The post on Warren Buffett made it into the Carnival of Real Estate over at 7DS Associates.
What’s Going On at Baja Fresh in Walnut Creek
Here are some pictures from today of what used to be the building attached to Baja Fresh and Kentucy Fried Chicken in Walnut Creek, California.
The owner of the property, Hall Equities Group, is redeveloping the property at the corner of S. California and Olympic Boulevard. By demolishing the old Warehouse Video store and golf shop, the developer is making room for two new office and retail buildings on the site.
The development is designed with pedestrian access in mind. As well, LCA Architects wanted to expose as much of the property to traffic on Olympic Boulevard as possible.
The property borders Alma Park. Alma Park is Walnut Creek’s “hidden park” located between Olympic Boulevard and Botelho Avenue. It is bounded on three sides by the Ivy Hills Apartments, Regent on the Park Condominiums, and Montecito Condominiums.
Part of the plan is to broaden the entrance to Alma Park in Walnut Creek. Hall Equities owns the property adjacent to Alma Park at 1855 Olympic Boulevard. In a land swap, Hall Equities traded a portion of the 1855 Olympic property for a small portion of Alma Park to make room for the new buildings. The redesigned entrance to Alma Park will enhance views into the park.
The City of Walnut Creek website has information relating to the project including architectural renderings, landscape drawings, and views from Alma Park.
During the redevelopment process Baja Fresh is planning to remain open.
Is a Property Manager Right for Your Investment?
Property managers are very important to passive investment property owners, to out of town property owners, and property owners with multiple real estate investments.
Passive owners, as opposed to active owners, generally don’t want to deal with the three “T”s of real estate investment ownership; toilets, tenants, and trash. Passive real estate owners are not the “hands on” investor. They allow others to manage the day to day activities while there investment produces income for them.
What do property managers do?
A property manager, manages property. They provide oversight and administration so that a property meets the investment objectives of the owner.
A good manager will find and screen tenants, maintain an investment property, collect rents, evict non-paying tenants, and pay bills related to the real estate under management. They perform almost all of the tasks that an owner would normally handle.
How are property managers paid?
Most property managers receive a percentage of the gross income from a rental property. This can range from 2% to 10% of gross operating income depending on the standards for a geographic area. In some cases a property management company may charge a flat fee for individual rental homes.
How does a property manager help a real estate investor?
Daily Management Issues
Property managers can add value to owners that are unable or unwilling to handle the day-to-day activities of a property personally.
Thanks to the Second Law of Thermodynamics we know that things break down. Pipes and water heaters break, toilets and drains clog, and roofs can leak. A property management company takes these calls rather than the landlord. This leaves the landlord free to pursue other interests and invest in other projects.
Local Management
An owner with real estate in a another city or state will find it valuable to have a local management company collect the rents, screen tenants, and perform routine property maintenance. A real estate manager can help establish competitive lease rates from their local market knowledge.
Efficiency
Investment property owners with multiple properties may benefit from the efficiency a real estate manager can offer. An investor could continue working a 9-5 job while still reaping the benefits of owning multiple real estate investments, without having to deal with management responsibilities.
Legal Knowledge
The legalities of being a landlord vary from city to city. Rent control and tenant rights, if mishandled, can open a property owner to risk of a lawsuit. A knowledgeable property manger will keep a property in compliance with local, state, and federal laws.
Caveat Emptor: Buyer Beware!
Not all property managers are equal.
Unfortunately, property managers are tempted by greed like the rest of us. Some real estate managers may have unscrupulous arrangements with outside contractors that charge property owners above market rates for repairs, then pay a kickback to the real estate manager for using their service. Investors should “trust their gut” and go with managers that they feel are honest and trustworthy.
An investor should make sure that a property management company adequately maintains properties. Checking a few of their properties to see how well they maintain properties is a good idea.
When selecting a property management company ask for references or client testimonials.
The Institute of Real Estate Management (IREM) is a source for education, resources, and membership for real estate management professionals. IREM allows owners to search for IREM members.
(Photo: Front_Corner_Perspective_Landscape by Chad Jones)
Advice for Future Retirees From Current Retirees
The New York Times’ Bucks Blog is relating the details of a Merrill Lynch Affluent Insight survey that asked What Retirees Would Have Done Differently.
Topping both advice categories, for people between 10 and 15 years from retirement and those more than 15 years away, was “build a plan around what is most important to you in retirement.”
The Bank of America press release states:
Retirees who wished they had focused more on their “life goals” indicated that they would have spent more time determining how they wanted to live in their retirement years (38%) and based their retirement income needs not just on a number that would sustain them but on one that would help them live their ideal lifestyle during these years (13%).
Retirement Lifestyle
This survey serves as a reminder that retirement freedom requires planning and foresight.
Some retirees fail to imagine what their ideal retirement entails and are disappointed when they reach retirement. Simply “not working” does not a good retirement make.
Thinking about what you want in a retirement lifestyle allows you to plan accordingly. It also allows you to plan for the economic means (money) to accomplish the ideal retirement lifestyle.
Using Warren Buffett’s Principles to Invest in Real Estate
Did you ever notice that Warren Buffett seems to make very few bad investments?
On September 23, 2008 Mr. Buffett’s company, Berkshire Hathaway, invested $5 billion in Goldman Sachs preferred stock. Goldman offered a 10% annual return on the investment in preferred shares, $500 million per year. In addition, Berkshire Hathaway was given the option to buy $5 billion in common stock at a price of $115 per share. One year later the investment would have returned almost $3.1 billion to Berkshire Hathaway not including the annual, perpetual return on the preferred shares. (As of January 8, 2010 the investment would be worth $2.58 billion at $174.31 per share.) This is a return of 40%-60% in one year!
View Your Investment as Ownership of a Business
Warren Buffett writes in his 2008 letter to Berkshire Hathaway owners:
We like buying underpriced securities, but we like buying fairly-priced operating businesses even more.
In his 2007 letter to investors Buffett writes:
Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.
A real estate investor must realize that they are buying a business when they buy rental property. Businesses must market and sell a product to customers that are ready, willing, and able to buy in order to make a profit.
As a real estate investor your product is space and your customers are your tenants. For the apartment or multi-family owner their product is living space. The retail real estate owner offers storefronts to other businesses. The office building owner offers other businesses office space.
A successful real estate investor will market the space to their customers or tenants. An investor must offer it for a reasonable price or the tenants will not be interested. Investors must decide which tenant is most likely to rent the space and advertise where that tenant will see their advertisement. Maintaining a property that is appealing to potential tenants is part of the business of real estate.
A stock investor must analyze the competitive strength of the business they are buying. Will it be protected from outside competition? Does it have adequate cash flow? What is the demand for their products? What event may damage their business? How likely is that to occur?
Real estate investors should ask the same questions about their real estate investment. Is this property above or below the competition? Are new developments coming on line? If so, how will that affect my investment property? What economic factors contribute to the health of the local economy? Do people want to live near my investment? Who are the major employers?
Invest Based Upon Value Not Price
Warren Buffett learned much of his investment philosophy from Benjamin Graham, author of The Intelligent Investor. Benjamin Graham stressed value investing. In Mr. Buffett’s most recent letter to Berkshire Hathaway investors and this quote was on page 5:
Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.
Two things stand out from this quote. First, value is more important than price. If you invest in a piece of junk with no lasting value, it doesn’t matter what price you pay for it. Inversely, what price would you pay for the Hope Diamond or the Mona Lisa?
Mr. Buffett describes intrinsic value in the Berkshire Hathaway owner’s manual on page 5 as “the discounted value of the cash that can be taken out of a business during its remaining life.” Mr. Buffett goes on to say that intrinsic value may very from one investor to the next and even varies between himself and Charlie Munger, his business partner.
In real estate, investment properties provide cash flow through rent and offer the owner the ability to sell at a future date. Once the value of these cash flows has been determined (through discounted cash flow analysis), an investor can determine a price at which the value is worth an investment.
Second, price declines are advantageous to investors with cash to acquire new real estate. Price declines make valuable real estate more affordable.
Distressed markets do not function efficiently. Usually, this means that there is a shortage of willing and able buyers. Sellers are forced to compete on price for the few available buyers. Prices continue to drop until a willing and able buyer is interested to buy. This shortage of buyers leads to fear and further limits the entry into the market for new buyers.
Distressed markets also have a shortened time-frame. Sellers need to sell quickly or raise capital quickly. This provides unique buying opportunities for the savvy investor with cash available to scoop up discounted properties quickly.
If Possible, Use Other People’s Money
One of Berkshire Hathaway’s first purchases was National Indemnity, a property-casualty insurance company. Insurance continues to be one of Berkshire Hathaway’s major income sources. In Berkshire Hathaway’s 2004 investor letter Buffett writes this:
The source of our insurance funds is “float,” which is money that doesn’t belong to us but that we temporarily hold. Most of our float arises because (1) premiums are paid upfront though the service we provide – insurance protection – is delivered over a period that usually covers a year and; (2) loss events that occur today do not always result in our immediately paying claims, because it sometimes takes many years for losses to be reported (asbestos losses would be an example), negotiated and settled. The $20 million of float that came with our 1967 purchase has now increased – both by way of internal growth and acquisitions – to $46.1 billion. [emphasis added]
In real estate using other people’s money is typically accomplished through the use of a loan. A real estate investor invests a portion of the funds necessary to invest and a lender lends money to the investor for the balance of the purchase price.
Investors often call this leverage. Using a small amount of capital, the investor’s equity, to buy a larger asset. The “lever” is the loaned money. This concept allows an investor to earn a return not just on their capital, but also on the money they have borrowed.
The concept of leverage only works if the borrowed money is less expensive than the return generated by the asset. It is hard to make a profit borrowing money at 12% and investing it for a 10% return.
Pick Management Wisely
One of the the things Mr. Buffett has done extremely well is buy operating businesses. He selects businesses that have excellent management in place. Warren Buffett realizes the value of a quality management team and the benefits it offers to ownership.
In the 2004 Berkshire Hathaway letter to investors Buffett shares his instructions to his business managers:
“Run your business as if it were the only asset your family will own over the next hundred years. Almost invariably they do just that and, after taking care of the needs of their business, send excess cash to Omaha for me to deploy.”
Real estate investors should choose their property management companies wisely as well. A good manager will keep a property well-maintained and full of quality, paying tenants. A poor manager may cost an owner less, but may allow properties to become run down or allow unfit tenants to lease your property.
Feel Free to Say “No” to Opportunities You Don’t Understand
Mr. Buffett is not afraid to pass on investments that he doesn’t understand, even though he may “miss out” on some great investments. Mr. Buffet has repeatedly admitted that he doesn’t understand technology companies, and doesn’t regularly invest in them. This saved his company from incurring some huge losses during the Technology Bubble in the stock market.
Real estate investors should avoid investments that they don’t understand. If an opportunity sounds “too good to be true”, it probably is.
Apply a “Margin of Safety”
A margin of safety limits the risk of an investment. Benjamin Graham, Warren Buffett’s mentor, dedicated an entire chapter in his book, The Intelligent Investor, to the concept of a “Margin of Safety”. Graham writes:
In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too will pass.” Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.
Simply put, a margin of safety is room for error. If you think a stock is worth $12, pay $10 instead of $11.50 to guard against a miscalculation of value. Unless you are God, eventually calculations on future events are going to be wrong. A margin of safety helps to preserve your investment when your calculations are incorrect.
As real estate investors, we make many of our determinations based on assumptions about income to be received in the future. Applying a margin of safety allows us to invest with room for error should our assumptions be wrong. Recessions, plant closures, and natural disasters all affect real estate, but cannot be predicted. A margin of safety provides a buffer against these unforeseendisasters.
Conclusion
Real estate investors can benefit from the principles of stock investors like Warren Buffett. Viewing investments as a business, investing based upon value, prudently using leverage, picking management wisely, avoiding confusing investments, and applying a margin of safety will help real estate investors to invest with confidence in any type of markets.
Bay Area Real Estate Prices Going Up?
The Contra Costa Times, Contra Costa County’s major newspaper, is reporting today that Higher Bay Area home sales, prices offer hope. It is important to notice the first paragraph of the article.
The Bay Area real estate market continued to show improvement in November due to fewer sales of bargain-priced foreclosed homes and more sales of higher-priced properties.
According to a report released Thursday by MDA DataQuick of San Diego, the median price paid for a home in November was $387,000, an 0.8 percent decrease from October, but up 10.6 percent from November 2008. Last month’s median price was the second consecutive month that saw home prices rise on a year-to-year basis since two years ago. The median is the point at which half of the homes sell for more and half sell for less. [emphasis mine]
The author, Eve Mitchell, astutely notices the reason the median home price, the price at which half of the sales were above and half of the sales were below, rose is due to more high-priced homes selling.
This doesn’t mean housing prices are actually rising, though they could be. It does mean a greater number of homes above the median price have sold in November than in November of 2008.
The article goes on to say,
In Contra Costa County, the median sales price for a home was $290,000 in November, a 9.4 percent gain from a year ago.
“We are really starting to see the high-end loosen up. Obviously, the borrowers have to be well qualified, but we are starting to see more financing.” said Robin Dickson, executive vice president of J. Rockcliff Realtors, an East Bay brokerage.
Another reason that median prices are up from a year ago is that there are fewer short sales and bank-owned foreclosure in the marketplace now, she said.
Still, she would not be surprised to see more foreclosures come into the market next year.
“We know they are out there but the banks are hanging on to them for now,” Dickson said
Foreclosure Crisis Not Over
Mish in Tip of the Iceberg With Luxury Short Sales; Fannie, Citi Suspend Foreclosures for Holiday Season, links to a Bloomberg article that states,
Homeowners with mortgages of more than $1 million are defaulting at almost twice the U.S. rate and some are turning to so-called short sales to unload properties as stock-market losses and pay cuts squeeze wealthy borrowers.
If this trend of luxury home defaults continues, expect to see more luxury real estate return to the market as bank-owned REOs. This could continue to lower the median home price.
Bloomberg also reports ‘Shadow Inventory’ of U.S. Homes Climbs, Report Says. (HT: Calculated Risk)
The number of homes that may be in the pipeline for a sale because of foreclosure and delinquency climbed about 55 percent to 1.7 million at the end of September, according to estimates by First American CoreLogic.
Rising Interest Rates Leads to Lower Prices
According to the Chicago Sun-Times, Freddie Mac is reporting the 30-year mortgage rate is up to 4.94% from 4.81% last month. Lower interest rates allow buyers to afford more house, because their monthly payment is lower. If the interest rate continues to rise, home values may stay flat or fall as borrowers will find it difficult to qualify for higher priced homes.
Conclusion: Prices Not Likely to Rise
While news of a greater number of higher-priced homes selling is positive, it does not indicate that the value of homes is actually rising. As well, with a looming “shadow inventory” and the specter of higher interest rates in the future home prices are not likely to rise in the near future.
(Photo Credit: Modern Northwest House by pnwra)
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