Invest in properties like Warren Buffett (Part 2/2).

Posted on Thursday, March 20 2014

In the first part of this newsletter series, we shared with you some excerpts from Warren Buffett’s 2013 Letter to Shareholders. We ended by saying that we will share with you the key lessons you can take home when investing in real estate.

So, what lessons did we pick up from analyzing Buffett’s two investment properties?

Lesson # 1 – Keep it simple, silly (KISS).
For one, he bought these properties after the economic bubble popped. While fear paralyzed other investors, Buffett took advantage of this special situation and bought cash flow properties. Property investing is quite simple and Buffett chose not to overanalyze things. It is especially easy to get into the analysis paralysis mode when the sky is falling and fear dominates the investment climate. Buffett recognized the upside of buying income producing assets in the midst of a depressed market. He realized that the benefits would most definitely outweigh the very limited (and almost non-existent) downside. He was able to form this opinion because he looked at his investments from a long term perspective (as it should be). He did not try to time the market or predict when it would reach the bottom. He even admitted to his inability to do so and more importantly, his doubt on those who claim to have the crystal ball.

Lesson # 2 – Numbers are worth (more than) a thousand words.
The two deals that he purchased have a net yield (a.k.a. cap rate) of around 10% at the time of purchase with strong fundamentals for future earning growth. Buffett bought these two properties sight unseen and he hardly ever visited them. He looked at the numbers and was satisfied with the earning potential of these incoming producing properties (as opposed to buying solely for capital gain). In the past, he has even admitted that he preferred not to visit the businesses that he was acquiring because he was afraid that he would get too emotionally involved with the deal. He was worried that his emotions would cloud his judgment. Hence, he is a strong proponent of investing when the numbers make sense.

Lesson # 3 – Investing is a team sport.
In the past, and again in this letter, Buffett talked about the importance of knowing one’s area of competence and staying within that area. He termed it the “circle of competence”. He knows exactly what he knows and more importantly, what he does not. He does not pretend to know it all and is not shy to seek help from other investors whose circle of competence is outside of his own. For his purchase of the New York commercial property, he opted to form a syndication with a small group of investors who had more experience than he did when it came to property investing.

Lesson # 4 – Triple tax advantage.
Within six years of their purchase, the market improved and the group refinanced the equity out of their New York property deal. They used the proceeds to pay the shareholders 150% of their initial investment. On top of that, the 50% gain was absolutely tax free. In our opinion, this is one of the greatest advantages of investing in real estate as opposed to other asset classes. If you have a great investment, the last thing you would want to do is give it up and sell. With real estate you have the option of refinancing the equity and using the income from the property to service the new debt. The money that you get from refinancing is considered neither an income nor a capital gain and it cannot be taxed. Furthermore, the interest payment on this new loan is a tax deductible expense. Therefore, not only can you pull out your equity tax-free, your income tax from the property will also be reduced. Furthermore, the government allows you to deduct your rental income with a depreciation expense (a.k.a. “phantom cash flow”), which is a business expense charged on your tax return (even though you never actually forked out any cash to pay for this “expense”). Combine the tax free capital gain with the mortgage interest deduction and depreciation expense and you can see how property investing offers tax advantages like no other investment. Although tax benefits should not be the sole reason for your real estate investing, it is still nice to have this cherry-on-top, much like capital appreciation. Our emphasis is always on the “cash flow” or as Buffett likes to call it “earning potential”.

Lesson # 5 – Understanding the earning potential.
Lastly, these two properties of Warren Buffett illustrate what many seasoned property investors probably already know. However, it can also be applied to investing in other areas, such as stocks, bonds, or even in your businesses. Buffett, with his one-of-a kind financial intelligence and business acumen, is able to use the same investing principles to apply where it is most profitable, in buying businesses. For everyday investors, this means investing in the stock market. The stock market can be a very lucrative place to invest. However, one needs to have a very good understanding of complex accounting and be able to read financial statements of publicly listed companies. On top of this, an in-depth knowledge of financial principles and an analytical ability to calculate the intrinsic value of a company is a must. Anything less and you would be considered speculating (a fancy word for gambling) as opposed to investing. That is why at P4P we truly believe that property investing is one of the best asset classes for everyday investors. It’s simple and can be easily understood. The only math one needs to successfully invest in real estate is addition, subtraction, multiplication and division. The only accounting knowledge you need is to be able to subtract rental income from operating expenses.

So, these are the 5 valuable lessons we picked up from looking at Buffett’s property investments. When analyzing your next investment, remember to keep in mind these lessons. If you want to learn more about how you can invest in the US property market for cash flow, much like Warren Buffett did, then please book a time to speak with us. We will be able to show you what you need to know to invest successfully and profitably in the US.

To Your Financial Freedom,

Chayot & Jennifer Ing-aram

America property Investment for New Zealanders



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Expert's Bio

Chayot Ing-aram

Chayot is the co-founder of Property4Prosperity, Inc. He lives and breathes property investing. He received his BBS with Honours and Master in Finance from Massey University. He has been featured in one of New Zealand’s bestselling property investing books, interviewed in New Zealand Property Investor Magazine, and worked in the Committee for the local Property Investors' Association. He is currently residing in L.A., California, where Property4Prosperity, Inc.’s headquarter is located.

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