Removing Fear & Greed from the Real Estate Investing Process through Education
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On RealtorMag today I spotted an article that states the obvious, but in my opinion does not go into any detail on WHY the point of the article is true. As a reference, here is the linked to the original article:
This article is stating the obvious. Anyone, such as a real estate student, will be more likely to want to pursue purchasing real estate once they have become educated. Education dispels fears by providing facts rooted in logic & reason. The two most powerful forces in any market are Fear and Greed. Fear is more powerful. It takes a stock, and typically Real Estate, a long time to appreciate in value relative to how fast it can crash when people lose confidence, fear takes over and everyone heads to the exits at the same time. Markets ALWAYS overshoot more to the downside than they do to
the upside. The educated people who had the cash during the real estate bust were the very first into the market in 2008 & 2009, and since 2011 have been reaping the rewards of the opportunities provided by the Greedy; many of which got gutted financially.
So what really creates the opportunity? It is a combination of the Fear/Greed paradigm, combined with a general lack of education & sophistication in the general populace. As soon as something, ANYTHING, starts going up and looks promising, people with any kind of cash start to pour into it, regardless of whether they understand the business or not. Don’t just take it from me, take it from the most successful investor in US History, Warren Buffett:
1) One of Warren Buffett’s biggest rules is to never invest in anything you do not fully understand. If you cannot figure out how a venture makes money, don’t walk…RUN!
2) Another rule of the great Warren Buffett is a contrarian rule “Be Fearful when others are Greedy, and be Greedy when others are Fearful”.
3) And according to Warren, the number one rule for building success, wealth and prosperity is NO DEBT! I, personally, don’t have billions of dollars at my disposal, so for the majority of us, a reasonable amount of debt incurred to accomplish a real estate purchase is often necessary. I try to keep debt as low as possible and make sure that any debt incurred is for tangible investment and not superfluous, materialistic, nonsense.
Most people fall into middle & lower income brackets. They have more of an emotional attachment to their money, and generally speaking, therefore have a greater predisposition to Fear & Uncertainty, which certainly clouds judgement. This is not to say that more wealthy people do not share this trait too; after all, these are HUMAN characteristics. These emotions are experienced the moment an opportunity to either
Buy or Sell occurs while the market is in a state of turmoil (or not, but opportunities generally occur when there is an “inefficiency”, typically created by turmoil), be it on the way up or on the way down. If you are a person investing in real estate, you should have a long term approach. It is easy to still get sucked into the mentality of the 2000-2007 market, where people were trading real estate almost as quickly as they could buy and sell a stock.
As Michael Douglas points out in the movie Wall Street, “Greed is Good”, or at least it can be. We all desire more money and greater prosperity for ourselves and those we care about. The very idea of investing is to, bottom line, make money; even if that investment is tied to something “Socially Responsible”, which is completely secondary in the majority of people’s minds. It is Greed that puts us into a position where we are presented with an opportunity to make an investment. Without the desire to make more money, there would be no desire to consider making an investment in the first place. It is at that point where people not only feel the emotions of Fear & Uncertainty, because they are emotionally tied to their money, but while they are sorting through those emotions, they are also trying to contend with what is known in Economics as “Opportunity Cost”; meaning, if I spend my 100K in savings on buying this investment property, I will be giving up the ability to put that 100K to work elsewhere should an opportunity avail itself, or already be considered as an alternative.
It is here where emotions must be put to the side and the would-be investor needs to perform an analysis (actually a set of them). Generally speaking, they should be performing a SWOT Analysis: Strengths, Weaknesses, Opportunities & Threats. If you do not understand HOW you will make money, scrap the opportunity until you fully understand How and all of the Issues, Risks, Actions & Obligations that will come with the investment.
In order to answer under each of those columns in SWOT, additional analyses are needed, such as Market Analysis: pulling comps, doing inspection(s) of the property and getting a rock solid idea of what it can rent for and/or sell for versus the total cost of ownership. You must know what your ROI (return on investment) and your CAP rate (Capitalization Rate is what you get to keep after Taxes, Dues and other expenses on the property are paid for) will be. Be sure to include the cost(s) of Commissions, Rehab and Satisfaction of any Liens associated with the property. This is typically done via a Pro Forma.
While considering the choice (or choices, in which case you may have several Pro Forma documents in front of you) of an investment, you then need to compare it to other types of investments. For example, if I take my 100K and buy an investment property with it, my ROI might be 10% and my CAP rate might be 7%. I might weigh similar opportunities with similar numbers. But I also should look at the “What if I simply invest it in an REIT (Real Estate Investment Trust), that pays a Dividend of 10%? Right now (2013), that looks “better” because even if I am making over the 400+K a year where the tax becomes 20%, I still get to keep a full 1% more (meaning it would be an 8 CAP) than if I owned property and I have none of the management & ownership & general upkeep headache of a property. However, the savvy investor should consider that a physical piece of property can be borrowed against (so I can invest in yet another property, possibly as much as doubling my ROI and absolutely increasing my ROE (Return on Equity). The additional “cost” associated with this would be whatever the mortgage debt associated with the borrowing would be and this too, can be clearly put on paper and calculated in a Pro Forma. In addition, income generated from the property or properties, can be offset with not just taxes & other expenses, but rental properties can also be Depreciated (this is an additional “Deduction”).
The vast majority of would-be investors, in my experience, have little to none of the above knowledge or expertise, and while I have given a pretty solid synopsis, it is simplified and incomplete. A complete dissertation on the subject itself is beyond the scope of my response.
Circling back to the original point, and concluding: given all of the above that I have written about proper investment analysis, there is no mention of emotion playing a role in the decision making / evaluation process, and “gut instinct” has absolutely nothing to do with a legitimate analysis; NOR DOES LUCK! This is where the value of a qualified (and by qualified I mean BEYOND simply licensed to practice real estate) Real Estate Professional can be of tremendous value to an Investor; and a be a provider of “Luck”.
Note: Be prepared to either pay a TRUE real estate professional for properly done Analyses & Pro Forma, or at the very least sign a Buyer-Broker Agreement. As a Real Estate Professional I get paid Fees as well as Commissions, and dependent on the transaction at hand, I have deducted my fee(s) from the total Commission(s) paid on property closings. Be wary of agents “working for free” or not requiring a commitment. The best Brokers & Agents I have met in the business get paid, one way or the other (or both) for their services; and they have a lot of repeat business.
I am a Licensed Real Estate Broker specializing in Residential Real Estate transactions from Downtown Miami, through the Miami Beaches and into Fort Lauderdale along the US1 Corridor and East. Whether you are a First Time Home Buyer, an Institutional Buyer, or Private Investor, I will be happy to provide you a consultation to evaluate your real estate investment goals. I can be reached at 1-800-798-9192 ext. 333. My MLS Website can be found at http://REBroker.Miami.
I am a Qualifying Broker Metro International Investments & Miami Beach Brokers.
View all posts by Christopher J. Lazaro