I’m Betting Against Buffett’s New Venture — Here’s Why

“If I had a way of buying a couple hundred thousand single-family homes… I would load up on them,” Warren Buffett said in a CNBC interview in 2012, citing the historically low mortgages rates at the time.

#-ad_banner-#Buffett went on to say that his Berkshire Hathaway (NYSE: BRK-B) simply wasn’t set up to purchase and manage what would be the world’s largest portfolio of single-family homes. However, he is cleverly doing the next best thing.

Berkshire is quietly building an empire within the housing market that doesn’t actually own, manage or otherwise control single-family homes. His new business is a transactional business that profits from the buying and selling activities of others — namely, the residential real estate brokerage business.

Berkshire is rolling across the United States snapping up and rebranding local and regional brokerages under its own name. If you haven’t seen  Berkshire Hathaway HomeServices’ maroon signs in your area, you likely will soon.

Needless to say, residential real estate sales are a huge business. This industry saw its first wave of consolidation as a highly fragmented group of small local operators were acquired or displaced by larger regional firms. After a second wave of consolidation, the marketplace is now controlled mostly by a handful of national franchises — and as I see it, Berkshire Hathaway is leading the next wave of consolidation in the residential brokerage business.

I first noticed this change when I visited my old neighborhood in Philadelphia. Nearly every home for sale boasted a maroon Berkshire Hathaway HomeServices sign posted on the property, with the name of the local brokerage for brand recognition. These new signs left no doubt that Buffett is in this market in a big way.

  HomeServices’ growth is completely reliant on the continued improvement of the national real estate market — but the market is tied to interest rates, which have started to click higher.  

Unknown to most investors, Buffett entered the real estate brokerage business back in 2000 with the acquisition of HomeServices as a portion of his buyout of MidAmerican Energy Holdings. Over the past several years, Berkshire Hathaway HomeServices has allocated close to $500 million for acquiring regional real estate brokerages. The sales force has grown by more than 50% during the past 24 months and now numbers about 22,000 agents.

HomeServices’ CEO has said that the real estate market’s slow but sustained improvement means the time is right to expand Berkshire’s footprint in the industry. A quick review of HomeServices’ newsroom page shows the firm has been very busy building its brand and acquiring smaller brokerages across the country.

So the question isn’t whether Buffett is going to have a winner with HomeServices — it’s too soon to tell. HomeServices’ growth is completely reliant on the continued improvement of the national real estate market — but the market is tied to interest rates, which have started to click higher. In addition, home sales have been dipping recently.

Perhaps more significantly, the traditional brokerage model — in which homebuyers deal with licensed professionals in making what is often the biggest purchase of their lives — is facing heavy headwinds. The rise of the Internet and discount brokerages has made real estate deals less expensive for consumers, and many are even handling their own transactions. Educated consumers simply will not be willing to pay the high commissions required to maintain the huge infrastructure of large brokerage firms.  

Despite the strength and speed of Berkshire’s move into residential real estate, I think these headwinds will prevent the development of organic growth (not based on acquisitions) over the long term. The commission-based sales model HomeServices is built on could well be breathing its last breaths, and I expect the unit will be a weight around Berkshire’s neck within the next few years.  

Risks to Consider: As an upside risk, Berkshire Hathaway’s broad diversification may cushion the effects of a slump in its HomeServices unit.

Action to Take –> The market has shown approval of Berkshire’s aggressive moves in residential real estate, but I suggest shorting the company’s Class B shares as long as $131 is not taken out on the upside. I expect BRK-B to be trading near $100 within the next 12 months. 

P.S. My colleague Nathan Slaughter has been telling readers of his High-Yield Investing advisory for months about one enormous but little-known opportunity in real estate. To learn more about Nathan’s absolute favorite picks in real estate, which help regular investors unlock an income stream previously reserved only for America’s privileged elite, you can read his special report by clicking here.