Concerned your investment portfolio is in a bubble?

You can’t predict. You can prepare.

No investor wants to be on the wrong side of a market cycle. In hindsight, we can pinpoint when one market cycle ends and another begins. However, its impossible to predict when and what circumstances will usher in the next cycle.

According to the illustration above, currently (2021-22), we are in the Mania Phase of the market cycle. In the “Mania Phase” assets can go from overvalued to more overvalued depending on investor emotions.

At some point, the credit market tightens and interest rates are forced higher to combat rising inflation. Many borrowers are then unable to roll over their debts, and the cycle repeats itself.

The fundamental business of the country…is on a sound and prosperous basis

-President Herbert Hoover, (October 25th, 1929)

Four days later, from the quote above, the stock market crashed wiping out billions of dollars. The Great Depression and the more recent Great Recession, reminds us that our government offers very little true insight to what may happen or how to be prepared.

Intrinsic Value

The true intrinsic value of an investment property can’t be easily attained. It’s best to be used as a guide to evaluate the risk of investment at a given period of time. Real estate’s intrinsic value can deviate from its market value based on a number of factors. The most common are supply & demand and the cost of capital (interest rates, etc.).

In our opinion, intrinsic value for real estate could be better characterized as it’s value when it reverts to the mean. The below illustration demonstrates how investors emotions and market forces can pull values like a pendulum in different directions.

Using this pendulum above as an example. If the property’s intrinsic (neutral-mean value) was $100,000, then during market swings of limited supply and excessive lending (Greed), the value could be pushed to $150,000 or higher.

Conversely, the property’s value could be pushed in the opposite direction toward (Fear/Anxiety), thereby lowering the value to $50,000 or less. During the Great Recession real estates intrinsic value diverged severely from its mean toward Fear & Anxiety.

The most dangerous period in time for investors is during the “Greed Phase” or as illustrated in the first chart the “Mania Phase”.

Too much money chasing too few of goods.

Lenders along with investors are encouraged to take on more risk late in the “Mania Phase” in search of a greater return.

Most investors are risking their wealth and future because they are told their isn’t another way. They are told to ignore market cycles and blindly pursue dollar cost averaging strategies.

As Howard Marks put it: “Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity“.

Its seems counterintuitive to like something more the higher it becomes in price. However, that is exactly the mindset with most investors. We should be pessimistic when prices rise rapidly and optimistic when they become lower at a bargain.

Our investing strategy is different

In real estate, where we invest, most investors only look from the standpoint of creating equity by improving the property or increasing rents. This is popularly know as “value add” investing.

During times of market peaks, novice investors become self described experts in this strategy. Early in the “Mania Phase”, these investors are further encouraged to take greater risk from seeing the past success of their peers.

This strategy may backfires badly when either interest rates rise or an unforeseen negative event takes place. The problem is further exasperated when investors leverage their property with short term loans.

The best strategy is to find equity instead of speculating that you can create it.  

This is easier said than done to find equity in real estate. Sellers are better equipped than ever to know their properties market value. Currently, the pendulum isn’t swinging in the investors favor to purchase without undue risk.

Therefore, best place to look for equity is where loans are created. Preferably, loans that were created during neutral or negative periods in the market.

Lenders aren’t in the real estate business they are in the credit business. When a borrower stops paying on a loan, it’s in the lenders best interest to sell that loan as fast as possible. In the mortgage investment world, this is known as a non-performing loan.

Investors, like our group, purchase these loans at a discount based on the time it will take to foreclose and the amount of equity to be acquired.

Purchasing loans is only one way Protect & Build Wealth. As the market cycle inevitably changes, more opportunities will present themselves. 

The question is will you be prepared to take advantage?