Investors Fear

I had a really interesting question from an investor who WANTS to buy but is very reluctant. His question (actually a double-question) was indicative of the fear that keeps many investors on the sidelines even though they KNOW this is the time to buy. So I want to answer this double question with some market background and an investment strategy going into 2010.

I was telling this investor that I had found two really nice houses with panoramic mountain and city views – NOT fixers – in the foothills area under $100/sf, and I also found “several” in North ABQ Acres under $110/sf. If you follow prices in the Far NE of ABQ, then you know we haven't seen prices like these in 15 years. $110/sf for a view lot house up there is a screamin' great deal, and he wants to buy one… but his question was, “When will the market recover?”

But I think what he was really asking me was, “WILL the market recover?” You see, asking WHEN the market will recover is just a timing question and it's easy to answer. If you believe, like I do, that we're “in the bottom” then you know this is the time to buy because the market in 1 or 2 or 3 years will be better than it is today. It doesn't matter if we're at the bottom or just about at the bottom or just past the bottom. In 2-5 years, it WILL be better. That's why contrarian investors buy when the market it down, while the “play-it-safe” investors wait for the market to recover before they buy.

But when you ask WILL the market recover, you're really addressing the fear-question. In 2005 when the market was flying high, no one believed it would decline even though cyclical markets like real estate and the stock market always do. Now that the market's at the bottom, no one believes it will improve… but it will. It always does. It's the cycle of business and economy.

But this particular investor also said, “Unemployment is over 10%, in Florida it's 16%! The economy is still in bad shape.” I agree, there's no doubt about that.

But remember the rules of “cause and effect.” Unemployment is not a CAUSE or an economic indicator; it is an economic EFFECT. The experts refer to the four horsemen of the economic recession: asset deflation, reduced credit availability, rising unemployment, and food and energy inflation. Here's what happens in EVERY economic cycle: people load up their houses or apartment buildings with debt and when they can't afford it anymore they sell into a rising market. But at some point market values peak buyers can't afford the inflated homes, so the sellers can't sell, then they have to reduce the price and sell lower.

Then their loans are “underwater” where the property is worth less than the loan balance. Banks tighten credit and stop lending on underwater assets, so if asset owners can't sell, they bleed their bank accounts dry until they go into foreclosure. Then they have less money to spend on discretionary items. Then retail sales go down and companies' earnings go down so they cut capital costs and lay off workers (unemployment). Then companies sell less so they try to borrow money for operational capital, but risk to banks goes up so interest rates rise (inflation).

But here's where the cycle begins to repeat. When inflation goes up, companies and asset holders become distressed and INVESTORS START SNAPPING UP BARGAIN-PRICED ASSETS. Why? Two reasons: first, they know that the bargain-priced assets they buy today will be worth much more in the future. Second, investors also know that when inflation creeps up, interest rates will be higher, so the assets they buy now with cash or low-interest loans can be resold at a favorable interest rate spread. This is a HUGE future income boost because you'll have appreciation income PLUS interest income, and interest income can easily be much more than appreciation. If you don't believe this, consider how much interest you give your credit card bank and how little you pay down the actual balance! HINT: novice investors sell for “simple interest” but savvy investors sell for “compound interest.”

So going into 2010 and coming off this BOTTOM MARKET, here's your strategy:

1. Look for well priced desperate sellers who are NOT short-selling. These folks have bled their bank accounts dry and will give away all their equity just to stop the bleeding. Don't be greedy though; be prepared to pay the current list price which will be reduced so much the properties are way under market value.

2. Look for well priced bank foreclosures because banks certainly want these properties off their books. But if the bank reduces the price by a big amount, please don't try to squeeze more out of them. They'll just reject your offer. It's standard bank pricing psychology. Instead offer asking price so you'll get a fast approval, then I know some fool-proof techniques to get price reductions AFTER we have them under contract without losing the contract.

3. If you're a cash buyer then you can also go for well priced short-sales If you have patience and can wait 6-9 months to close.

In all the above scenarios, buy with cash (yours or someone else's) or with today's low-interest loans, then plan to hold for a year or two, then sell on REC with ample downpayment and 2-7% interest rate spread.

If you do this and have a patient 2-4 year investment outlook, there's no way you won't make money… unless you wait to buy AFTER the market has already recovered. Remember where the stock market was in March – down at 6500 – now it's back up to 10,500. In EVERY market cycle the housing market follows the stock market by 6-9 months and the commercial market follows by another 6-9 months. Always has, always will. Unless the planet blows up, of course. keep in mind. that all the above can occur for investors who willing to step out and take a chance. A chance on themselves, but more importantly, a chance on what they believe in and after doing their homework on any given deal.