Warren Buffet’s guide to evaluating (Property) deals
A reporter asks Warren Buffet, what's his advice for the average investor who can’t just sit there and observe the market and think 'oh it's going to go higher, it's going to go higher'.
Warren Buffet’s reply reveals his methodology of how he evaluates if buying that particular company is a good deal or not.
"What we think about is, how much is it selling for and how much do we think its worth. We bought it (PetroChina) at $35 billion effectively, I felt the company was worth at least a $100 billion.
I read an annual report and it described a very good company and I sat there and read it and I thought this company is worth around $100 billion. Now, I didn’t look at the price first, I look at the business first and try to work out what its worth because if you look at the price first ill get influenced by that. I look at the company first, I try to evaluate it and then I look at the price and if the price is way less than what I’ve valued it at then I’m going to buy it.”
So by working backward, Buffet is able to come to a logical conclusion. Now, how can this be applied to property?
If you’re looking to buy a property to develop and sell, then:
1. First, work out what the property is going to be worth once it is developed.
2. Take off all the costs involved to develop the property.
3. Take off your profit margin that you’re looking to create.
4. This calculation will give you the offer price. At that point you look at the asking price and see if you can make the deal work.
The problem with looking at the price first is that we get emotional about making the numbers work and build in scenarios which justify the potentially higher asking price. Because of this, people often end up over paying for a property, and then try to pass on the higher cost to customers in form of higher prices. However, this rarely works as the market will only pay what the market price is and so the developer is forced to reduce their profit margins.
By working backward, and coming up with a logical conclusion before looking at the asking price you are less likely to make that mistake.
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful - Warren Buffett