Invest in Real Estate Like Warren Buffet
Updated: Jul 2, 2019
Investing in real estate counts among-st the most cherished personal decision for most people. The pride of owning a home and the financial security it accords makes it a top financial choice. Besides, the relatively high investment returns in real estate means it has been the escalator to wealth for a large majority.
However, the process of a property purchase can be complex and at times overwhelming. Given the large capital commitment that a property demands, it’s imperative that buyers have the right framework for making what is often the most important financial decision of their life. While everyone has their own investing preferences, a reliable approach for ensuring success would be to learn from the principles of investing masters and apply them in making crucial decisions.
Here, we have listed some of the tenets of wisdom from investing legend, Mr. Warren Buffet. This invaluable knowledge when applied thoughtfully can serve as a dependable structure for making intelligent real estate decisions.
1. “Our favorite holding period is forever”
The key practice common to most investment success stories is the credo of long term holding period. This is because the mathematics of generating long term wealth is based on the power of compounding. And this can be achieved best only when we carefully choose a quality asset and let time do its work. A longer holding period is particularly important with cyclical assets like real estate since it allows for asset values to recover from any short-term downturns.
This can also be observed from the fact that for most average people in India, their best investment story is their primary residence. That’s because people do not look to make a quick buck through their home. For the sense of stability and emotional connect that a home carries, people hold on to it for years thus benefiting from the power of compounding.
We fully subscribe to this view and strongly recommend against short term speculation in real estate. Whether your purchase is an end use home or a commercial property meant purely as an investment, we firmly advise to have a holding period of at least 5 years. As the benefits of recent structural changes (RERA, GST, Demonetization) kick in and with the fundamentals of Indian economy looking strong, real estate being a cyclical asset will surely reward the patience of the long-term investor!
2. “Rule No. 1: Don’t lose money. Rule No. 2: Never forget rule No. 1.”
One perception about investment success is that high risks yield high returns. While a certain willingness to assume risk is needed, it is essential to have a stoic focus to guard against losses. In the philosophy of value investing as propounded by Warren Buffet, the key to long term investment success lies in minimizing risk and avoiding instances of permanent loss of capital.
A short calculation can bring forth the importance of this principle. Let’s assume an investor suffers a 30% loss on an investment of Rs 1 Cr. This would leave him with Rs 70 lakhs. Now, to only recover and get even with his initial capital, you would need to earn a return of 43% on the remaining 70 lakhs! On the other hand, two successive years of 10% returns will swell your portfolio to Rs 1.21 crore!
This prophecy has particular relevance in real estate since it involves a large upfront investment. Given the importance and financial weight of real estate for an average Indian family, any instance of a property gone wrong can-do irreparable damage your portfolio and long-term well-being. The key to real estate success thus lies in careful developer selection. It is essential that you buy a property only after doing a diligent research on the developer and title records and make sure you never get stuck with an unscrupulous developer where your capital gets stuck indefinitely.
3. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
A popular notion about value investing is to buy assets at a ‘deep discount to value’. This is sometimes interpreted to mean buying assets which are trading cheaply. However, this may not necessarily be the correct understanding of the principle of value.
Put Straight, Cheap ≠ Value. The ability to spot value is a complex art. There are many reasons why an asset would trade cheaply and often it is poor fundamentals. So blindly chasing things which are cheap can be a costly investment mistake!
Warren Buffet professes that it is much better to prioritize quality over price. This is because a quality asset’s earnings and hence value will increase overtime and even if it is bought at a relatively higher price, its strong fundamentals will ensure that we eventually get a good return on our investment. Hence, on balance focusing on quality is a much better option for the average investor.
We for one, couldn’t agree more with this in context of real estate in India. A common ploy used by some developers in the price sensitive Indian market is to lure customers into buying their properties by quoting a lower price. In principle, the practice to seek bargains is definitely a good idea. However, key here is to understand that a low price often means poor quality of construction, questionable title records, deficient maintenance and unsatisfactory post-sales service. Moreover, the ‘low price’ tactic is frequently used by the crafty and financially weak developers to create rush sales in projects which may never see the light of day.
Noting the financial importance of real estate, we very strongly recommend property buyers to do solid on-ground research and stick to only quality developers- those with a track record of timely delivery and reputation for quality. Doing this will not only ensure a satisfactory usage experience and higher investment returns but also prevent the cardinal sin of ‘permanent loss of capital’ which may happen on account of delayed or perhaps non-delivery of property!
4. “A public opinion poll is no substitute for thought”
To earn superior returns in business or in investments, one needs to act on a well-informed independent view. To base decisions on the widely held public opinion or the consensus of media experts is the recipe for poor results.
It’s not difficult to see why this would be the case. If an idea, a key insight or strategy is widely known and accepted, it would mostly be baked in the price of assets, thereby removing the chance of earning excess returns. And given asset markets tendency to overshoot and undershoot, following the herd could also mean that one would get in at exactly the wrong time!
This observation is as true for real estate as it is for stock investing. We believe that the route to success in Indian real estate lies in doing on-ground research. Since professional research on real estate in India is not well developed, there is little if any substitute for hitting the roads. It is also not prudent to rely on online forums. Most of the views stated on these forums are either gamed or mostly ill-informed personal opinion of individuals which may be biased and have little relevance to reality. Besides property being a tangible asset is best understood by assessing the location, design, construction quality et cetera- things which are best understood by actual physical inspection.
In case of doubt, a buyer would be well served to take advise from a small group of trusted relatives/friends who understand the local market or engage an ethical & knowledgeable consultant rather than relying on the vicissitudes of a public opinion poll!
5. “Risk comes from not knowing what you are doing.”
According to Warren Buffet, key to successful investments is to be an expert on what you invest in and clearly understand the reason for your investment. He recommends that when making investments, it is sensible to limit yourself to situations where you are knowledgeable and confident.
If you do not understand why you are investing and are not fully informed about your choice of investment, you would never be sure on the right price for the asset, the right time to buy or perhaps the right time to sell. In such situations you would likely be swayed by the opinions of others and end up making bad decisions.
In context of real estate, a buyer must first clearly understand why they are making the investment. Is it for end use or for investment? How long do you plan to hold it? What returns do you expect to receive? How do you plan to finance it? And most importantly what would be the impact of the down-payment and EMIs on your finances and if it can be managed comfortably?
Once there is clarity on above, a buyer should then evaluate if they have the time, network and knowledge to make an informed decision. In real estate, a buyer should generally limit themselves to a market that they understand as thoroughly as a local. A buyer is best served by choosing a city and location that they have either stayed in or visited frequently. It is essential that you physically inspect the property and the surrounding areas rather than relying on marketing content of developers or opinions of online forum participants.
Investors should also be well aware of the reputation and track record of developers and the correct transaction price on recent deals. Finally, you should do a thorough research on the prospects of infrastructure-commercial development in the area and gather accurate information on current and expected rentals of the property.
In case you feel you are unable to execute the above due diligence steps alone, it would be wise to engage a trusted advisor who can provide you with reliable research and handhold you through execution. Important point is that you should invest only when you have done requisite work and can intelligently answer the above questions.
Making a property purchase is a critical decision which can be difficult and exhausting. Here, we have tried to simplify things by listing the winning principles of value investing which have stood the test of time. Given the large financial commitment that real estate involves, it is essential to execute it thoughtfully and what better than taking guidance from the greatest investor ever!