Jan 30, 2024
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One of the last market warnings Charlie Munger, Warren Buffett’s late business partner, issued revolved around commercial real estate. Munger said he saw a storm brewing in the sector that could engulf the banks and impact the broader market.
“The buildings don’t go away,” Buffett said at the May 2023 Berkshire Hathaway (BRK.A) shareholders meeting. “But the owners do,” Munger chimed in at what was to be his last annual meeting.
The rise of remote work is a driving for in the Shifting office demand that could result in a 35% plunge in office values by the end of 2025, according to a recent report from Capital Economics. It also projects that those values are unlikely to recover before 2040.
“I think that the hollowing out of the downtowns, in the United States and elsewhere in the world, is going to be significant and quite unpleasant,” Munger said, adding at that time that he predicted the U.S. economy will weather the storm but that commercial real estate will eventually “involve a different set of owners.”
Munger’s bear case
The concern could be based on the fact that foot traffic near stores in metropolitan areas is 10% to 20% below pre-pandemic levels while office attendance is 30% lower than before COVID, according to a 2023 report by the consulting firm McKinsey.
That’s bad news for commercial landlords. It’s worse news for their lenders. Munger said in an April interview with the Financial Times that the U.S. banking sector was “full of … bad loans” in the commercial real estate sector. Eventually, higher interest rates, lower rental income and resulting lower property values could send some of these loans underwater.
Despite Munger's dire warning, investors still see plenty of potential for steady returns and appreciation in commercial real estate, particularly in necessity-based properties that are essential to the surrounding community.
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Berkshire Hathaway may be avoiding commercial real estate, but there’s significant potential upside in residential real estate opportunities and you don’t have to be a landlord to take advantage.
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Homebuilders
Instead of focusing on commercial real estate, Berkshire Hathaway is more actively involved in residential property development, having added stakes in several homebuilders in recent months.
The portfolio now includes sizable positions in D.R. Horton (DHI), Lennar (LEN) and NVR (NVR). A potential boom in homebuilding could benefit them all.
According to a December report National Association of Realtors, there is a current national shortage of roughly 5.5 million units. That’s because there have been more households formed than homes built over the past decade since the Great Financial Crisis. Now that lumber prices are lower and there’s persistent demand, investors are betting on a housing boom.
Retail investors can also get involved in this space through a publicly listed homebuilder or the S&P SPDR Homebuilder ETF.
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