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The Full Nelson

An Open Letter to Warren Buffett

Dear Mr. Buffett:

I have followed you over the years and am a tremendous fan. I have always been impressed with your eye to invest in companies which have strong fundamentals and great long-term earnings potential. You have also lead by example, by not following the herd. You have taken bold positions (being greedy at times when others have sat on the sidelines in fear.

You have no doubt some exposure to real estate by investing in Wells Fargo and companies which benefit from a housing market uptick such, as Benjamin Moore and Cort. You have faired well. In your last quarterly letter, you mentioned that the housing market has bottomed and that you see this as an opportunity. I couldn't agree with you more.

With all this in mind, I still don't believe that Berkshire Hathaway has proper real estate diversification. You could greatly enhance your holdings by owing real estate directly. To rectify this, I have a recommendation: buy Brooklyn, specifically every investment property in Brooklyn.

Last year, you could've done so for the very reasonable sum of $1.5 billion dollars, which would have only been a fraction of the estimated $37 billion in cash in Berkshire's portfolio. According to Massey Knakal's estimates, this would have included 742 properties. Not a bad investment, seeing how this would have only bought two or three trophy office buildings in Manhattan.

In 2010, the US Census said Brooklyn's population was 2,504,700 people, which is 30.6% of New York City. It is the 5th largest city in the US. That has certainly grown as many now prefer to live in the borough. When else could you buy a top 5 city for $1.5B?

The fundamentals of this market are also very strong. Accordingly to the 2011 NYC Housing and Vacancy survey, Brooklyn had a vacancy rate of only 2.61% compared to the city of average of 3.12%. Even Manhattan had more vacancy. As a result, the rents there have soared. MNS reports that residential rents have grown 10% in the last year. This trend should continue as little new product is being built as land is few and far between.

The office market is also very strong in Brooklyn. According to Newmark, the vacancy rate is only 6.9% with affordable asking rents of $30/SF, which is almost half of Manhattan's, a great value considering it is only 10-15 minutes away by subway.

You would be able to benefit by immediate attractive cash flows. The current average returns for apartment buildings range from 5.4% for an elevator building to 7.28% for a walk-up. Seeing how you can borrow money today at 3% for 5 years at 65% loan-to-value, this would create cash-on-cash returns of over 8% in some cases. These cap rates are about 100-150 basis points above 2006-07 levels when interest rates were considerably higher.

Better yet, these investments have tremendous upside as most apartments in New York City are rent regulated and the rents are artificially low. As the units become vacant, there is only upside. You will be able to buy the real estate at well below replacement cost. Apartment buildings sold for under $200/SF on average last year in the borough. Even if land was free, you could barely build new for double the cost.

With all this in mind, now is the time to strike. We will look back on this window of time when interest rates were low and returns for hard assets are attractive. In 2006-07 rates were higher creating negative leverage in many cases. Today you can receive great cash-on-cash returns. Others are already starting to notice as Brooklyn's dollar volume is on pace to double this year. I'd make your move before Bill Gates decides to diversify.

James P. Nelson, Partner

James Nelson is a Partner at Massey Knakal Realty Services. Since 1998, he has been involved in the sale of more than 200 properties and loans with an aggregate value of over $1.3 billion in the NY Metro Area. He can be reached at [email protected] or 212-696-2500 x7710.

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