Buffett and Commercial Real Estate


I’ve seen a number of references recently to an article in Forbes where Warren Buffet make comments on a couple of commercial real estate properties he has owned for years.   I copied the story below –
Read it with a couple of things in mind :
While Buffett is not a CRE investor per se, think about 1. the companies he owns and the properties they own – within their cash flow models they have massive portfolios   2. The time frame he describes.  3. The stability he references.
Here you go .
…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. 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 unleveraged 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 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. I’ve yet to view the property.
Income from both the farm and the NYU real estate will probably increase in decades to come. Though the gains won’t be dramatic, the two investments will be solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.
I tell these tales to illustrate certain fundamentals of investing:
  • You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”
  • Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.
  • If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.
  • With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.
  • Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)
My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following — 1987 and 1994 — was of no importance to me in determining the success of those investments. I can’t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.
There is one major difference between my two small investments and an investment in stocks. Stocks provide you minute-to-minute valuations for your holdings, whereas I have yet to see a quotation for either my farm or the New York real estate.
It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings — and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his — and those prices varied widely over short periods of time depending on his mental state — how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.
Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits — and, worse yet, important to consider acting upon their comments.
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.
A “flash crash” or some other extreme market fluctuation can’t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment. Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.
During the extraordinary financial panic that occurred late in 2008, I never gave a thought to selling my farm or New York real estate, even though a severe recession was clearly brewing. And if I had owned 100% of a solid business with good long-term prospects, it would have been foolish for me to even consider dumping it. So why would I have sold my stocks that were small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group they were certain to do well. Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?

Better than an MRI ? Bonds?

Wednesday morning October 31st I attended a breakfast put on by Riverview Savings.

You might expect that something on the morning of All Hallows Eve might be a bit frightening, but on this particular morning what we heard was actually more reassuring.

Bill  Ehling Vice president at Federated Investment management flew in to consult with  Riverview Asset Management wealth managers Tuesday at dinner, and still had plenty to share at breakfast.  Ehling is the Fixed Income market strategist at Federated.  He  has been a long term trader in the bond market, and his thesis;  even more than equities, if you pay very close attention  and analyze the data bond markets  can give you very clear insights into the true financial health of a country and it’s economy.

His first pronouncement – which took me by surprise – of the 200 Trillion dollars that makes up the worlds wealth, seventy five (75) per cent is in bonds.  Nations and corporations have used this as a source of financing for centuries .  These markets are huge, they have long histories, and he talked about having researched data back to the founding of the United States.

While the US situation hasn’t been great, it is better than any other countries.

We’ve been growing at about two per cent, which doesn’t increase employment at any significant pace.  If you look at Europe and Japan they’ve been stagnant or have continued to experience job losses.

He referenced the study by Rogoff and Reinhardt the two Harvard economists.  This is the same study that was mentioned in my post Breakfast on West Coast time.  It  is a study of banking crises back several hundred years.  When these  are Systemic as this one was (is) and we will have on going deleveraging for many years, and have a  very slow slog to regain ground.  So there is still work to do.

Another factor that adds drag , we have  a much more diverse global economy. We’re battling “competitors” that even thirty years ago had minimal impact on theUS.  This along with a changing demographic that has many countries experiencing the aging of their populations will provide even more friction to slow our progress down.

However his reading of the markets is slow sluggish growth, not a downturn.

4th Quarter Drive

I’ve mentioned before that Bill Connerly the Oregon economist who is highly regarded has consistently said he sees reasons for optimism in the latter part of 2011, even with the slow down we have expreienced.   Here is a post on his September  Businomics Blog  .   Notice he says that commercial lending has been improving, and actually surged  in July. 

So while you may want to prepare a little defense  if things hold or trend down a bit more, but  don’t take your eye off the possibility of a better quarter coming up.   Solidifying your growth and improved market share are likely if your prepared.

Remember this as well…  2012 is an election year, both the  President and a whole slew of Democratic senate seats are on the line.  They will pull every lever they can to generate activity.

Fabulous Fed Friday – August 26

As we wait for the Chairman to speak, let’s review another key indicator of our economic condition. 

The recently released Consumer Price Index rose a disturbing 0.5% in July, exceeding forecasts.  Such prices are up 3.6% during the past 12 months, exceeding the 2.3% rise in average hourly earnings for all employees on private nonfarm payrolls.

To no ones surprise…higher energy costs led the way, with overall energy costs rising 19.0% during the past 12 months.  Expectations that sluggish domestic and global economic growth could lead energy prices even lower than what has developed in recent weeks helps sooth some of the inflation anxiety in financial markets.

Food costs rose an estimated 4.2% during the past year,   which most of our restauratuers would say is understated.   The weak U.S. dollar hasn’t exactly helped either.

The “core” measure of consumer inflation (which excludes volatile food and energy costs) rose 1.8% during the past 12 months.  This measure is within the Fed’s perceived long-term “core” target range of 1.5% -2.0% annually.  At the same time, the 1.8% core rise is three times what is was as recently as last October.

Most forecasters, including the Fed, expect consumer inflation pressures to moderate in coming months as economic growth most everywhere seems to be slowing.  Should inflation pressures not moderate, any new stimulus from the Fed would be limited.

We’ve discussed before the unpredictable nature of inflationary pressures.  They may seem to ebb and flow, like the tide at the coast, and it may not always appear to impact you, but they steadily erode your purchasing power.