{"id":47890,"date":"2014-02-26T20:10:10","date_gmt":"2014-02-27T01:10:10","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=47890"},"modified":"2014-02-26T20:10:10","modified_gmt":"2014-02-27T01:10:10","slug":"outside-box-buffetts-annual-letter-can-learn-real-estate-investments","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2014\/02\/26\/outside-box-buffetts-annual-letter-can-learn-real-estate-investments\/","title":{"rendered":"Outside the Box: Buffett\u2019s annual letter: What you can learn from my real estate investments"},"content":{"rendered":"

By John Mauldin<\/span><\/h4>\n
\"\"It does not hurt to be reminded once in a while about what it means to be a \u201ctrue investor,\u201d and who better to remind us than Warren Buffett? Today\u2019s Outside the Box<\/em> comes to us from the pages of Fortune<\/em> magazine (hat tip to my good friend Tom Romero of Capital Research Partners, who is a pretty fair investor in his own right).<\/p>\n

Fortune<\/em> seems to have had the inside scoop on Mr. Buffett\u2019s pronouncements over the years. I still keep some old Fortune<\/em> magazines with interviews of Mr. Buffett to remind myself about the basics. For whatever reason I was up at 5 o\u2019clock this morning and began reading this piece, and it functioned just as well as coffee as a wake-up call.<\/p>\n

Warren starts off by telling us the stories of two relatively minor real estate investments he made, one in the \u201980s and the other in the \u201990s, but where he\u2019s going is straight to the heart of some fundamental investing principles.<\/p>\n

Most of us get all wrapped up, from time to time, in the daily or weekly movements of our investments; but Warren wants us to remember that \u201cGames are won by players who focus on the playing field \u2013 not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.\u201d<\/p>\n

Easier said than done; but he\u2019s right, of course. Now, it\u2019s certainly OK dwell at length on the macroeconomic big picture, right? I mean, that\u2019s half my fun most days! No,<\/em> says Warren,<\/p>\n

Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: \u201cYou don’t know how easy this game is until you get into that broadcasting booth.\u201d)<\/p>\n

So Warren wants our feet planted squarely on the field of play; he doesn\u2019t want us up in the stands or, heaven forbid, watching the game on TV. And forget reading some commentator\u2019s analysis of yesterday\u2019s game or his take on the rest of the season!<\/p>\n

Well, OK. So if this is the last Outside the Box<\/em> or Thoughts from the Frontline<\/em> you ever read, at least I got you this far, right?<\/p>\n

But read on, and be sure not to miss Warren\u2019s very pithy (and timely!) quotation from the late Barton Biggs.<\/p>\n

And let me point out that when Warren suggests a future portfolio of 90% S&P index funds, he is talking about very, very long-term portfolio design and not something that retirees who need income or have a shorter-term focus (less than multiple decades) should be thinking about.<\/p>\n

And to be fair, Buffet\u2019s process of choosing which investments to put into his portfolio would not allow him to end up with very many components of the S&P 500. So I don\u2019t share his bias against active management, though I have to agree that most of what passes for active management is problematic. But there is a lot we need to remember and ponder in Buffett\u2019s Benjamin Graham old-style value investing.<\/p>\n

I have never met the man, but I would like to. I think we might have more in common than some readers would imagine. Including hamburgers.<\/p>\n

Today I\u2019m flying to Los Angeles, where I will speak tonight and tomorrow for my partners at Altegris Investments. I am particularly looking forward to spending time with Jack Rivkin. I always learn a lot. Then I get on a plane to fly all the way across the country to Miami. I will be speaking for my close friend Darrell Cain at his annual conference as well as spending time with Pat Cox, who is going to come over from the West Coast of Florida. I hope to get a good part of this weekend\u2019s letter done on the flight.<\/p>\n

Then it\u2019s on to Washington DC for a series of meetings. George Gilder is flying down from Boston and has offered to introduce me to a few of his friends, and I will do the same for him. We will hopefully be sitting down for a video in which we\u2019ll discuss some mutually interesting ideas, as well as share a dinner or two where we\u2019ll talk about a variety of policies with a few people who are perhaps in positions to do something about them.<\/p>\n

Packing for a week in a variety of different climates is always an interesting process. And keeping up with my reading and writing and gym time and, most importantly, friend time will make for a very busy next seven days. You make sure you enjoy yourself. Now let\u2019s see what Warren has to tell us about investing.<\/p>\n

Your thinking a lot about portfolio strategy lately analyst,<\/p>\n

John Mauldin, Editor
\nOutside the Box<\/em>subscribers@mauldineconomics.com<\/a><\/p>\n

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Buffett\u2019s annual letter: What you can learn from my real estate investments<\/strong><\/h2>\n

This story<\/a> is from the March 17, 2014 issue of Fortune<\/em>.<\/p>\n

February 24, 2014: 5:00 AM ET<\/p>\n

In an exclusive excerpt from his upcoming shareholder letter, Warren Buffett looks back at a pair of real estate purchases and the lessons they offer for equity investors.<\/em><\/p>\n

By Warren Buffett<\/p>\n

\u201cInvestment is most intelligent when it is most businesslike.\u201d
\n\u2013Benjamin Graham, The Intelligent Investor<\/em><\/p>\n

It is fitting to have a Ben Graham quote open this essay because I owe so much of what I know about investing to him. I will talk more about Ben a bit later, and I will even sooner talk about common stocks. But let me first tell you about two small non-stock investments that I made long ago. Though neither changed my net worth by much, they are instructive.<\/p>\n

This tale begins in Nebraska. From 1973 to 1981, the Midwest experienced an explosion in farm prices, caused by a widespread belief that runaway inflation was coming and fueled by the lending policies of small rural banks. Then the bubble burst, bringing price declines of 50% or more that devastated both leveraged farmers and their lenders. Five times as many Iowa and Nebraska banks failed in that bubble\u2019s aftermath as in our recent Great Recession.<\/p>\n

In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.<\/p>\n

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.<\/p>\n

In 1993, I made another small investment. Larry Silverstein, Salomon\u2019s landlord when I was the company\u2019s CEO, told me about a New York retail property adjacent to New York University that the Resolution Trust Corp. was selling. Again, a bubble had popped \u2013 this one involving commercial real estate \u2013 and the RTC had been created to dispose of the assets of failed savings institutions whose optimistic lending practices had fueled the folly.<\/p>\n

Here, too, the analysis was simple. As had been the case with the farm, the unleveraged current yield from the property was about 10%. But the property had been undermanaged by the RTC, and its income would increase when several vacant stores were leased. Even more important, the largest tenant \u2013 who occupied around 20% of the project\u2019s space \u2013 was paying rent of about $5 per foot, whereas other tenants averaged $70. The expiration of this bargain lease in nine years was certain to provide a major boost to earnings. The property\u2019s location was also superb: NYU wasn\u2019t going anywhere.<\/p>\n

I joined a small group \u2013 including Larry and my friend Fred Rose \u2013 in purchasing the building. Fred was an experienced, high-grade real estate investor who, with his family, would manage the property. And manage it they did. As old leases expired, earnings tripled. Annual distributions now exceed 35% of our initial equity investment. Moreover, our original mortgage was refinanced in 1996 and again in 1999, moves that allowed several special distributions totaling more than 150% of what we had invested. I\u2019ve yet to view the property.<\/p>\n

Income from both the farm and the NYU real estate will probably increase in decades to come. Though the gains won\u2019t be dramatic, the two investments will be solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.<\/p>\n

I tell these tales to illustrate certain fundamentals of investing:<\/p>\n

\u2022You don\u2019t need to be an expert in order to achieve satisfactory investment returns. But if you aren\u2019t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don\u2019t swing for the fences. When promised quick profits, respond with a quick \u201cno.\u201d<\/p>\n

\u2022Focus on the future productivity of the asset you are considering. If you don\u2019t feel comfortable making a rough estimate of the asset\u2019s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn\u2019t necessary; you only need to understand the actions you undertake.<\/p>\n

\u2022If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.<\/p>\n

\u2022With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field \u2013 not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.<\/p>\n

\u2022Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle\u2019s scathing comment: \u201cYou don\u2019t know how easy this game is until you get into that broadcasting booth.\u201d)<\/p>\n

My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following \u2013 1987 and 1994 \u2013 was of no importance to me in determining the success of those investments. I can\u2019t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.<\/p>\n

There is one major difference between my two small investments and an investment in stocks. Stocks provide you minute-to-minute valuations for your holdings, whereas I have yet to see a quotation for either my farm or the New York real estate.<\/p>\n

It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings \u2013 and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his \u2013 and those prices varied widely over short periods of time depending on his mental state \u2013 how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.<\/p>\n

Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits \u2013 and, worse yet, important to consider acting upon their comments.<\/p>\n

Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of \u201cDon\u2019t just sit there \u2013 do something.\u201d For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.<\/p>\n

A \u201cflash crash\u201d or some other extreme market fluctuation can\u2019t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment. Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.<\/p>\n

During the extraordinary financial panic that occurred late in 2008, I never gave a thought to selling my farm or New York real estate, even though a severe recession was clearly brewing. And if I had owned 100% of a solid business with good long-term prospects, it would have been foolish for me to even consider dumping it. So why would I have sold my stocks that were small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group they were certain to do well. Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?<\/p>\n

When Charlie Munger and I buy stocks \u2013 which we think of as small portions of businesses \u2013 our analysis is very similar to that which we use in buying entire businesses. We first have to decide whether we can sensibly estimate an earnings range for five years out or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings \u2013 which is usually the case \u2013 we simply move on to other prospects. In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decision.<\/p>\n

It\u2019s vital, however, that we recognize the perimeter of our \u201ccircle of competence\u201d and stay well inside of it. Even then, we will make some mistakes, both with stocks and businesses. But they will not be the disasters that occur, for example, when a long-rising market induces purchases that are based on anticipated price behavior and a desire to be where the action is.<\/p>\n

Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.<\/p>\n

I have good news for these nonprofessionals: The typical investor doesn\u2019t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th century, the Dow Jones industrial index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st century will witness further gains, almost certain to be substantial. The goal of the nonprofessional should not be to pick winners \u2013 neither he nor his \u201chelpers\u201d can do that \u2013 but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.<\/p>\n

That\u2019s the \u201cwhat\u201d of investing for the nonprofessional. The \u201cwhen\u201d is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs\u2019s observation: \u201cA bull market is like sex. It feels best just before it ends.\u201d) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs. Following those rules, the \u201cknow-nothing\u201d investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.<\/p>\n

If \u201cinvestors\u201d frenetically bought and sold farmland to one another, neither the yields nor the prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.<\/p>\n

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.<\/p>\n

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I\u2019ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife\u2019s benefit. (I have to use cash for individual bequests, because all of my Berkshire Hathaway (BRKA) shares will be fully distributed to certain philanthropic organizations over the 10 years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard\u2019s. (VFINX)) I believe the trust\u2019s long-term results from this policy will be superior to those attained by most investors \u2013 whether pension funds, institutions, or individuals \u2013 who employ high-fee managers.<\/p>\n

And now back to Ben Graham. I learned most of the thoughts in this investment discussion from Ben\u2019s book The Intelligent Investor,<\/em> which I bought in 1949. My financial life changed with that purchase.<\/p>\n

Before reading Ben\u2019s book, I had wandered around the investing landscape, devouring everything written on the subject. Much of what I read fascinated me: I tried my hand at charting and at using market indicia to predict stock movements. I sat in brokerage offices watching the tape roll by, and I listened to commentators. All of this was fun, but I couldn\u2019t shake the feeling that I wasn\u2019t getting anywhere.<\/p>\n

In contrast, Ben\u2019s ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. These points guide my investing decisions today.<\/p>\n

A couple of interesting sidelights about the book: Later editions included a postscript describing an unnamed investment that was a bonanza for Ben. Ben made the purchase in 1948 when he was writing the first edition and \u2013 brace yourself \u2013 the mystery company was Geico. If Ben had not recognized the special qualities of Geico when it was still in its infancy, my future and Berkshire\u2019s would have been far different.<\/p>\n

The 1949 edition of the book also recommended a railroad stock that was then selling for $17 and earning about $10 per share. (One of the reasons I admired Ben was that he had the guts to use current examples, leaving himself open to sneers if he stumbled.) In part, that low valuation resulted from an accounting rule of the time that required the railroad to exclude from its reported earnings the substantial retained earnings of affiliates.<\/p>\n

The recommended stock was Northern Pacific, and its most important affiliate was Chicago, Burlington & Quincy. These railroads are now important parts of BNSF (Burlington Northern Santa Fe), which is today fully owned by Berkshire. When I read the book, Northern Pacific had a market value of about $40 million. Now its successor (having added a great many properties, to be sure) earns that amount every four days.<\/p>\n

I can\u2019t remember what I paid for that first copy of The Intelligent Investor.<\/em> Whatever the cost, it would underscore the truth of Ben\u2019s adage: Price is what you pay; value is what you get. Of all the investments I ever made, buying Ben\u2019s book was the best (except for my purchase of two marriage licenses).<\/p>\n

Warren Buffett is the CEO of Berkshire Hathaway. This essay is an edited excerpt from his annual letter to shareholders.<\/p>\n

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The article Outside the Box: Buffett\u2019s annual letter: What you can learn from my real estate investments<\/a> was originally published at mauldineconomics.com<\/a>.<\/div>\n
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By John Mauldin It does not hurt to be reminded once in a while about what it means to be a \u201ctrue investor,\u201d and who better to remind us than Warren Buffett? Today\u2019s Outside the Box comes to us from the pages of Fortune magazine (hat tip to my good friend Tom Romero of Capital … <\/p>\n

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