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Is Real Estate a Gruesome Business?
Warren Buffett defines a “gruesome business” as one that requires a lot of capital and produces a low rate of return. Is real estate gruesome? Let’s see:
- Does it “require significant capital to engender … growth” (WB, 2007; PB p. 14)?
Yes. The median home price in America is about $220,000. The average rent is about $800/mo. So a home costs almost 23 years in rent. That’s a lot just to get started.
A previous article talked about how potentially $1,700/mo can be spent just on maintaining a $250,000 property. As a percent of rents, that’s definitely a lot.
And once your house is full, you can’t get much more revenue except by buying another house.
- Is your house more like a candy bar or a cup of sugar?
Warren writes (1982; PB p. 15), “[Differentiation] works with candy bars (customers buy by brand name, not by asking for a ‘two-ounce candy bar’) but doesn’t work with sugar (how often do you hear, ‘I’ll have a cup of coffee with cream and C & H sugar please’).
Every house has a little bit of “candy bar” to it, since it’s so rare that any two apartments look and feel the same. But every house also has a little bit of “sugar” about it when customers are looking for “off street parking, laundry, two bedrooms.” I think most apartments are more sugar than candy bar.
- Do you feel real pressure to be “the lost-cost producer” (2000; PB p. 15)?
How many of us landlords have reputations for being big spenders? That’s right, none.
All this doesn’t mean you can’t make money in real estate, but it does mean you need to be very careful. Here are some tips:
- Watch that purchase price. Don’t pay too much for a rental property.
- Work hard to differentiate. Make your ad glossy and your apartment smell good.
- Keep costs down. Shop for insurance every year, refinance if you still haven’t, and spend money on projects that will save money over time, like good rain water management, durable surfaces, and upgraded plumbing.
The Warren Buffett quotes in this article come from his “A Few Lessons for Investors and Managers,” edited by Peter Bevelin.