Most portfolio managers and asset allocators believe that property should always feature as part of any diversified portfolio. This mentality isn't limited to just Wall Street. Many extremely wealthy investors and people in business have an extensive portfolio of property alongside their other investments.
However, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and Warren Buffett (Trades, Portfolio) have never gone down this route. The Oracle of Omaha owns his own home and has held a holiday home and farm in the past. Apart from these assets, he's never disclosed any other substantial direct real estate holdings.
The same goes for Berkshire. While the company does own some real estate assets in its subsidiaries, which are required for the running of these businesses (such as offices and warehouses), there's never been any real substantial effort to acquire property as an investment. This is based on observations made in my work following Buffett and his investment history over the years.
Buffett and REITs
Having said all of the above, we do know that Buffett has owned real estate investment trusts, or REITs, in the past.
Several years ago, it became clear that the Oracle of Omaha had acquired around 8% Seritage (SRG, Financial) for his personal portfolio. Then, in 2017, filings showed Berkshire's subsidiary, National Indemnity, acquired 18,621,674 shares of STORE Capital Corp (STOR, Financial). This near 10% stake in the company cost less than $400 million, a small fraction of Berkshire's total cash pile.
But why has Buffett been mostly avoiding REITs all these years? We could argue that the Oracle of Omaha doesn't understand real estate and, therefore, he won't invest in the sector. After all, Buffett has never invested in anything he does not understand.
That is a good argument, but his right-hand man Charlie Munger (Trades, Portfolio) has been active in the real estate development business for decades. By all accounts, he's still developing properties today. That suggests he would know quite a bit about real estate and would be able to council Buffett on cheap real estate assets if needed.
Another reason why Buffett might have stayed away from these sorts of companies is tax. The billionaire once noted that REIT income is taxed differently to dividend income when the REIT units are owned in an insurance portfolio. As a result, buying REITs for Berkshire's portfolio would come with tax drawbacks.
This brings me to another point of dividends: REITs are primarily an income investment. Indeed, the whole REIT structure was designed to move income from the company to investors in the most efficient way. However, Buffett has never been an income investor. He'd rather a company retain capital to be reinvested at high rates of return, rather than paying it out to shareholders.
Low rates of return could be another possible reason why Buffett has stayed away from these businesses. The Oracle of Omaha is usually interested in companies that can compound investors' capital at a double-digit rate every year. Very few real estate assets can achieve this type of return. If they can, they're unlikely to be cheap enough for Buffett to buy.
A range of reasons
Overall, it seems as if there's a range of reasons why Buffett might stay away from REITs, but this is all my speculations based on obervation, and it does not mean every investor should follow in his footsteps.
As I mentioned above, many billionaires do own property, and that includes Munger. If it's an asset you understand and if it meets your investment goals, there's no reason why it should not feature in your portfolio.
Another thing to consider is that while Buffett does not own REITs directly, he does own REIT-like assets, such as BNSF. This firm owns enormous amounts of property, with REIT-like qualities, but it generates high rates of return and is more tax efficient.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Berkshire Hathaway Is Not an Index Fund, So Don't Expect It to Act Like One
- Klarman: Use a Range of Values to Reduce Uncertainty
- Charlie Munger: Always Be Ready for Change
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