Erfahrung for Real Estate Investors, Part 1

“Be fearful when others are greedy … and greedy when others are fearful.” – Warren Buffett

In the last few years, you’d come across dozens of articles about the real estate boom. Today, they’re about bubble and bust. Here’s a smattering from the last week:

“The Boom Is Over, but Don’t Expect Big Drops in Real Estate Prices, Realtors Say.” That’s from the South Florida Sun-Sentinel. It’s basically a press release from the National Association of Realtors (NAR) presented as news. Well … what would you expect NAR – whose members make their living selling property – to say? “Prices are going to fall through the floor. Don’t buy now”?

Then there’s this little gem from The Sentinel of Carlisle, PA: “Real Estate Profits Not Assured.” You don’t say! You mean if you pay market price in an overpriced market and set yourself up for negative cash flow with an adjustable rate loan whose payments are creeping up, up, up … profits aren’t assured?

US News and World Report takes a much more grave view, and they deserve credit for putting an opinion on the line. Their headline is “Housing Bubble Correction Could Be Severe.”

Last, and perhaps least, is Business Week.Their article rates at the bottom of our little survey, because they’re straddling the road. No one can say you’re wrong if you don’t take a position. And they’re doing some classic fence sitting. Their headline is “Bubble, Bubble, Who’s in Trouble?” The article begins: “Worried investors are hunting for safe havens. But with so many bubbles about, it’s anyone’s guess which way to turn.”

I suppose that’s true. But I’m going to give you my guess anyhow. In fact, I’m going to tell you where I’m putting my money. I could be right or wrong. But my view is at least based on erfahrung.

Michael Masterson has written about erfahrung many times in ETR. It’s a German term for “experience-based knowledge.” And my experience as a real estate investor – as a stock market investor too – is that you tend to make your biggest profits by going against the crowd when the crowd is caught up in emotion.

I’ve learned this not only from my own investments, but also from some of the most successful property investors I know. And some very successful stock pickers – like Warren Buffett and Sir John Templeton, to name a few – have made a similar point.

Don’t get me wrong. People like me are always going to insist on value when we invest. But when folks start to practically give away income-producing assets at far below market prices … well, we’re going to do them the courtesy of taking some of those assets off their hands.

Profiting From the Fear Factor

We’re early in the correction phase in many of the bubble markets. Yet fear is undoubtedly beginning to dominate a lot of them, including the market where I live in South Florida. Along with a few other value-focused investors that I know, I’m starting to find a handful of deeply under-market, cash-flow deals, the likes of which we’ve not seen in years.

They’re not common. They’re still few and far between. But you don’t need to find many of them to make a big difference in your life.

But before I give you some examples, let me present my anti-bubble credentials. I don’t want you to think I’m saying you shouldn’t worry about bubble markets. Far from it.

Unless you have a system for finding deeply undervalued cash-flow properties, you should absolutely stay away from buying property in the bubble markets. However, if you know what you’re doing … you may begin to find a few extraordinary under-market, cash-flow deals even in those areas.

But again, before I get to that, allow me to present my anti-bubble papers …

A Bona Fide Bubble-Buster

As you may know, I developed a program for ETR that covers just about every aspect you can imagine about deep-value investing in small residential properties (one to four units). It’s called Main Street Millionaire. I first published the program in 2003. Even back then, I dedicated an entire tutorial (#8 out of 24) to real estate bubbles. The tutorial is called “Are You Living in a Bubble Neighborhood?”

Also, in May of ’04, over two years ago, I wrote an article for ETR titled “Will You Be Protected When the Bubble Bursts?” Here are a few snippets from it …

“As an investor in real property today, you have to be especially careful. Prices in many areas have doubled in the last 3 to 5 years, while real estate traditionally doubles in value about once every 12 years. You may be buying after much of the easy-money appreciation has already occurred in your neighborhood, and if you get caught up in a bidding frenzy, you could get hurt …

“I’m not so sure the current boom in real estate prices can last much longer. If it goes longer than another year, I’d be surprised. And if interest rates do start to rise, unemployment skyrockets, or there’s some terrible turn of events in the global political situation, things could turn bad quickly. Trees don’t grow to the sky.”

In that article, I also mentioned that I was still buying select properties – because I “waited for my pitch,” insisting on deep value. And I was able to find a few at 30 percent or more below market and at prices where the rents more than paid for the carrying costs (loan payments, taxes, insurance, and an allowance for maintenance and vacancy).

As always, I advised my readers to only buy cash-flow properties at a discount, using fixed-rate loans. Then, I gave this piece of advice:

“It’s a good time to review the cash flow of each investment and consider unloading any that will hurt you if the bubble bursts and your rental income drops significantly.”

I say this to show you that I have never been an apologist for real estate. It’s a great investment class – and I think you can make money in just about any market if you know what you’re doing. But you’ll never hear me say anything close to “You can’t lose in real estate.”

You can lose in anything if you try hard enough. (“Profits aren’t assured,” as the Carlisle Sentinel pointed out.) But if you know what you’re doing and understand market cycles – and that real estate markets are local – you can find extraordinary deals. Not only in the bargain markets, but also a handful of great deals in the bubble markets.

Patient, Value-Focused Buyers Can Make Substantial Profits From Eager Sellers

Since the beginning of the year, I’ve done four real estate deals at substantial market discounts. Two are in a deflating bubble market and two are in a deep-value nascent bull market. By conservative estimates, I’d say they generated $185,000 in “instant equity” the moment I signed on the dotted line.

On Monday, I’ll go into more detail about how I found and qualified each one of these deals.