What Warren Buffett Can Teach You About Real Estate
“The investor of today does not profit from yesterday’s growth.” – Warren Buffett
Warren Buffett didn’t make the bulk of his money by being a great investor. That was just the first part of his success. If that had been the extent of it, he might have a paltry $100 million or so today . . . instead of the more than $44 billion Forbes says he has.
The second part of his success — the part that turned his success into phenomenal success — was that he leveraged his expertise. He attracted a modest pool of investors at first . . . then a growing pool as he proved he was good at his business. Then, he went a step further and bought some insurance companies.
That meant he now controlled billions of dollars of other people’s money, in the form of insurance premiums. He used this money to buy even more companies — always being a sharp evaluator of businesses first and a sharp financier second.
You have probably done something similar at least once in your life — without thinking of it in just this way.
When you buy a house, what are you doing but seeking investors? You think you’ve found a reasonable value and so you go to the bank and say, “Lend me $100,000 on this property.” To prove it’s a good deal, you make your proposal. You say, “I’m putting $25,000 of my own money into it. Your loan is fully collateralized by the property. I’ll pay you 6% a year for the money, plus all the closing fees and a thousand or so up front for your paperwork.”
The bank says, “OK, let us check it out. We’ll send someone over to look at the property and do some research on it. If the value checks out, fine. Then we’ll need to check out your income and your history of making payments. If that checks out too, we’re in business.”
So the appraiser appraises your house. They run a credit check on you. And, Bingo!, you own a $125,000 property . . . pulling only $25,000 out of your pocket.
The bank has become your investor. They’ve forked over $100,000 on a deal you brought to them.
Pretty much the same thing happens when you go to a bank for a loan on a piece of investment real estate. The key difference is that in addition to checking out your income, they also check out the income the property produces in the form of rents. So even if you’re not making enough on your own to support a loan on the property, you can get a loan to buy it if it produces the kind of income that shows it should largely pay for itself.
Now extend this a little further. Instead of borrowing $100,000 on a $125,000 property — or 80% of the value — you borrow the whole thing. This time, the seller of the property lends you the down payment (this is called a “purchase money mortgage”) and a bank or other lender lends you the $100,000. Now you’ve got two investors — the seller and the bank — and you control a $125,000 property with no money out of your pocket.
If you’re a good investor first and foremost, that property will still more than pay for itself — including allowances for vacancies and maintenance. But as it goes up in value, who gets all the appreciation? The investors?
No. You.
If the property doubles in value in about 10 years, the $125,000 combined loan might have been paid down to about $100,000 in that time (depending on the exact terms). So now you’ve got a $250,000 property with $100,000 in loans on it. Your equity — or the cash you’d put in your pocket if you sold it at that point — would be $150,000. You made $150,000 in 10 years . . . and your original cash investment was zero (though you may have invested a few days’ work).
Bob F. does precisely this. He has a half-dozen investors who will buy into just about any project he puts together. Why? He’s a proven entity. He knows his business. Has a history of making money in real estate. He’ll secure a large parcel of land, buy it with investors’ money, and then subdivide it. He takes a piece for himself, and the rest goes to his investors.
They know exactly what he’s getting out of the deal, and they’re thrilled because he makes them good money. As for Bob, once he finds a deal, he basically puts a quick $100,000 or so in his pocket.
I recently bought three properties in a six-week period, each with 100% financing. Each pays for itself — all the financing plus taxes, insurance, etc. And there is still reserve to cover maintenance and vacancies. I basically spent a few days putting the deals together. I don’t exaggerate when I say that I bought those properties under market value and could sell them today for a combined profit of at least $100,000 after just a few months. But I’ll hold and manage them. I may develop one of them into a larger project . . . because I expect these three alone will be worth more than $500,000 (net) to me in the next 10 years. Possibly more.
At times, I’ll put my own money into a deal . . . 10%, 20%, or 25% of the value . . . and finance the rest. Other times, I’ll use 100% financing. And I now have quite a few lenders and investors who are eager to invest in my deals.
When you first learn how to invest well . . . and then learn how to finance well . . . there is no limit to the success you can achieve in real estate. (Ed. Note: Justin Ford is the editor of Main Street Millionaire, ETR’s real-estate investment success program.)