When you do a Google search on “the greatest investor”, Warren Buffett’s name will come out as the top. When it comes to investing, he is no doubt one of the greatest investors of all time. Over the years, he built an $80 billion of personal fortune, all through his investments! His listed company, Berkshire Hathaway, has grown from a share price of $290 in 1980 to more than $300,000 per share today. That is more than 100,000% returns!
Every year, in the Berkshire Hathaway’s annual report, Warren Buffett will write the very famous letter — “Letter to the Berkshire’s Shareholders”, in which he will share his investment philosophy and strategies. Over the years, many books have been published based on the contents. Good news is Warren Buffet has been sharing his investment methodology over the years, which allow retail investor like us to “copy” and learn his strategies.
First and foremost, who is Warren Buffett?
Warren Buffett was born in 1930 in Omaha. Since young, he has been showing the talent on investing and running a business. From selling over-priced Coke to the tourists to building a small pinball machine business, he had done it successfully. At the age of 9, he made his first stock investment!
In Waren Buffett’s investment journey, Benjamin Graham, his most important mentor, has a huge influence on his investment decisions. The latter taught him about value investing, one of the most used investment strategy, which eventually forms one of the core components of his investment methodology.
By understanding Warren Buffett’s investment style, you can attempt to invest like him. In this post, we’ll give you the highlights of how you can invest in REITs using the Warren Buffett way.
What is Warren Buffett’s investment philosophy?
Most people think that Warren Buffett is a value investor. He invests in companies or businesses with a price tag less than their fair value or net asset value per share. For example, if the net asset value per share of a company is $1 per share, Warren Buffett will only consider investing if the share price is less than $1. This concept is very similar to property investing. If the valuation price is $1m, you would only buy if the price tag is $1m or lower. This would make sure you always invest when the price is “cheap”, and in some sense, it helps to mitigate your downside risk.
Some people also regard Warren Buffett as a growth investor, where he looks for companies with growing earnings and strong earnings prospects. One of his classic investment was Coca-cola in the 80s. The company share price was overvalued at that point of time, but Warren Buffett thought that Coca-cola had built a brand that is non-replaceable, which allows the company to grow its earnings in the long run.
Most of the people do not seem to aware that Warren Buffett is also a dividend investor. 90% of the stocks in his portfolio pay an average dividends fo 2 to 3%. Besides, most of his shares are dividend growth stocks, which distribute higher and higher dividends years after years. Take Coca-cola, for example, and the company has been increasing its dividends for more than 55 years! Warren Buffett will then use the received dividends to reinvest in the company.
How does Buffett approach investments?
We believe that Warren Buffett is a value investor, a growth investor and also a dividend investor! And his investment methodology can be applied to REITs investing.
To find good companies, you need to evaluate the companies thoroughly and understand their business and market. As mentioned previously, Warren Buffett evaluates companies on three different aspects:
First, Warren Buffett looks for companies with growth catalysts to increase its future profits. He will specifically look at a few factors:
A company which has maintained consistent performances with high-profit margins with low or minimal debt is likely to increase its future earnings
He searches for investment moats. A company with moats tends to be more sustainable in the long run. For examples, Coca-cola has built a brand that almost non-replaceable; Google captures a market share and creates an ecosystem with a high entry barrier.
Another thing he looks at is the company’s management, which we will discuss later.
Lastly, he waits for the right entry price for good companies.
Once he finds a growth company, he will calculate the fair value of the company. He wants to buy shares at a price significantly less than that value (the property investing scenario). As inspired by Benjamin Graham, a “margin of safety”, the difference of the actual value and trading value of the company is required to justify the risk of owning the company. He will wait for falling prices due to irrational market movement, which creates opportunities to invest at low prices.
Lastly, he repeats the steps above and continues to reinvest in companies with strong earnings potential at bargain prices.
We can apply the same methodology to REITs investing.
First, look for REITs with growing net property income (earnings equivalent) or distribution per units. Evaluate the REITs future earnings potential through acquisitions or asset enhancement strategies. Then, wait for reasonable pricing to buy the shares. And finally, continue to reinvest dividends in good REITs.
Want to learn how I generate double-digit yield through REIT investing?
How does Warren Buffet evaluate the management of a company
Warren Buffett prefers a manager with the mindset of a business owner. He wants them to protect the interest of the shareholders, not themselves. He always looks for the indication of managerial qualities.
The very first he looks at is the company’s accounting. A good manager should produce consistent results over the years. For example, Frasers Centrepoint Trust (J69U), the REIT manager managed to increase the distribution per unit (DPU) and net asset values per share (NAV/share) over the years through acquiring yield accretive properties. Such a track record showed that the REIT manager had been consistently extracting values for the shareholders.
While growth is good, Warren Buffett always looks for managers who are down to earth. He believes that high growth is not sustainable in the long run and extraordinary growth in the short term is dangerous as well. For example, MacarthurCookIndustrial REIT increased its portfolio size by 75% in one year after its IPO in 2007. While the DPU grew by 18% the year after, the REIT immediately went into trouble during the 2008/2009 Global Financial Crisis. During the crisis, both the net asset values and DPU were compressed. To maintain the regulated gearing ratio and to pay off the interest expenses, the REIT needed to raise fund urgently. The REIT manager proposed private placement with a discount of 73.8% against its NAV/share! While the shareholders were not pleased with the proposal, it was approved eventually. The share price dropped by more than 60% in one day! The DPU in the subsequent year dropped by more than 50%! This is one example that the REIT manager was too ambitious to obtain growth and did not act in the interest of the shareholders when a problem occurred.
REITs managers typical get paid in
% of the DPU performance
% of property acquisition
A REIT which is rapidly expanding may not be a good sign. This will not just increase the portfolio risk, but also increase expenses as hefty performance fees to be paid to the managers.
When it comes to REITs investing, we need to always remind ourselves, that consistent and stability are the key to succeed! A good REIT manager requires the qualities of a good marathon runner. Speed is not essential; consistency is the key!
A Case Study Using Mapletree Industrial Trust
Mapletree Industrial Trust (SGX: ME8U) was listed in the year 2010. After three years of operation, the performance was excellent, with a 30% increase in both share price and DPU. The REIT manager showed good qualities of prudent management, which also aligned the interest with the shareholders.
From the business standpoint, the REIT was in a good position in 2013. With the slowdown in the global economy, lots of companies moved their offices from the expensive central prime location to a cheaper option of industrial units, operated by REITs like Mapletree Industrial Trust. This created a strong demand for industrial, which boosted the REIT’s property income. Besides, with the support from the government, the rapid growth of the fintech industry and data centres created a new segment for the REIT to grow its income.
With proper management, growing industry and strong fundamentals, the last thing that Warren Buffett would look at is the good entry point. From the historical trading pattern, the lowest price-to-book ratio was 1.1. In 2014, the share price was trading at 1.1 price-to-book again, which indicated an excellent investment opportunity. If you had bought the share during that year, you would have enjoyed more than 100% return after holding the shares for five years! If you employed our portfolio re-balancing and leverage strategy, your returns would have exceeded 300%!
Warren Buffett’s investment philosophy isn’t particularly complicated. While we can’t invest like Warren Buffett exactly, but we can definitely use some of its methodologies to pick profitable REITs.