You don’t need to be an expert in order to achieve
satisfactory investment returns... Focus on the future productivity of the
asset you are considering.. If you instead focus on the prospective price
change of a contemplated purchase, you are speculating.. Games are won by
players who focus on the playing field – not by those whose eyes are glued to
the scoreboard... " - Warren Buffett
Warren Buffet is a household name. He needs no introduction.
Suffice it to say that Warren Buffett is an American business magnate,
investor, and philanthropist. He is widely considered the most successful
investor of the 20th century. He was ranked as the world's wealthiest person in
2008 and as the third wealthiest person in 2011.
It is a great privilege to learn from this investment guru.
In an exclusive excerpt from his popular shareholder letter, Warren Buffett
looks back at a pair of real estate purchases and the lessons they offer for
equity investors. Hear Warren Buffett:
...let me first tell you about two small non stock
investments that I made long ago. Though neither changed my net worth by much,
they are instructive.
This tale begins in Nebraska. From 1973 to 1981, the Midwest
experienced an explosion in farm prices, caused by a widespread belief that
runaway inflation was coming and fueled by the lending policies of small rural
banks. Then the bubble burst, bringing price declines of 50% or more that
devastated both leveraged farmers and their lenders. Five times as many Iowa
and Nebraska banks failed in that bubble’s aftermath as in our recent Great
Recession.
In 1986, I purchased a 400-acre farm, located 50 miles north
of Omaha, from the FDIC. It cost me $280,000, considerably less than what a
failed bank had lent against the farm a few years earlier. I knew nothing about
operating a farm. But I have a son who loves farming, and I learned from him
both how many bushels of corn and soybeans the farm would produce and what the
operating expenses would be. From these estimates, 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.
I needed no unusual knowledge or intelligence to conclude
that the investment had no downside and potentially had substantial upside.
There would, of course, be the occasional bad crop, and prices would sometimes
disappoint. But so what? There would be some unusually good years as well, and
I would never be under any pressure to sell the property. Now, 28 years later,
the farm has tripled its earnings and is worth five times or more what I paid.
I still know nothing about farming and recently made just my second visit to
the farm.
In 1993, I made another small investment. Larry Silverstein,
Salomon’s landlord when I was the company’s CEO, told me about a New York
retail property adjacent to New York University that the Resolution Trust Corp
(RTC) was selling. Again, a bubble had popped — this one involving commercial
real estate — and the RTC had been created to dispose of the assets of failed
savings institutions whose optimistic lending practices had fueled the folly.
Here, too, the analysis was simple. As had been the case
with the farm, the un-leveraged current yield from the property was about 10%.
But the property had been under managed by the RTC, and its income would
increase when several vacant stores were leased. Even more important, the
largest tenant — who occupied around 20% of the project’s space — was paying
rent of about $5 per foot, whereas other tenants averaged $70. The expiration
of this bargain lease in nine years was certain to provide a major boost to
earnings. The property’s location was also superb: NYU wasn't’t going anywhere.
I joined a small group — including Larry and my friend Fred
Rose — in purchasing the building. Fred was an experienced, high-grade real
estate investor who, with his family, would manage 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.
The moral of this story is that you don't necessarily have
to be an investment genius to reap from real estate investment. Secondly, real
estate investment has the tendency to out perform other forms of investment
with the passage of time.
References:
http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/
Wikipedia
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