Sunday, May 01, 2005

Warren Buffett Weighs In On The Housing Bubble

Hold on to your hats because the Oracle from Omaha just threw a ton of controversy into the bubble discussion. "He and Munger issued stern new warnings about the residential real estate 'bubble,' the destabilizing effect of hedge funds on the financial markets, and the possibility of another terrorist strike against the United States."

Buffett may have been reading this blog! "A lot of the psychological well-being of the American public comes from how well they've done with their house over the years. If indeed there's been a bubble, and it's pricked at some point, the net effect on Berkshire might well be positive [because the company's financial strength would allow it to buy real-estate-related businesses at bargain prices]."

"We're like an incredibly rich family that owns so much land they can't travel to the ends of their domain. And they sit on the front porch and consume a little bit of everything that comes in, all the riches of the land, and they consume roughly 6 percent more than they produce. And they pay for it by selling off land at the edge of the landholdings that can't see. They trade away a little piece every day or take out a mortgage on a piece."

"Buffett to Munger: 'What do you think the end will be?' Munger: 'Bad.'"


At 11:19 AM, Blogger Dan said...


I read Warren Buffet's comments and what struck me the most was him telling of the house he recently sold where the replacement cost of the house would have been 500K but the land cost is about 60 million an acre...

So does that mean that the bubble is mostly in the cost of land?!


At 11:35 AM, Blogger Greenlander said...

This comment has been removed by a blog administrator.

At 11:36 AM, Blogger Greenlander said...

There are three ways of valuing real estate.

1. The replacement cost. If there were a vacant lot, how much would it cost to buy it, and then how much more would it cost to build a house on it? For instance, if a lot costs $500K and construction of the house costs $500K, then the replacement cost is $1M.

2. How much income can it generate? How much rent can it generate. Historically, houses have traded at 8 to 10 times annual rents. (The ratio of price to annual rents is sometimes called the GRM.)

3. The third is to look at what comparible properties have traded for in the recent past.

You can tell we're in a bubble, because the price you get in #3 is way out of whack with what you'd get using #1 or #2.

A lot of the "bubble" arguments stem from arguing that prices are way out of line with rents.

Buffet is arguing #1. Construction costs are well known... probably around $250 - $300 a square foot in urban areas. So, by looking at what the place sold for, you can walk backwards and figure out how much the land is valued for.

At 1:28 PM, Blogger Ben Jones said...

Greenlander did a good job of explaining the situation. I would add that a builder I know will secretly tell me about how much they mark up what the subs charge them. To think all these stucco-buyers are paying a premium for chicken wire and foam out here in the desert!

It really seems that peiople buy into any justification. On the coasts, they don't have land. In the city, its the commute and shopping. Out in the middle of nowhere, they point to how much prices have gone up. This mania is so complicated, it needs a book to explore the psychology.

The Buffett comments may blow the lid off this bubble. Good to hear from you Dan.

At 1:42 PM, Anonymous Anonymous said...

Reminds me of the tale during the late 80's of Australia selling its Tokyo consulate, then paying off its budget deficit with the proceeds.

At 2:33 PM, Anonymous Anonymous said...

and land would perhaps be numero uno in consideration of the house prices, given the saying "they don't make it anymore, if technology didnot exist for vertical development.. so same piece of land can support few to few hundreds of families (of course county regulations would apply)..

moreover, the same technology which made our PCs, DVDs, Cars cheaper do lower the construction costs as well (raw material/labor cost included)

At 2:50 PM, Blogger John Law said...

marc fager talked about a company caught up in a financial meltdown and it's stock capitalization was LESS than the value of it's hong kong subsidiary!

I think some companies also did sales of Japanese bulidings they owned and reaped huge returns before their bubbles collapsed.

At 3:23 PM, Blogger realist said...

i believe the cost of real estate is driven by "location, location, location," not building costs, building costs, building costs. you know you bought in the right neighborhood, when they start knocking down 4,000sq.ft houses to build something new. i can have a house built for $85 a foot, whether it's on the oceanfront or ten blocks inland. trust me, the house on the oceanfront will go for seriously more money..

At 3:29 PM, Anonymous Anonymous said...

I don't think Buffett's comments are going to make any differece. Smart money already knows what's comming and is out of RE for some time already.

The guys that are buying right now may not even know who Warren Buffett is.

At 4:02 PM, Anonymous Anonymous said...

"i believe the cost of real estate is driven by "location, location, location," not building costs, building costs, building costs."

First of all, the famous "location, location, location" referred to RETAIL space, not residential. Primarily it referred to how much customer traffic a store was going to have and its demographics, thus how much revenue (and assumeably profit) it would have.

This has NO context in residential RE, unless you are renting the house out and its location makes a difference.

"you know you bought in the right neighborhood, when they start knocking down 4,000sq.ft houses to build something new."

That just means you will have stupid neighbors ! Desireability is important, but *most* home locations are interchangeable and anemities mean as much or more than location. There really is no shortage of desireable places to live in most cities.

"i can have a house built for $85 a foot, whether it's on the oceanfront or ten blocks inland. trust me, the house on the oceanfront will go for seriously more money.."

Sure it will. Who wouldn't want to live on the ocean ? (Other than the storms and salt damage and the commute.) However, aside from oceanfront property and maybe not even then, there IS NO LAND SHORTAGE and thus no reason for land to be appreciating uncontrollably.

At 4:10 PM, Anonymous Anonymous said...

"given the saying "they don't make it anymore"

This is another misused quote ! While they don't make it any more, when was the last time you couldn't buy land ? There is tons and tons of it just about everywhere and the return on that land has to justify its price !

Lets remember something else: residential construction only occurs where are jobs and jobs require commercial real estate. If the price of land is sky high, businesses won't be locating there.

That is one really telling sign about the RE boom: it seems to be residential only, not commercial. I don't hear of any businesses having trouble finding space/land, which leads me to believe that we have a lopsided boom. For me, lopsided = unsustainable.

At 4:56 PM, Blogger realist said...

anon, where is your logic? do you think that land in the great plains (51% of the continental u.s. with only 3% of the population) and land in manhattan have the same value? i've been hearing the location, location quote on residential real estate for 30 years, your version is a first for me. i build beach houses and have seen lots on wilmington beach, nc go from $30,000 to $300,000 in less than two years. my building costs are up 10% in the same period.

At 5:07 PM, Anonymous Anonymous said...

Prime vacation property may be the exception to the rule, but "location, location, location" was referring to retail and nothing else.

If you go to LV and other places, there is land as far as the eye can see. It is not rare.

Furthermore, the prices you speak of clearly aren't reflective of a properties earning potential. Yes, some people will pay $300K for a certain location, just like they will pay $1000 for a bottle of wine and $150 for a restored muscle car. However, for the vast majority of us, there is no shortage of land.

At 5:09 PM, Anonymous Anonymous said...

realist: do you think the purchasers would have paid $300K if they *knew* the price of the land wasn't going to go up any further ? I doubt it.

Of course I don't think that Montana land is the same price as Manhattan.

At 5:49 PM, Anonymous Melissa said...

Munger: "You have a real asset-price bubble in places like parts of California and the suburbs of Washington, DC. "

At 7:18 PM, Anonymous Anonymous said...

I live around New York City... and i always love when someone say: "They're not making anymore land." ... and i always say: "No, they're not. But they're certainly re-developing it."

At 8:13 PM, Blogger Sunny said...

4:10 Anon,

Oh yeah, commercial has followed residential. There is not a single commercial property in my FL county and many others for the past two years that would not have had to have been "fed" every month to break even. To many small business owners owning commercial property is, by their estimation, akin to a gold mine.

At 8:13 PM, Blogger Sunny said...

Clarify above post, a "single commercial property" FOR SALE.

At 8:37 PM, Blogger John Law said...

with a bubble always going back to where it started at least. we're looking at 30%-50% decline easily.

At 8:59 PM, Blogger goleta said...

I don't see much demand for for commercial properties, unless you mean real estate offices. Then it's a different story. Office rents have never been lower in the Bay area since dot com bust.

People with non-RE related jobs are moving away from California. Since half of new jobs created here are RE related, pretty soon, the ones stay are either RE investors or realtors.

If the bubble doesn't burst, it'll one flipper feed on another. Realtors always say there is too much demand and not enough supply, but real demand, the ones who are buying homes to live, is disappearing fast. It's become almost impossible for california companies to hire out-of-state employees and get them move here.
U-Haul truck rates for out of state route are 3 to 4 times of the same route in the opposite direction.

Everyone is moving out. who needs the office space?

At 9:00 PM, Blogger John Law said...

the local RE company has turned an empty lot into a big new RE headquarters...

At 12:17 AM, Anonymous bob r said...

"U-Haul truck rates for out of state route are 3 to 4 times of the same route in the opposite direction."

Yes, but you're not counting the folks coming over the border. They generally don't use U-Hauls.

At 5:37 AM, Blogger Sunny said...

Yes, commercial demand is low, rents are low, but commercial sales are HOT. Cap rates are extremely low in Fla, between 3 and 5%. Cap rate is calculated by dividing the annual rents by the price of the property. A $500K property might rent for $1500 a month for a cap rate of 3.6%. If it rents for $2500 a month the rate is 6%. A few years ago they were 10% which would yield a monthly rent of $4166.

At 2:56 PM, Blogger Brian Richards said...

To all the thoughtful posters and Buffet:
I still have yet to read any factual information which convinces me that there IS a real estate bubble. (But I must admit, California coastal and Florida coastal real estate is pretty pricey)
Our currency, the dollar, has depreciated by a good 30% over the past decade, and I predict, with increasing inflation, real estate prices will continue to rise.

At 1:32 AM, Blogger watch them run said...

Bring Negroes into neighboorhood and prices drop forcing white people to run and sell cheap. Then build further out and force white people to buy your new over inflated housing. This is whats happening in Detroit.


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