Berkshire Hathaway 2002 Annual Meeting Audience Question # 36

Real estate is accurately priced most of the time

Warren Buffett:

Number 2.

Audience Member:

I’m Bob Kline, from Los Angeles.

I wonder if you could give us a glimpse into your investment process, the way you approach looking at a particular industry. And I wonder if you could use real estate as an example.

I know real estate hasn’t been a big, huge part of Berkshire’s portfolio over the years. And I wonder if that’s because you view real estate as a commodity business or if, maybe, the cash flows from real estate tend to be more predictable than, perhaps, from some other industries, and thus, it tends to be less likely to be mispriced, and therefore less likely to find terrific bargains in real estate. So…

Warren Buffett:

Yeah, you’re… go ahead.

Audience Member:

So, just wondering if we could… if we were watching a discussion between you and Charlie hashing out the merits of real estate, how it would go.

Warren Buffett:

Well, it would go like all our other conversations. He would say no for about 15 minutes… and I would gauge by the degree to which he… the emotion he put into his ’no’s as to whether he really liked the deal or not. But the…

We’ve both had a fair amount of experience in real estate, and Charlie made his early money in real estate. The second point is the more important point.

Real estate is not a commodity, but I think it tends to be more accurately priced… particularly developed real estate… more accurately priced most of the time.

Now, during the RTC period, when you had huge amounts of transactions and you had an owner that didn’t want to be an owner in a very big way, and they didn’t know what the hell they owned, and all of that sort of thing, I mean, you had a lot of mispricing then.

And I know a few people in this room that made a lot of money off of that.

But under most conditions, it’s hard to find real estate that’s really mispriced.

I mean, when I look at the transactions that REITs engage in currently… and you get a lot of information on that sort of thing… you know, they’re very similar. But it’s a competitive world and, you know, they all know about what a class A office building in, you know, in Chicago or wherever it may be, is going to produce.

So at least they have… they may all be wrong, as it turns out, because of some unusual events, but it’s hard to argue with the current conventional wisdom, most of the time, in the real estate world.

But occasionally there have been some, you know, there could be big opportunities in the field. But if they exist, it will certainly be because there’s a… there’ll probably be a lot of chaos in real estate financing for one reason or another.

We’ve done some real estate financing and you have to have the money shut off to quite a degree, probably, to get any big mispricing across the board.

Charlie?

Charlie Munger:

Yeah, we don’t have any competitive advantage over experienced real estate investors in the field, and we wouldn’t have if were operating with our own money as a partnership.

And if you operate as a corporation such as ours, which is taxable under Chapter C of the Internal Revenue Code, you’ve got a whole layer of corporate taxes between the real estate income and the use of the income by the people who own the real estate.

So, by its nature, real estate tends to be a very lousy investment for people who are taxed under Subchapter C of the code relating to corporations.

So, the combination of having it generally allows the activity for people with our tax structure, and having no special competence in the field means that we spend almost no time thinking about anything in real estate.

And then such real estate as we’ve actually done, like holding surplus real estate and trying to sell it off, I’d say we have a poor record at.

Warren Buffett:

Yeah, C corps really, it doesn’t make any sense. I mean, I know there are C corps around that are in real estate, but there are other structures that are more attractive.

There really aren’t other structures… I mean, Lloyd’s is an attempt at it, to some degree… but there aren’t other structures that work well for big insurance companies, or…

I mean, you can’t have a Walmart very well that does not exist in a C corp. So, they are not subject to S corp, or partnership competition, that determines the returns on capital in the discount store field.

But if you’re competing with S… the equivalent of S corps… REITs or partnerships or individuals, you’ve just got an economic disadvantage as a C corp, which is, for those of you who don’t love reading the Internal Revenue Code, is just the standard vanilla corporation that you think of… all of the Dow Jones companies, all of the S&P companies, and so on.

And as Charlie says, it’s unlikely that the disadvantage of our structure, combined with the competitive nature of people with better structures buying those kinds of assets, will ever lead to anything really interesting.

Although, I would say that we missed the boat, to some extent, during the RTC days. I mean, it was a sufficiently inefficient market at that time, and there was a lack of financing that— we could have made a lot of money if we were… had been geared up for it at that time.

We actually had a few transactions that were pretty interesting, but not… but nothing that was significant in relation to our total capital.

Charlie Munger:

We thought significantly about buying the Irvine Corporation…

Warren Buffett:

Yeah.

Charlie Munger:

… when it became available. So, but that’s the only big one I can remember that we seriously thought about.

Warren Buffett:

Yeah, and that was in 1977 or so, as I remember?

Charlie Munger:

Way back.

Warren Buffett:

Yeah, Mobil Oil was interested, and you know, Don Bren ended up putting together a group for it.

And that kind of thing could conceivably happen, but it’s unlikely.

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