Four Real Estate Investment Tips That You Can Learn from Warren Buffet, and Other Stock Investors

Some of the most successful stock investors ever have based their investing principles on value investing. Investors such as Benjamin Graham, Irving Kahn, and Warren Buffet, have used value investing to build vast empires of wealth. Wanna know how they did it? We got some real estate investment tips for you!

Value investing was conceived by Benjamin Graham, and David Dodd, in their classic book, “Security Analysis”, written in 1934. Although they were talking about stocks, there is still a lot to be learned from value investing that can be applied to other investment vehicles. This article will show four real estate investment tips that real-estate investors can learn from value investing.

Real Estate Investment Tips to Learn from Value Investing

1. Investing vs Speculating

In value investing, it’s important to make the distinction between being an investor and being a speculator. In “Security Analysis”, it is defined as this:

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative”.

So, there are 3 things needed for something to be an investment:

• You need to have done thorough analysis.
• You need to be reasonably sure that you won’t lose your money.
• You need to be reasonably sure that you will make some money.

In terms of real-estate, this means that just buying and selling real-estate, does NOT make you an investor. If you’re buying properties at random, just because there is a boom and all property is going up in value, you are not investing. You are speculating.

There is nothing wrong with speculating, you just need to be aware when you are speculating, versus when you are investing.

2. Value vs Quality

The second of the four real estate investment tips we have for you is the concept of “value vs quality”.

Value Investing doesn’t really have any formulas or rules. It is more of a theory, with some general principles. Because of this, there are many ways to do value investing, and different ways to apply it.

Benjamin Graham focused on buying stocks significantly below value, with little emphasis in the quality of the stock, in regard to their long term prospects.

This can be a useful strategy for real estate investors, particularly when they are first starting out, and need to build up equity fast.

Warren Buffet still looks at the value of a stock but puts a lot more emphasis on the quality of the stock. He only buys stocks that he thinks have good long-term prospects, with a bright future in front of them.

This is generally a good strategy for real estate investors to move to later on, when they have built up their portfolio. The long-term, well-chosen property will make significantly more capital growth than poorly chosen property and may be worth buying even if it can only be bought at market value. 

And with commercial real estate investment, it may be worth getting a lower rental yield, if this means you can have a high-quality tenant, who will pay the rent reliably. This is a strategy that famous New Zealand commercial real estate investor Bob Jones has applied, with great success.

3. Margin Of Safety

One of the most important principals in value investing is margin of safety.

The Margin of Safety is the idea of making sure that you only invest if your calculations show that there is a significant profit to be made. There is no way your analysis can be 100% accurate, so the margin of safety gives you a buffer, to use when your calculations are slightly off, or you get worse than average luck, or any number of unexpected problems occur. 

So when estimating the value of a stock, you use conservative estimates for earnings, etc, to come up with the value. If your estimated value comes in at $10, then you don’t buy the stock if it’s currently selling for $9.75, because it’s too risky, and if your calculations are off, you won’t are buying a bargain. If the price is currently $6 though, you might buy it, because you have a $4 margin of safety to use if you estimated incorrectly.

The same principal applies to real-estate.

Suppose you are looking at a deal, and you find you can buy some land for $100,000 and you can build a 4-bedroom house on it for $150,000.

If new 4-bedroom houses in the area are selling for $270,000 then should you do the deal? Theoretically, it will only cost you $250,000 to buy/build with a sale at $270,000 so you should make a $20,000 profit. 

But that isn’t much margin of safety. What if building costs blow out, and it cost more than $150,000 to build? What if you can’t sell it straight away so you have some holding costs? What if the other 4-bedroom houses in the area have much better kitchens than you realized, and you can actually only sell for $245,000?

There are a lot of unknowns here, and because your margin of safety is so small, unless everything goes right, you can quickly find yourself making a loss.

If on the other hand, 4-bedroom houses in the area are selling for $350,000 then you have a projected profit of $100,000.

You can afford for a lot of things to go wrong, and you can still make a profit. 

In the first case, if building costs go up by $50,000, the deal will cost you $30,000.

In the second case, because you have a much larger margin of safety, if building costs go up by $50,000 then you will still make a profit of $50,000.

Margin of Safety is a very important concept to all investors, and all real estate investors should think about it if they want to be around for the long term.

4.  The myth of Risk vs reward

The last of the 4 real estate investment tips is the myth about risk and reward.

Conventional wisdom says that to increase your reward in investing, you must increase your risk. This is often true, but the Margin of Safety principal can turn this around.

When margin of safety is used, a higher reward actually means a lower risk!

You can see this in the example above. The deal that is projected to make $20,000 is quite risky, whereas the deal with a projected profit of $100,000 is much safer because a lot more can go wrong before a loss is made.

This doesn’t mean that high reward always means lower risk though. The conventional Risk vs Reward wisdom is still correct in general. So, if you borrow more to buy a property, your risk and reward have increased. If you buy in a small town to get a higher rental yield, your risk and reward have increased.

This Risk vs Reward theory is only incorrect when directly applied to the Margin of Safety concept. So, if you buy something for $100,000 that all your analysis shows are worth $200,000, then your reward has gone up, while your risk has gone down.

Conclusion

There you have the 4 real estate investment tips we can learn from the most successful stock investors based on their investing principles on value investing. Apply these real estate investment tips and who knows, you might be the next billionaire!