Berkshire Hathaway's letter to shareholders written by Warren Buffett came out in February and here are 7 lessons that apply to multifamily investors:
Berkshire has returned 20% vs. S&P 500 index of 10% since 1965. If you cannot achieve better returns then the index, why is anyone going to invest with you?
If you as a multifamily syndicator cannot generate better returns than the US treasury why am I going to invest in your deal? Or the stock market? Or a REIT? Why am I giving up liquidity to invest in your deal if I do not get a better after tax return that investing in an alternative?
You vs. the alternative
Mentoring/Multifamily investor Groups: LPs are getting deals from all the GPs in the group. How is your deal going to stand out? Your deal needs to be better than the alternatives (returns, safety)
Outside investor groups: all they see is your deal. Can you convince them to do multifamily? What education do you need to do before the deal.
Old Capital arranged $1B in Multifamily loans in 2018. Who do you want to trust with your next multifamily loan?
Berkshire does not give quarterly numbers, they never have a number to hit. They have seen it lead to bad behavior and fudging of numbers or forced companies to make bad decisions.
Sometimes when doing a value add multifamily property, you have to turn over the rent roll and take a dip in occupancy. If you had to keep occupancy at 95% you could never execute your business plan of upgrading units and raising rents.
Switching lender to lender to save a few basis points or to win one particular deal can come back to bite you. Build a relationship with a lender and they will help you on future deals, assumptions, supplementals, capex draws.
Berkshire has over $122B in float from its insurance business. 15 of the last 16 years the insurance business has received more in premiums than it has paid out due to rigorous underwriting. While many insurers give disciplined underwriting lip service, at Berkshire it is a religion.
How good are your GPs at underwriting the deal? Expenses to the penny and knowing the rental comps to understand the upside in the deal? Have to know the underwriting of a deal to make sure the investment is going to work.
At rare and unpredictable intervals, credit vanishes and debt becomes financially fatal. “A Russian roulette equation- usually win, occasionally die; this might make sense for someone who gets a piece of the company’s upside but does not share in its downside.”
How much cash does a GP have in a deal? Or is it all carried interest?
Structure your debt carefully. At this point in cycle might not make sense to take short term loans, but focus on longer term debt to avoid getting caught in a downturn during your loan maturity and potentially losing all of your investor equity.
1976 Berkshire purchased 50% of GEICO for $47MM. In 1995, Berkshire purchase the remaining 50% of GEICO for $2.3B (50x what they first paid). Since 1995, GEICO has generated profits of $15.5B. In addition, to generating float available for investment.
Many multifamily investors are stuck on price/unit 5 years ago. Properties that traded for $20k/unit are now trading for $80k/unit. You have to evaluate the deal based on the cash flow it is generating and make an investment based on the best information you have on the deal. Rents are up over 40% from the downturn so cash flow has increased significantly on these properties.
Tony Nicely ran GEICO from 1995 to 2018. Took Geico from 7th to 2nd largest insurance company and increased sales by 1,200%. Increased Berkshire’s value by $50B. Warren personally thanked Tony for his service.
When choosing investments, make sure you have the right jockey in the seat. Berkshire made the bet on GEICO because Tony was in the seat and it grew exponentially. As multifamily investors, make sure you know who will be running your investment for the next 3-5 years.
Even going one level down, the GP should know their property manager and leasing agent. They are the day to day interaction with the customer and are running your business. Make sure your staff is the best at what they do.
Choose the right lender. One that can get the loan closed, but can also help you win deals and meet investors.
Example of $1MM investment in S&P 500 in 1942, when Warren first started investing until today it would be $5.3B based on an 11.8% annual return. If you paid an investment manager or 1% so you received an annual return of 10.8%, the total would be cut in half at $2.65B.
Is the GP taking a acquisition fee, disposition fee, lending fee, loan guarantee fee, asset management fee? How aligned is the GP with the LP in terms of % of profits. How much risk is in the deal for the LP of this going to zero?
At GE, my chief risk officer use to say “Don’t take equity risk for debt returns”. In essence, it meant you are putting up a majority of the money and if this deal goes perfect you get none of the upside, but if it doesn’t go right you get holding the bag.
Analyze the deal see how much is coming from cash flow vs. residual sale. How much of the profit goes to GP vs. the LP. Are they having to take on bridge debt to make the deal work or is this a FNMA or Freddie loan?
Warren Buffett is known as one of the best investment managers in the world and he has grown Berkshire into a portfolio of profitable companies. We should all hope to create a portfolio for ourselves as profitable and large as Warren, but we can learn from him the lessons he has learned at 88 years young.
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