Saturday, August 2, 2008

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Property Investment Tips: Warren Buffett's Margin of Safety

The following is an excerpt from one of my favourite books, "The Best Investment Advice I Ever Received" on Warren Buffett's third investment principle which involves the margin of saftety:
His (Warren Buffett's) third principle involves the margin of safety. That means, as Buffett once put it, you're never that precise in your ability to calculate the worth of a stock but what you can do is estimate. He has often said investors should find properties where there is a wide discrepancy ... and if you can buy them at two-thirds of what they're worth, do it. How does an investor accomplish that? As you pick through company reports and filings, add up the numbers and ask yourself whether the price of the business (or stock) is lower than its value. In other words, if you can calculate that a company's stock is worth between $80 and $120, and you can buy it at $60, then buy it.

Applying this principle to property investment would look something like that:
If you estimate the worth of a mass market property to be from $800 psf to $1200 psf, then buy at $600 psf.

At first sight, this may look like a grossly over-simplification of a complex investment decision. But, really it's just that simple and it works. I've applied the principle myself in all its literal sense and today, I'm sitting comfortably on a property I bought in 2006 at a price which Warren Buffett would have been proud of :). On a serious note, if you are a property investor who's not under any pressure to buy property at the current high price, unlike the unfortunate home buyers, do give Warren Buffett's margin of safety some serious thought. Going forward, property price looks set to fall but precisely because I've bought my property with Warren Buffett's margin of safety, I'm not one bit nervous about the inevitable market correction. It'd have been very different if I've bought my property at the property peak of 2007. So you see, we're not talking about profit margin here, we're talking about safety margin - a necessarily, not a good to have, cushion against the market downside risk.

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May also want to read:
History of Singapore Property 1960 to 2008
Buy or Not Buy: How to decide amid mixed market signals
When to Buy, When Not to by
Property Price Index Graph Plotter & Online Property Valuation
Your Property Investment Determines Your Financial Success in Your Life
HDB Resales: West Sees Highest Price Increase

7 comments:

Kenneth said...

Hi smartbuyer,
How do u calculate the worth of the property u are buying?Eg PSF $600 or $800. Is there a formula for it? I agree with the warren buffett margin of safety. He has his own ways to calculate the investment worth. Can pls kindly enlighten me as i am also looking for a property.
Regards

Anonymous said...

Hi Smartbuyer,
How do u calculate the worth of the property is within the margin of safety? Is there a formula for it?Eg:PSF $600 or $800. How do u determined whether it is worth to buy? Warren buffett has his own distinctive sense for spotting investment. Pls kindly enlighten me as i am also looking for a property but wish to LEARN before i EARN.

Regards

Smart Buyer said...

Hi Kenneth,
What I've read in this book mentioned here is Warren Buffett estimates these values. He's probably has a way of doing it like you said. For me, I estimate based on the property prices transacted during a up and down cycle. For example, a typical mass market EH condo will cost about $500 psf at bad time and $1000 psf at good time. Hope it helps.

Smart Buyer said...

Hi Kenneth,
Let me elaborate a little further about the above example of the FH mass condo. The mean of $500 an $1000 is $750 and two-thirds of that would $500.. so $500 psf will be a safe buy.

Back the example I mentioned in the post, the estimated high price for the property in question is $1200 and the low $800, so the average is $1000 and two-thirds of $1000 is $666 - the Warren Buffett's price :)

kenneth said...

Thanks alot for the clarification. Its a pleasure blog for ppl like me hunting for 1st property to learn new things on.

Regards

Anonymous said...

Hi smart Buyer,
Just a clarification, How do you obtain such transaction prices ? is there a particular website that provides such info. I am actually a greenhorn in this field and i must say your blog is fantastic.

Smart Buyer said...

Hi,
You can find Warren Buffett's investment tips somewhere in money.utalkitalk.com.

Good luck.

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The blogger here has been affectionately named by close allies as "Smart Buyer" but really, he's not smart. Smart Buyer just believes that being prudent is smart. That's the essence of the message of this blog and Smart Buyer hopes it'll benefit other property buyers.

Smart Buyer :)