Over the years, Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) has ventured in a lot of different businesses: textiles, insurance, banking, and recently even technology (Berkshire owns over 5% of Apple (AAPL, Financial)). But there are asset classes that Buffett and his partner Charlie Munger (Trades, Portfolio) have chosen to stay away from. In particular, they have never really invested in the real estate sector on a large scale (although they have done some small-scale real estate financing). At the 2002 Berkshire annual shareholder meeting, the duo explained why they made this decision.
Real estate is more accurately priced than other assets
Interestingly, Munger made a lot of his early money in real estate. Despite this, neither he nor Buffett have had a lot of interest in putting Berkshire’s money into property. Buffett explained this decision by saying that most developed real estate is accurately priced most of the time, which makes it difficult for a value investor like him to find underpriced bargainss. Of course, as we all know, after 2002, the U.S. housing market became historically overpriced, leading to the 2008 financial crash, which definitely validates his logic to a certain degree.
Buffett said that the reason for the dearth of underpriced real estate can be attributed to the high competitiveness of that industry. Although real estate is not a commodity, the methods available for valuing commercial real estate in big cities are shared across all the major real estate investment trusts, so it’s difficult to find good value property.
He added that real bargains only start to emerge in the property market when there is some chaotic breakdown in real estate financing. Big mispricings start to crop up when there is a lack of investors willing to commit capital to real estate, and these kinds of situations are relatively rare. Moreover, as Munger added, Berkshire doesn’t have any significant advantage in this sector:
“We don’t have any competitive advantage over experienced real estate investors in the field, and we wouldn’t have if we were operating with our own money as a partnership. And if you operate as a corporation such as ours, which is taxable under chapter C of the Internal Revenue Code, you’ve got a whole layer of corporate taxes between the real estate income and the use of the income by the people who own the real estate. So, by its nature, real estate tends to be a lousy investment for us”.
In other words, there are two reasons why Berkshire stays away from this sector. First, they have no real informational edge in what is already a crowded market. Second, it is inefficient from a tax perspective for them to invest in real estate. By contrast, REITs are exempt from a lot of taxes as long as they distribute 90% of the earnings to shareholders. So the combination of these two significant factors makes it easy to see why Buffett and Munger prefer to stick to their own circle of competence.
Disclosure: The author owns no stocks mentioned.
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