Warren Buffett Doesn't Buy Real Estate

Investing Strategies Retirement Investing
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I am an evil landlord but I also invest in stocks. Both? Diversification is good.

Bought a house in 2017 for 133K. According to Zillow it’s now worth $244K. I think it’s insane how fast real estate is rising. I actually wish it wasn’t so I could buy another inexpensive house. I also have a house I bought 15 years ago for $87K worth $190K. Then again I made 22% in the stock market last year so…both?

My fear is my kids won’t be able to afford houses. Crazy prices.

Both houses are rented at about $300 below current market rates but the tenants are zero hassle and I’m more than breaking even so I just figure I’ll cash in when I sell.

I spend about 12 hours a year managing two SFH rentals. I owe about $65K on one and the other is paid for. Got trusted plumbers and HVAC guys on speed dial.

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One of the problems of real estate is when you go to sell your collection of rental properties after 20-30 years. When the mortgages all paid off…and you’ve written them off with depreciation over the years. You get to pay full income tax rates on the gains.

With stocks, you only pay capital gains on the sales price.

Once again, you demonstrate your misunderstanding of tax law. You will pay ‘full income tax rates’ (i.e. ordinary income rates) up to 25% on the depreciation that you took (should have taken) through the years. But that depreciation was only on a portion of the original basis, since land the land value can’t be depreciated, and any depreciable improvements that you added. So for any properties purchased 20 or 30 years ago, the depreciation that is taxed at ordinary income rates is likely a very small portion of the total capital gain - maybe 10% - 20% On the other 80% - 90% of the capital gain, you pay capital gains rates, just like stocks.

And even with stocks, the original purchase price may not be the basis - things like return of capital, mergers, etc. can change your cost basis in a stock.

AJ

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I’m pretty happy with nice “set it and forget it” index funds, with a small sprinkling of individual stocks. No repairs, no crazy tenants moving 20 people in, and I can cash out in a day if I want to. I’m not saying I’ll never be a landlord again, but I probably won’t.

When I was working for Exxon I got posted to London office for a year. On those kinds of international assignments, Exxon hired Merrill-Lynch as a property manager to keep watch on your US home and rent it out if you wanted. Or you could just sell the US home and Exxon paid the brokerage commission and closing costs for you.

Anyway there was one guy in the office that kept his home in New Jersey in a semi-rural area about 40 miles from NY City. There were apparently some kind of apple orchards nearby. When he went home for Christmas he stopped by the property for a look. He found that there were triple-high bunkbeds constructed out of 2 x 4’s in all the bedrooms. Someone had rented the property from Merrill-Lynch and turned it into a migrant workers camp for the orchards.

There was a Brit in the office that got posted to somewhere else in Europe who owned a large home in an up-scale London neighborhood. Merrill rented it out to a Saudi family. When he returned there was a 6 ft diameter area of burned out carpet in the center of the living room plus smoke/heat damage on the ceiling above. He surmised that they were roasting a goat or a camel over an open flame.

intercst

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Yes, Warren Buffett probably doesn’t buy real estate. But the businesses he runs do. They buy real estate to have a place to run their businesses. Probably not all of them, but plenty do. And it’s certainly possible that for a couple of them, real estate is a significant asset.

Oh - and BRK DID buy some real estate back in the 1990s. Did pretty well on it, too. Probably should have kept it, but he sold it a couple of years after he bought.

That real estate was disguised as a restaurant chain. McDonald’s. But don’t fool yourself, McDonald’s is a real estate business, not a restaurant business.

McDonald’s Corp franchises out the restaurants. But they own the property for most of their franchisees and rent it to them. They make way more money in real estate than they do as a restaurant.

Buffett’s investment in McDonalds:
https://www.thecompoundinvestor.com/warren-buffetts-mcdonald…

McDonald’s as a real estate business:
https://whatisthebusinessmodelof.com/business-models/mcdonal…
https://www.wallstreetsurvivor.com/mcdonalds-beyond-the-burg…
https://1851franchise.com/why-is-mcdonalds-considered-a-real…

–Peter

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Excellent topic, and discussion. Two things come to mind:

*Different strokes, different folks.

*Diversification

I’ve owned both commercial and residential properties and no different than stocks, or most other investments much of it had to do with the purchase price. Around 2012 - still not recovered from the housing crash I did buy some townhomes in Northern Virginia (rather downscale, 3bed/1.5 bath units). Paid around $165k. Today - they are easily selling at $315K. In the meantime… I of course rented them out. I have a property manager who does all the work. I give final ok on tenant selection.

So - appreciation wise- just cash on cash not using leverage -9% annualized. Rental returns - after all expenses, repairs, fees, CPA costs etc - realistically - 4-5%. So annualized these have done 12-14% and I realize fully - many have done better in the stock market and that’s great.

In today’s froth, I admit (with paper bag on head lol) that I’ve bought a few more. Rental returns will only be 4%. Then - IF it appreciates that of course gets added on. Again - fully realize stocks have made more.

BUT - in the end, I want** one section ***of my portfolio to be “bricks”. Not Paper. If there’s a currency problem, or whatever – and the new cash is now marbles, I feel I can earn marbles renting a house out. Being 46 and retired- (no college degree, no fallback) I guess I like knowing that if the fit-hit-the-shan, I can tell my kids one day - sorry I couldn’t do the 1st tier colleges for you - but here’s keys to your 1st house.

Depreciation: Almost ALL of the rental income is depreciated. So this year for instance—my real estate companies have “ZERO” income - meaning the 1st $78,000 in dividends and long term stock gains - are 0% tax. Is there depreciation re-capture when I see: Yes – but on units that I bought in partnership with my kid - well, when I croak - he owns it- no cap gains recapture unless he sells. Oh and my income is legally low- I get a nice health insurance credit - hat tip taxpayer - we love ya’:wink:

I like having a balanced amount of money, in a solid, touchable thing - that most people need or want.

Could it crash again? Sure. just like stocks or any investment. But there’s only so much “Hey look my stocks crashed again. Dollar cost average! Tax loss!” I can tolerate.

I like that as my kids get older - they can learn basic bookkeeping, listen in on tenant selection discussions - stuff that schools don’t teach and stuff even business grads - don’t have exposure to.

Again, not in any way arguing it’s a better investment. Stock returns over the long term - are better.

For me, it’s diversification+ a few intangibles.

REITS? I’ve been in ACC over the years - people keep shelling out for college - not even questioning the costs. It’s been a nice steady-eddy for me.

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So for any properties purchased 20 or 30 years ago, the depreciation that is taxed at ordinary income rates is likely a very small portion of the total capital gain - maybe 10% - 20% On the other 80% - 90% of the capital gain, you pay capital gains rates, just like stocks.

Remember, that benefit is only available to individuals. Corporations do not get a lower tax rate on long term capital gains.

And that is probably why Warren Buffett doesn’t buy real estate directly in Berkshire Hathaway. As a corporation, BRK would pay higher taxes on that income than an individual would. Real estate is best held in an entity that allows the taxes to be paid at individual tax rates. Usually, that’s going to be a Limited Partnership or an LLC. You can get a higher after-tax return on the same investment when an individual pays the taxes compared to a corporation.

–Peter

PS - Extending the McDonald’s example from my previous post, MCD gets away with being a real estate company because they can get insanely high returns from their real estate investment. They are not renting to just anybody. They are renting to McDonald’s franchisees who have to pay the high rent if they want to get the franchise.

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Someone had rented the property from Merrill-Lynch and turned it into a migrant workers camp for the orchards.

Ugh.

My last tenant apparently lost his job during COVID, and/or so did several of his friends and family, so he moved them all into my house. There were 6-8 people living there when I booted them.

They managed to keep it on the down-low for quite a while by parking cars at the recreation center nearby—my neighbor later told me she didn’t see a lot of cars, but there’d been a lot of foot traffic past her house.

Merrill rented it out to a Saudi family. When he returned there was a 6 ft diameter area of burned out carpet in the center of the living room plus smoke/heat damage on the ceiling above.

Mine was a ton of water damage and a small fire. There was a small leak under the sink that he never called in about. Finally discovered when water was literally running out of the side of the house between the brick wall and foundation—when the neighbor saw it. Tons of damage to my kitchen.

Small fire when the thermostat supposedly broke and the tenant tried to “fix” it. Not sure what happened there, but burn marks and a giant hole in the wall.

In retrospect, I should have known something was up—this guy called for maintenance things ALL the time when he first moved in. (“Lightbulb out in the dining room” —you know, the decorative ones you just screw in—and the bulbs were in the closet. At least 6 calls because the bathtub didn’t drain fast enough—three different plumbers told him it was fine). Then—nothing, because he didn’t want anyone in the house to see all the people living there.

Many more stories, glad to be done with it.

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One of the problems of real estate is when you go to sell your collection of rental properties after 20-30 years. When the mortgages all paid off…and you’ve written them off with depreciation over the years. You get to pay full income tax rates on the gains

Or you could do a 1031 “Starker” exchange and not pay any taxes on it at all until final disposition. Try that with your stocks, which you may tire of, or about which the story changes, or they get a new CEO named Putin, or whatever. You pay taxes then buy something else with your reduced equity.

With the 1031 you pay nothing in taxes. You probably need a lawyer and a holding company, and the costs come to around $10,000 (depending) but that can be a lot better than paying $200,000 when trading up. And though it’s called a “like kind” exchange the rules are quite flexible. You can exchange a rental house for a duplex or apartment building. An industrial property for something else. Developed land for a farm. Or lots of other stuff.

This doesn’t mean the tax goes away, but it’s delayed, delayed, delayed, which is nearly always a better thing.

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“This doesn’t mean the tax goes away, but it’s delayed, delayed, delayed, which is nearly always a better thing.”

True…but there comes a point…where if you have five or six or ten properties, you’re getting up into your late 70s or 80s, and you wish to sell out…

that first property was depreciated /and appreciated - but that’s deferred as you trade to a ‘similar price’ situation in value…and now get to depreciate it…and have ‘cash flow’ again. When you’ve taken most of that depreciation, you can do another Starker trade - deferring the taxes due again.

Then eventually you’ll have tons of depreciation - which, when you sell it, is full income tax rate. Plus of course, some caps on the ‘real estate part’ of the property. Sell several properties at once, and you hit the high tax brackets.

t

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Then eventually you’ll have tons of depreciation - which, when you sell it, is full income tax rate.

No, it’s not. The rate on gain due to depreciation of real estate (section 1250 gain if you care to research it) is limited to 25%. Less if you’re in a lower tax bracket.

The rest of the gain is at capital gain rates, which are no more than 20%. And for many small time investors will be 15%.

The medicare tax on high investment income can add another 2.9% to both of these.

Still, that’s a long way away from the current max of 37% - which will go to 39.6% in 2026 unless congress changes the cutoff date for the lower tax brackets.

–Peter

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Of course there’s the way the really rich do it.

Buy, borrow, die.

Avoids all of those nasty taxes.

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Still, that’s a long way away from the current max of 37% - which will go to 39.6% in 2026 unless congress changes the cutoff date for the lower tax brackets.

Ah, you are missing one gigantic step. The President has to not veto it. We could very well end up with a Republican House & Senate that passed a bill to retain current tax rates, but it’s unlikely that a Democratic President will sign off.

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Ah, you are missing one gigantic step.

Don’t try to get so cute. It’s not a gigantic step. It will be well-known if the President is going to sign or veto before it comes to a vote in Congress. And even if the President vetoes the bill, Congress can override the veto.

I’m pretty sure my meaning is well-understood in context without getting bogged down in the details of how laws are made in the US.

If not, you should mention that the bill will need to originate in the House and not the Senate. And perhaps you should clarify that by House, I mean the House of Representatives, and not the house down the street. And by House of Representatives, I mean the US House of Representatives and not some state’s House of Representatives. And let’s not forget to discuss which committees and sub-committees will need to meet to discuss the bill, and how much better the bill’s chances will be if it has bi-partisan sponsorship and not just sponsors from one party. Except that the bi-partisan sponsors should not be people who are currently on the “outs” with their party (Liz Cheney and Joe Manchin might - or might not - be current examples of people on the “outs” with their party, but that’s another long discussion that might need it’s own thread. And, quite seriously, would be a discussion for another board. But I’m trying to be comprehensive here and not miss any steps or minute details.)

And that’s all to say that the relevant portion of the law currently has an expiration date in the not too distant future. And that laws can be changed between now and then.

–Peter

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Ah, you are missing one gigantic step.

Don’t try to get so cute. It’s not a gigantic step. It will be well-known if the President is going to sign or veto before it comes to a vote in Congress. And even if the President vetoes the bill, Congress can override the veto.

I’m pretty sure my meaning is well-understood in context without getting bogged down in the details of how laws are made in the US.

If not, you should mention that the bill will need to originate in the House and not the Senate. And perhaps you should clarify that by House, I mean the House of Representatives, and not the house down the street. And by House of Representatives, I mean the US House of Representatives and not some state’s House of Representatives. And let’s not forget to discuss which committees and sub-committees will need to meet to discuss the bill, and how much better the bill’s chances will be if it has bi-partisan sponsorship and not just sponsors from one party. Except that the bi-partisan sponsors should not be people who are currently on the “outs” with their party (Liz Cheney and Joe Manchin might - or might not - be current examples of people on the “outs” with their party, but that’s another long discussion that might need it’s own thread. And, quite seriously, would be a discussion for another board. But I’m trying to be comprehensive here and not miss any steps or minute details.)

And that’s all to say that the relevant portion of the law currently has an expiration date in the not too distant future. And that laws can be changed between now and then.

–Peter

I stand by my assertion that getting both chambers as well as the President to agree on something as partisan as tax rates is way more difficult than your post would suggest.

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I stand by my assertion that getting both chambers as well as the President to agree on something as partisan as tax rates is way more difficult than your post would suggest.

And that may very well be why the TCJA was set to expire on Dec 31, 2025, instead of after 2027, which it could have been extended to.

AJ

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I stand by my assertion

And I’ll stand by mine - that I never mentioned the difficulty or lack thereof in getting legislation passed. Just that tax law can change, particularly when you’re looking at a 3 or 4 year period.

For the record, having worked professionally in taxes for 40 years, I’d plan on one significant tax bill per Presidential administration. Reagan passed a really big one. Bush Sr got one done in the second year of his administration. Clinton pushed one through. Bush the younger got two done in his first term. Obama passed one. Trump passed one.

My prediction is that Biden will get a tax bill passed. What will be in that bill is something I’m not going to speculate on, other than it will likely be a tax increase rather than a cut. Then again, the expiration of the Trump tax cuts might be sufficient. Who knows?

–Peter

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Don’t try to get so cute. It’s not a gigantic step. It will be well-known if the President is going to sign or veto before it comes to a vote in Congress. And even if the President vetoes the bill, Congress can override the veto.

If that was true then a President would never get to veto a bill, and they do. And even if the Republicans take control of the House and the Senate, they’re not going to get 2/3 of BOTH to override a veto. But sometimes they just take votes so they can say “I voted against taxes” or whatever.

Maybe Biden won’t push for a tax bill and the expiration of the current law will be enough. That remains to be seen. But in any event it won’t be a life changing uh, change for most people, including most of those here.

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Maybe Biden won’t push for a tax bill and the expiration of the current law will be enough.

He already pushed. And if there is any chance at all, he’ll push again.

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Hope so. Taxes need to go up. Though it would be good not to penalize working (as intercst says, in terms of taxes working for a living is the dumbest thing you can do). Gotta pay the bills, or at least we should try.

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Gotta pay the bills, or at least we should try.

Can’t be done given the state of politicians putting getting re-elected ahead of the best interests for the country. For every dollar of tax revenue raised, politician will spend $1.20. No ability to prioritize. All good ideas must be funded now.

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