What Warren Buffet Can Teach You about Rental Properties?

You probably already know the name Warren Buffett, right? Referred to as the Oracle of Omaha, Buffett has turned his investing wisdom into a multibillion dollar business. Buffet’s outstanding success as an investor is based in large part on his approach to investing; he is always on the lookout for the best return. As one of the world’s wealthiest investors, when Warren speaks, people listen.

What did Warren Say?

Buy now! Or more to the point, on a recent interview conducted by CNBC, Buffett made the case that investing in rental properties is one of the best opportunities out there. Specifically he spoke about the tremendous opportunities available for buying distressed single family homes.

He went on to explain why he was focusing on buying distressed single family homes and then renting them out. First, in some cases, the property values have fallen 50% or more. Sometimes the property value has dropped even below the replacement value. Then, if you can purchase this distressed property with a low interest rate, you have built in leverage.

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Buffett’s explanation also made the case that he wasn’t talking about the flippers. No, under his scenario, he envisioned buying distressed single family homes and renting them out for five years. By then, property values will have increased. Even if the property value never reaches the levels of the 2008 real estate crash, you still come out ahead because you bought in for such a small amount of money.

In the interview, Buffett highlighted a few more enticing tidbits for potential rental property investors. For one, rent is already rising. You have probably seen stories in the mainstream media discussing the rise of rental rates. Without even thinking about the economics, you can tell this is a good sign. There is demand for rental properties, and the demand is so far ahead of the supply that landlords are happily raising the rent.

Another bit of evidence from Buffett on rental properties is the reality of today’s workforce. Because of the economy, downsizing, etc. more and more people can’t qualify yet for a mortgage to buy their own home. Obviously, the less people able to qualify for a mortgage the more demand there will be for rental properties.

Another shift increasing demand for rental properties is a shift in the viewpoint. Some people have gotten fed up with the ups and downs and the constant maintenance needs of owning a home and would prefer the ease of simply writing a rent check every month.

Another point to consider is that owning rental properties can be an excellent inflation hedge. The policies of the Federal Reserve Board and Congress notwithstanding, many financial pundits are concerned about future inflation. Owing your own rental real estate gives you a built in inflation hedge.

Finally, consider Buffett’s point about leverage. Right now interest rates are still low. On the other hand, property values are beginning to rise. This means that the available leverage is decreasing. Remember you will get the maximum leverage when the interest rate is the lowest and the property value is the lowest. Any increase in interest rates or property values decreases the amount of leverage available.

The Other Side of the Coin

Buffett did offer some caveats to potential rental real estate investors during his interview. For one thing, he made the point that the type of real estate investing he is talking about is more suited to the “handy” type of investor. He was referring to the need to get involved, the type of person who has no problems with rolling up his sleeves and taking a hands-on approach to managing his investment. In other words, Buffett was making the point that rental property investing is not like those promises on late night TV. Don’t deceive yourself into believing this is some sort of “set it and forget it” type of investment. Unlike buying a stock or a mutual fund, owning a rental property requires a lot more time and attention, even if you hire a professional management company to take care of most of the work for you.

Over time, those who are able to purchase in a down market with low interest rates will come out ahead. This is classic Warren Buffett investment advice applied to the rental real estate market.

So what about you…are you about ready to take the plunge into owning a rental property?

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  • JT /

    Early in his “hedge fund” partnership, a friend asked why he wasn’t buying real estate. He replied, “Why should I buy real estate when the stock market is so easy?”

    Of course, things change over time. Given the spread between cap rates and interest rates, there probably won’t be a better time to buy than there is now. In markets where real estate sells for less than the cost of replacement, I think it’s a no-brainer. Supply is constrained until new constructions sell for more than the cost to build, so the economics are in the favor of the investor.

    Buffett would likely be more than impressed with the cash on cash returns you’re getting on your rentals, no doubt!

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