Do not let the allure of a beautiful home distract you from considering all the variables when purchasing property. While It can be difficult to step back and look at the exogenous conditions in the marketplace when consumed with site visits, price comparisons, and eager salesmen, it could prove to be disastrious if you do not do your due dilligence.
Howard Marks, cofounder and chairman of Oaktree Capital Management – an investment company with over $2 billion in assets under management – writes multiple memos each year regarding various topics in the financial markets. In one of my favorite memos he aptly entitled “Ditto”, Marks very lucidly describes cycles in financial markets using the real estate sector as a prime example.
One main theme in the memo is discovering what it takes to be a contrarian. If you are looking to buy a home, whether you like it or not, you are an investor. Your home is an asset that will appreciate or depreciate in value. If you are instead interested in renting, rather than considering it an investment, you can look at the opportunity cost of renting now versus later.
Most times, one will find the best deals or masked valuable opportunities in times when conventional wisdom sees the real estate market as unstable and treacherous. Or conversely, one will wind up over-paying for a property when most people think the market is booming and can only go up.
In Marks' eyes, in order to be a successful contrarian you have to be able to:
- See what most people are doing and understand what is wrong about their behavior
- Possess a strong sense for intrinsic value, which most people ignore at extremes
- Resist the psychological pressures that make most people err, and thus Buy when most people are selling and sell when most people are buying
My favorite financial idiom, which is directly in accord with Marks’ comments, was spoken by N.M. Rothschild, a 19th century banker whose investment banking company still thrives today:
“Buy when the cannons are thundering and sell when the violins are playing.”
It is one of the most difficult things to do; not only to have antithetical views when there is chaos afoot, but to also have the gumption to act on these views. And on the flip side, to challenge yourself to resist the notion that the market cannot fail, and sell at a point when the growth seems unstoppable. If you can master this, it will allow you to strategically jump in and out of the real estate investment cycle with the finesse necessary to see big returns on your positions.
As Marks has done time and again, he comprehensibly describes a generally incomprehensible phenomenon to the layman. As you read through this market's cycle, think about how you might view each step from a buyer’s perspective. Where would a contrarian act?
The Cycle Of The Real Estate Market
Below I have provided Marks' mapped out example of how this cycle progresses, as well as the repercussions that arise and build on each other over time:
Bad times cause the level of building activity to be low and the availability of capital for building to be constrained.
In Conclusion: Consider The State Of The Cycle Before Investing
As is made clear, one seemingly small variation in the sequence can cause domino effects that perpetuate this turbulent -- yet ultimately (somewhat) predictable cycle. Looking at the example above, one can see clear patterns emerging, and the subsequent investment opportunities they give way to. Having the ability to understand and make decisions based on this understanding can prove invaluable when analyzing the real estate market and its components -- regardless whether you are a seasoned real estate investor or first time home buyer. Deals in real estate take time so be careful to not only consider the current market conditions; look to the future (and the past) as the landscape can quickly change right before your eyes.
