Imagining a cashflow monster

Regular readers know I’m an avid follower of Berkshire Hathaway, Warren Buffett’s company.

One interesting thing about BH is that Buffett never issues dividends. His argument is that he can find better uses for cash the company generates than the investors could on their own (particularly given that dividends are subject to taxes at the individual level).

By constantly re-investing the cash thrown off by BH’s vast holdings, Buffett is able to compound the value of its holdings perpetually.

Public real estate companies are organized differently – as Real Estate Investment Trusts (REITs). This structure acts as a pass-through entity (like an S-Corp or LLC) so that the distributions investors receive (effectively, dividends) are not subject to double taxation.

In exchange for this special treatment, REITs are required to distribute the vast majority of their earnings to investors. In other words, they are unable to re-invest their earnings. To grow, they need to sell more shares to the public, effectively diluting the ownership stakes of their present investors.

Why am I thinking about this stuff now?

The (ever-shifting) Republican tax bill winding its way through Congress right now is designed to cut corporate taxes (on C corps, like BH, Apple, Google, etc.) from 35% to 20%… a level which is well below the individual rate.

What if, in response, you organized a real estate holding company C-corp.?

Investors would be given the following rules of the road:

  1. The company will buy income producing real estate;
  2. The company will utilize sophisticated tax structuring to absolutely minimize taxable income, and any such income would be minimally taxed;
  3. There will be no dividends – so no double taxation;
  4. There will be no new shares issued – so no dilution;
  5. Instead, the company will reinvest all cashflow from operations, refinances and (eventually, asset sales) back into more income producing real estate, which will in turn generate more cash for reinvestment.

At some point, the company would need to provide a market for its shares… probably via being publicly traded. This would allow investors who wanted out to get liquidity.

But, so long as management is smart and frugal with overhead, I think most investors would be happy to leave their money in, effectively permanently, and have it perpetually compounded in a tax-efficient manner.

It would be the ultimate, diversified, tax-efficient, long-term real estate play.