Concerned you’re investment portfolio is in a bubble?

You can’t predict. You can prepare.

The only sure thing we as investors can rely on is that markets have cycles. We may not know where we’re going in a market cycle. However, we can know were we’re at. In our current “Mania Phase” assets can go from overvalued to more overvalued depending on investors emotions. At some point, the credit market will begin to raise interest rates inline with inflation. Borrowers then will be unable to roll over their debts and cycle will repeat itself. The question, which no one knows, is when.

In addition, we can’t rely on experts or our government for answers to our future. Here are few quotes just before the Great Depression.

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

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

We are only at the beginning of a period that will go down in history as the golden age.

Irving T Bush, President of Bush Terminal Co. (November 15th, 1928)

Intrinsic Value

Our investment groups objective is to gauge real estate investments relative to its true value. This is more of an art than a science. Real estate’s intrinsic value can deviate from its market value based on supply and demand. Furthermore, the rising and lowering of interest rates can exasperate the properties value.

Due to these market forces, our investment group is mostly contrarian buyers. During peak market cycles our group is relatively inactive, and only seeking investments that can be purchased well below market value and closer to it’s intrinsic value.

In our opinion, intrinsic value for real estate could be better characterized as its 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 as an example. If the real estate’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 real estate’s value could be pushed in the opposite direction toward (Fear/Anxiety) lowering the value to $50,000 or less. As we saw during the Great Recession, when real estates intrinsic value diverged severely from its mean.

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 puts 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 sentiment with investments.

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. 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 risks from seeing success from their peers.

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

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

This is easier said than done in real estate. Sellers are better equipped than ever to know their properties value, due to technology and the internet. 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 of the ways we Protect & Build Wealth. As the market cycle inevitably changes, more opportunities will present themselves. 

The question is will you be prepared to take advantage?