Would Warren Buffett buy UK property?

0:02Hey everyone, Rob B here with Rob D. What if we gave you the framework of investing like the world's most successful investor? Well, you can do that. It is possible and it's possible with property and we're going to take you through that framework and that structure today.

0:24Welcome to the Property Podcast. Thank you for joining us. In case you don't know, we run a business that arranges more than£100 million worth of property deals for our clients every year. You can find out about that at propertyhub.net slash invest. But we've got to be realistic. As investors go, we are not among the greats. But we can turn to some of the greats to see what we can learn from them when it comes to UK property right now, and what opportunities exist, how they would think about the market. And that's what we're going to do in today's episode. Before we get into this episode, which I know you're going to love, let's get into our new story of the week.

0:56And this week's news story is a really interesting one, Rob. The headline, it's from Right Move, Commuter Growth Peaks in the North, Manchester and Glasgow Lead the Way. Not a great headline, but why it's a great story is another way of describing this is the ripple effect, something that we talk about on the podcast a lot. We talk about the major places you should be investing, but we often reference the commuter belts of these hotspots that we talk about as great places to invest as well and this article's captured the essence of that and gone one step further and started to recommend some areas next to all these major cities yes so the really interesting thing about this for me is that not all ripples are equal because it's showing annual property price changes in various areas and there is a huge divergence so despite them being commuter hotspots some are growing very very fast and others are shrinking so the top of the an annual price increase of 13.5%.

1:56What? Woopa. For the second place, Rochdale, of course, commutable for Manchester, up 8.7%. Then also up there, you've got St Helens, where you can commute to Liverpool or Manchester. Court Talbot for Cardiff, Wigan for Manchester, all above 6 % annual growth. But then down the bottom, as you can probably guess, you've got to travel south, where you've got Haywood's Heath in Sussex. Prices down 4.8%. Down 4.8%. You've also got Bath, down 3.8%. Leamington Spa, down 3.3%. And so I think the very clear pattern here, it is a geographical one, but it's not really a geographical one. It's an affordability one.

2:29Prices are rising where there's room for prices to rise. So Haywood's Heath, Bath, Leamington Spa, all very lovely areas, but very expensive areas. So prices are struggling because of affordability, mortgage rates, other factors. Whereas in areas that are equally commutable, equally strong, but affordability is better, prices are lower to start with. That's where we're seeing the growth and some very, very strong growth in some cases. That's why you always, always need to be aware of the average. The average is your enemy when it comes to property, because that's what everything is reported on, the average is.

2:59But as we talked about on the podcast, time and time again, there are winners and losers around every average. When you get the average number, of course, there are numbers higher and lower than that number in terms of regions and performance, but no one ever talks about that. No one ever gets into that. And that could make a huge difference to your wealth when it comes to property. And that's something we're going to talk about a lot more this episode, wealth and a difference picking correctly will make on your wealth. For a long time, the story of UK property was capital growth. Of course, we had the big run-up of the early 2000s where you had absolutely crazy growth.

3:33And even though the market hasn't been as wild since then, but still a big part of the reason for buying property has been its value going up. And even though over the long term, especially if you're using leverage, you're going to make the majority of your returns through capital appreciation, rental income has re-entered the chat. Because of what's happened to rents over the last few years, the income that a property can produce has started looking very interesting again. And that combination of strong income, along with property being kind of unloved as a sector, would attract the attention of a certain group of investors known as value investors.

4:07Now, if you're more a property person than a stock market person, then you might not have heard of value investing as a discipline before. You might think you know nothing about it. But there is at least one very famous value investor, Rob, that people certainly would have heard of. Absolutely. And that is Warren Buffett. Warren Buffett is the king of value investing. He's not the founder. That title probably would go to Benjamin Graham. And he was the person who mentored and taught Warren about investing this way. But Warren Buffett is certainly the poster child for value investing. That is really how he's made his fortune.

4:42He looks at buying assets for less than they're actually worth. Now, how could that happen? But it happens all the time. Now, to be clear, Warren Buffett does this the majority of time in stocks or businesses. So he will look at what he believes is the fair value of the business and then see if there's an opportunity to buy it for less. Now, how can that happen? Well, it happens all the time. Markets mispriced assets all the time. The stock market in particular, it's so led by sentiment, a word that we've talked about a lot this year on the podcast. Sentiment drives the markets as well. And sometimes the market can dramatically overvalue an asset.

5:22And the reverse is possible. It can also undervalue assets as well. And that could be for a variety of reasons, not just sentiment, but sentiment is a big part of it. And Warren Buffett has been exceptional, made him one of the richest people on the planet, at one point the richest by spotting opportunities that were in plain sight that others couldn't and buying them for what was below their perceived fair value. But you could do exactly the same with property investment because property investment is another asset and at some points property is overvalued, at some points it's at a fair value and at other points it's undervalued and again it's market sentiment.

6:05So if you go back to when it was overvalued, you could say, well, in the lead up to 2008, when we had a huge price surge, the sentiment was incredible for property. People were talking about how they could get rich quickly. There was a mania, but as an asset, it was dramatically overvalued. What it was worth and what it was trading for was a huge mismatch and that was corrected after 08 but are we now at a place where property is undervalued the market is pricing at one number but actually it's fair value is at a different place and that can create opportunity if it's true but it's easy to say it's true but let's look at it if it is true and that's our main mission of today's episode yes let's do that right now and there are a few different ways that you can try to calculate the fair value of a property and we'll look at all of them but let's start with and spend most of our time on the way that a value investor would do this which essentially is looking at the amount of income that a property produces and then going well how much am I paying for that income am I buying that income at a good price or not so I've gone and modeled all this out I won't bore you with the calculations but essentially one of the key inputs is what's called the risk-free rate of return or the risk-free benchmark and in the UK you could say that this is a 10-year guilt or government bond.

7:29So if you go and buy a bond there is in theory no risk at all. The government will pay you back and they will pay you a fixed amount and at the moment that amount is pretty high. You can give the government money for 10 years and they would pay you 5%. So when you build out the model you say okay well I need to clear at least 5 % because that's what I would get from the ultra safe bet and then actually I need even more of a return than that because when I'm investing in property well it's illiquid I can't just sell it instantly and I've got to do something there's management hassle of holding this asset you take that five percent and go well actually I want more than that to be equal with the benchmark but then you reduce it back down again because property gives you something that a bond does not which is growth in your income stream if you buy a bond you get five percent based on its price and its income today but you get it as a fixed amount so say it's a pound it's always going to be a pound.

8:18Whatever happens in the future is never going to go up to£1.05,£1.10. Not going to happen. You always get your pound. Whereas with rent, you know it's likely to go up over time. So in the model, you reduce what you require from property to take account of this benefit of long run rental growth, which I've modelled out about 3 % per year, which is roughly in line with expected wage growth. Once you've done all that, you get out at the bottom an estimated fair value or fair net yield for property, which based on the assumptions I put in is 4.5%. So if you're getting a net yield, not gross yield, a net yield of 4.5 % based on the price you're paying for the property, then that would represent fair value.

8:56Any net yield lower than that would represent poor value in the eyes of a value investor using this model. And anything above it would be cheap. It would be good value. So that's the benchmark that we're looking for in this model. And we can see where UK property currently lands against it. But we'll also, Rob, need to look at a few different places in different parts of the country because they're going to give us very different answers. Well, like you said, Rob, we need to look at this regionally. But before we do, let's start with the UK as a whole. And the UK as a whole, your net yield is going to sit somewhere between 4.3 to 4.9%.

9:26Remember, that's net yield. Gross yield is the number that's often quoted the most. The gross yield is higher, but the net yield, if you take 20 to 25 % off costs from the gross, that's where you'll roughly end up. London well that's a bit lower so London is 3.7 % to 4.1 % so if the UK is considered fair value London would be expensive but then there are pockets there are areas where the yield is better than average because if the UK average is one number London's is below that number there has to be areas above that number and the northwest is a great example of that the net yield in the northwest is 4.4 to 5.2 percent and actually there are cities and places in the northwest like liverpool where the net yield will be above five percent 5.1 to 5.7 so there are pockets within regions as well yeah so in the eyes of a value investor using this kind of model uk as a whole roundabout fair value London expensive parts of the north and the northwest cheap but models are very sensitive to the inputs you give them and different assumptions can often give you very different numbers so it would give us confidence if there were other ways of looking at whether UK property is cheap or expensive which lined up with this so we're looking at it through different lenses and getting to the same conclusion and there are two other ways the first of those is to look at it instead of through the lens of an investor but through the eyes of a home buyer instead which you can do by looking at price to income ratios so what does property cost in relation to the amount that people looking to buy it to live in are earning and if you did that you'd say again well the uk is probably you fair ish value so according to nationwide the price to first time buyer income ratio for the uk as a whole is 4.7 which is slightly below its 20 year average now you can say that oh well in the past it's been two or three but things are very different then and maybe they were better i'm not going to argue about that but they were different and so i I think 20 years is long enough to look at it over and say, OK, well, if we're below that average now, then probably reasonable to say that's roundabout normal, not cheap nor expensive.

11:38Now, London is, of course, more expensive. The ratio is 7.5. But coming down because London first time earnings are on the up and London house prices are not. And the north is, as you'd expect, cheaper. So the ratio is 3.5, lower than the country as a whole. So that's the second way of looking at it. But there is a third way, Rob. So what would be the third way, Rob? how else could you potentially assess where the value of UK property is right now? Well, we've looked at it as an investor and as a home buyer, but what about as a builder? So we can look at property through the lens of its replacement costs.

12:09So a way of doing this is to ask, what would it cost to buy the average home from scratch, including the land? So the cost of the land, the labour, the materials, everything to get a home built. And on this scale, a reading of exactly one means break-even. So the person building it, the developer, is making no profit margin, but they're also not losing anything. And if you look at this, the UK as a whole comes out at 0.89. So on average, the UK as a whole, you cannot build a property for a higher price than the market would pay for it. In London, it's even worse. It's 0.67. So you're miles off being able to cover your costs.

12:46And even in the northwest, the area where it's cheapest to build, still 0.97. so still just about unprofitable to build anything so again it's giving us confidence in our pattern we're seeing the same thing lined up in different regions but also wow r.i.p the government's house building target no wonder not much is getting built because in large parts of the country it's just not profitable to build anything it's a crazy situation it is because you've got a supply issue here you haven't got new stuff being built which means that there's a supply issue for people wanting to buy and live in homes but you've also got a supply issue when it comes to property coming to market, the amount of rental properties coming to market as well.

13:24That's interesting because then that could push up some of the numbers that we just talked about. So which of these models should you use? Well, I suppose it's up to you. For me, it's the first model comfortably. I think the second two are interesting and the third model, the one we just discussed, absolutely influences the others. But the second one, the big counter for me, the one that people often miss is the cost of lending. So Rob's talked about, oh, how 30 years ago that number was lower, and it was, but the cost of borrowing was much, much higher if you look back at interest rates, because most people will buy a property with a mortgage.

14:00So if you're buying everything with cash and everybody did, then you would look at it and go, well, at the moment, it's a bit below the 20-year average. It's not what it was 30 years ago. So in the last 20 years, it's below value, but against 30, it's overpriced but because we understand that we use mortgages that's where that model falls down flat for me the first model is the one that you'll hear us talk about in the podcast in different ways but we're getting far more into the data here and that's why it's really interesting but when you use that model you can start to take areas like the northwest but then pick pockets like i identified before like liverpool and go wait a minute there's real value here and there's some areas of the country that are fair value some that may be a little expensive but there are some areas right now because the yields have improved so much and prices haven't moved and the fundamentals are excellent where the value is absolutely brilliant so that's taking us into where the market is right now so if you look at the northwest as Rob said it's up to close to 20 percent below where fair value is and then you look at places like Liverpool which has yields north of 5%, Newcastle, which has yields north of 5%.

15:12Remember, these are all net yields. You've got parts of Manchester that are over 5%. You've got parts of Leeds that are over 5%. You've got parts of Nottingham that are over 5%. There's lots of areas within the UK, areas that we would call hotspots, which offer tremendous value at the moment when you assess it from that point of view. And while the property market is quiet at the moment, Institutions are spotting this opportunity because they're not interested in what Barry says down the pub about UK property. They're interested in the numbers and the numbers in these areas are becoming very, very attractive.

15:46But there's a way of bringing more areas into the bucket of underpriced assets, assets that are below the fair value, which means great buying opportunities. We've talked about generally, you know, the market of what shows value right now. But there's a way of, one, enhancing that value even further, or two, bringing areas in that you wouldn't think would work. But if you make this play, it brings other areas that you may have discounted and makes them attractive investment propositions. But Rob, what could that be? Well, that would be getting a discount. And this is where we've got one up on Warren.

16:24because when you're buying shares of a company you cannot get a discount today's price is today's price you don't know if you're buying it off someone who is desperate to sell or couldn't care less it makes no difference you are just paying today's price in property you can get a discount and importantly the discount can't be because of a problem so if there's a problem with the lease or there are structural problems then if you're getting it cheaper than the property next door then you're not getting yourself a discount you need to work out what it would cost to fix that and then get in below that price.

16:54But you can get a discount based on the circumstances of the seller. So in property, you can have two houses next door to each other, identical in every way that are both up for sale at the same time. One of those sellers is, yeah, I'd kind of like to sell, but they're not that fast. The other absolutely must sell. They have no choice. In that situation, of course, you're going to be able to get yourself a discount on one of those properties. And as you said, Rob, that can work for you in a couple of different ways. So if you've got an area that you'd happily would have bought in anyway, it was fair value or better, it was good value, and then you're getting in below that because you're getting a discount, well that's giving you what a value investor might call a margin of safety.

17:30It means that even if some of your assumptions are wrong and things don't go as well as you've expected, then you've got some margin in there because you got it at a lower price. But what you can also do, as you also said, is bring more areas into scope. There might be an area where you wouldn't normally buy because the numbers don't quite stack, but you can get a discount that means that the numbers do work. So a good example of this is a deal that we did over the last few weeks, which is a Southeast deal. The first Southeast deal we've done for a very long time, but it had Northwest yields. And the reason that it had Northwest yields is that we were able to negotiate a big, big discount.

18:01Again, that was related to the circumstances of the seller. We verified that that was a true discount from MarketValue, wasn't just taken off some marketing price. And therefore, we were able to arrange a deal for our clients in the Southeast, where normally you go, oh, this just doesn't work, but it worked. So discounts can be really powerful. And that's why we include it in our magic formula. The other thing that we talk about in our magic formula is the power of leverage as well. You need to use leverage. We talk about this on the podcast all the time and leverage accelerates this even further.

18:31And again, it's something that's not really done with stocks, but it is the norm for property. And this then supercharges that return. We've not talked about the power of leverage at all when we've looked at these numbers, but when you apply leverage, your returns multiply. Now, we're not going to get into this episode about how leverage works and how it multiplies it. We've covered that on the podcast extensively. We'll link in the show notes if it's an unfamiliar concept to you, so you can go back and listen to that yourself. But just understand that everything we've talked about so far is great.

19:02You apply discount, amazing. You apply leverage, then phenomenal. So what do you do with all this knowledge. I think that's where it leaves us now. What do you do with this information? Well, despite what we've taken you through today, I don't think you need to go into that level of detail where you're looking at net yields. By all means, do that. But what you need to do is just assess areas in the very simplistic fashion that we've done over and over across the years, because it gives you the ability to spot value. The way we've been so accurate at picking hotspots every year, every year we make predictions on what the property market's going to do in areas that perform well.

19:36The reason we've done well in that segment, that section on which areas will perform well, is just by applying a simpler version of what we've discussed today, which is to say, look at an area that has strong returns and great fundamentals. So the fundamentals are excellent and the returns are excellent. That means that there's value. And when you apply that simple principle, then you can look like you're some sort of sage on a podcast and then pick areas that seem to perform the best each and every year. It is that simple. We're not that bright. It's just a very simple concept that works over and over.

20:13You do not need to be trying to spot a future trend. You don't need to be over clever when it comes to property. There's lots of people who invested heavily into Bedford, for example, because Universal is coming to town. And you know what? They may do well. They may do very well. And people investing there now may do very well, but they might not. That's a strategy for me that seems to take this to the extreme, when you could just play a very simple game of looking for great returns, great fundamentals, because that will demonstrate great value. I think finally, Rob, it's worth emphasizing why value exists in all markets, but including a property market.

20:50We talked about it earlier, but it's sentiment. And because sentiment is the way it is right now, it produces areas that offer value, but it also produces the opportunity for discounts. So while most people fear this type of sentiment, as an investor, you should embrace it because you get these opportunities. Well, that's it. Everyone thinks that they want a property boom. But if you're still in the buying phase, unless you are on the decumulation phase and you're selling off your portfolio, you don't really want a property boom. Because all right, it helps out your loan to value position. It increases the value of your property relative to your mortgage.

21:24That's lovely. But if you're still buying, it makes it really hard to buy. We've been here before. I just remember how hard it was to get deals done around 2021-22. It was a nightmare and that was only a mini boom. So even though we can feel a bit ground down over time because the news is just so negative about property seemingly all the time, that does produce opportunities. And there have been times over the last few years for sure when that negativity is justified and when times have been tricky. But to me it doesn't seem like we're at that point now. I think you can imagine all the numbers, all the rents, all the purchase prices, all the mortgage rates exactly as they are now but things just feeling different and the market would be looking very very different from how it is now people would be acting very differently but because psychologically as a whole the nation is not in that state we are where we are the market feels grim and that's why those discounts and those opportunities are available and it's taken all this time into the episode but we'll finally do it we'll quote warren buffett it's his most famous line but it's made him one of the wealthiest people on the planet which is be fearful when others are greedy and greedy when others are fearful.

22:26And that is quite a motive, the language, which is probably why it's quoted so much. You don't have to feel like you're being greedy. Another way of framing this is when others have switched off, you switch on, take advantage of the situation. You didn't create this situation, the market did. You're just not being fearful. You're not being emotional to the market. You're taking advantage of the opportunities it brings. And I think if you do that over the long term, I think you'll be wildly successful as a property ambassador before you shoot off let us give you a bit more we always like to end with more and this week's hub extra rob you are recommending a film what have you got for us yes i watched a film the other day which i loved called the invite they've probably seen it promoted it's had quite a big push but it totally deserves it it's a movie but it looks like a stage play it all takes part in the same apartment nothing blows up there's no special effects it's all carried by the script and by the performances.

23:19Olivia Wilde, Seth Rogen, Penelope Cruz, Ed Norton are the only characters, actually, I think, but they are all fantastic. I can't say any more because it's quite hard to talk about this without getting into spoiler territory, but I really enjoyed it. So very much worth a watch. Well, thank you, Rob. You say you probably heard it promoted, but I'm in that weird camp that hasn't seen it promoted. That's the first I've heard of it. So that's why I love this segment of the show because lots of people learn new things and pick up little bits that aren't always property, but often are useful. So thank you.

23:48I will watch that film. And hopefully you'll be watching our YouTube channel. If you've not subscribed to that yet, you're mad. Go and do that. No, seriously, stop and go and do that. Right, you're back. Okay, great. And so make sure you also join us for the podcast, same time, same place next week. Between now and then, we'll be in the Sunday Times answering your questions and answering more questions with Ask Rob and Rob on Tuesday. So lots of wonderful things to put in your calendar, your diary, lots of content to keep you busy. so until we're back next week take care have fun bye-bye bye-bye