19 July 2019

Buffett’s property deals & fund bet: What lessons do they hold?

In his annual letter to the shareholders of his flagship firm Berkshire Hathaway Inc., excerpts of which were carried by Forbes magazine, billionaire US investor Warren Buffett spoke of two property investments he made over two decades ago. The Hong Kong Economic Journal’s Investor Diary column takes a look at what investors can learn from them.

The first deal was in 1986, when Buffett purchased a 400-acre farm located 50 miles north of Omaha in Nebraska from the Federal Deposit Insurance Corp. for US$280,000. The investment, which was made after the farmland bubble in the US Midwest had burst, was expected to yield annual return of 10 percent. But as things turned out, the farm tripled its earnings and is now worth five times the initial investment.

Buffett admits that he knew nothing about farming. But, there was plenty of historical data as to how much a land plot can yield, as well as statistics on prices of major produce like corn and soybean. It’s the proper value assessment based on these and a distress-pricing that combined to make that deal a winner.

The second one was in 1993, when Buffett bought a New York retail property from the Resolution Trust Corp., after a bubble had popped.

Instead of focusing on the price swings of commercial properties, Buffett cared more about the room for improvement in the way the property was managed and the potential long-term upside from rentals.

As new leases replaced old ones, the deal now rewards its shareholders with an annual return in excess of 35 percent of the original equity investment.

The message from the two deals for investors is that in any transaction, the most important criteria is the value that can be attached based on the quantum of likely future cash flows. Investors should only buy when the investment can potentially meet the returns target.

But following Buffett’s way is easier said than done. Acknowledging the limitations of an average investor, who may not be as good with numbers, or may not be able to buy into a panicky market to take advantage of super-cheap deals, Buffett offers an alternative as the column points out.

The billionaire has been in a bet with asset management firm Protégé Partners since 2008 on performance of their investment funds.

Buffett put his money into a simple index fund — the Vanguard 500 Index Fund Admiral — to “race” with Protégé’s five hedge funds.

In the six years since then, Buffett’s pick is leading with a cumulative return of 43.8 percent, as opposed to Protégé’s 12.5 percent.

Through the bet, Buffett is demonstrating how investors can make decent profit by using low-cost index funds to invest in a diversified portfolio of industries and gain from long-term development of the overall economy and growth of representative companies.

Buffett’s holding company Berkshire Hathaway has generated 990 percent returns in 20 years without paying any dividends, surpassing the 443 percent return of the S&P500 Index. Over the same period, the total return of Hong Kong’s benchmark Hang Seng Index (HSI) was just 264 percent.

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