Would you buy a property knowing that it may go down in value next year?
If I told you the answer could be a “YES”, you might think that I’ve lost my mind. But what if I told you the world’s greatest investors more often than not take advantage of this “stupid” thinking and reap enormous financial benefits out of it. The fact that the majority of the people think it would be a stupid idea is usually a good sign, because the majority of people usually get it wrong when it comes to money. Let me explain.
Let’s look at a very famous example from arguably the greatest investor of all time Warren Buffet. When he bought Washington Post shares initially they were still on their way down. That’s a point where no one would think it is a good time to buy. We may ask why Buffet didn’t wait for another year until the stock reached the bottom before he bought in.
I have spent a lot of time reading the investment philosophy of Warren Buffet and his teacher Benjamin Graham, and although they mainly invest in shares, I have found their principles apply exactly the same to investing in properties.
In case you didn’t know, Warren Buffet has never thought he had the ability to pick the bottom of the market; neither did he ever attempt to do so. Let’s look at a few of his famous quotes about why it is a dumb idea to buy an investment only when it is going up:
- “For some reason, people take their clues from price action rather than from values. What doesn’t work is when you start doing things that you don’t understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it’s going up.”
- “As far as you are concerned, the stock market does not exist. Ignore it.”
It is very obvious that Buffet buys investments that he sees have value and great potential, rather than looking only at what the investment has done in the past 12 months or will be doing in the next 12 months. He has said many times that he doesn’t know what the market will do in the short term and he does not try to predict it at all.
He simply works out what the share price of a company should be at any moment and what its future potential could be. He completely ignores whether the share is trending down or up at the time. He just buys it when he decides he is financially ready to do so and the share presents sufficient value to him.
If we apply the same philosophy to residential property investing, we would first need to work out whether the suburb we were looking at presented sufficient value for us to invest in. For example:
- If the residents in that particular suburb can’t afford more than $600k for a house based on their income, and if the suburb is already selling homes at an average of $800k, then the suburb is already over-priced. Even if the prices may have been moving up and may still look like they were continuing to go up, I would still stay away from the “hype” surrounding that suburb.
- However if the residents in another suburb could afford a $600k mortgage based on their income, and the suburb was currently selling properties at an average $400k, then the suburb is under-valued. Even if the prices were moving down in the short-term, I would still consider buying there as I would be buying into at least $200k of value that other people may have overlooked. Obviously other due-diligence would be still required to back my initial observations.
I know that ideally we’d all like to be able to pick the bottom as the right time to get into the market, but this idea is only good in theory and rarely doable in practice. This is due to the following reasons:
- If you are waiting for the price to reach the bottom before you buy, you can never know when the price has reached the bottom. Because when it really reaches the bottom, the negative emotion in the market will be at its peak. For those who couldn’t make a buy decision when the market news was less negative, what makes you think they can make a buy decision when the negative news is even worse? Hence 99 out of 100 people who try to pick the bottom usually miss the bottom.
- If you keep expecting the price to go down further on an investment, you will be constantly looking for negative news and references to confirm that you are right (that is what people do☺). Even when the price reaches the actual bottom and starts to rebound and move up, you tend to still think that the rebound is temporary and worry it will surely go down again soon just like what you have been predicting. Hence 99 out of 100 people who try to pick the bottom usually also miss out on the way up as well.
- What is worse than both of the above is that our money rarely sits still in our bank accounts. If you put away a lot of money waiting for the market to bottom out, it is in my observation that most of that money won’t be there for you to invest when the market really bottoms out, because fear and greed are two sides of the same coin. You can’t have one without the other. For example, if you are fearful to get into one investment, you are also likely to be greedy to get into something else at the same time. Hence many fearful investors find themselves getting into outrageous investment scams. If you look around, investment scams are more widely promoted during bad times than good times, because fearful investors create such demand for them.
Can you see why it is smarter for most investors to park their money into an under-valued investment that may or may not be trending down rather than leaving their money in the bank and test their ability to not do something silly with it?
So the best way to buy an investment is to ignore the price movement and act as if the market doesn’t exist just like Warren Buffet says. If you stop looking at the market, you won’t see whether prices are trending up or trending down, so it will force you to work out a value formula to follow instead.
When you come to decide when and what to invest, all you need to do is ask yourself the following 2 questions:
- Am I financially ready to do so?
- Am I buying an investment that has sufficient value now and in the future?
Our recommendation for the first question is to follow an investment plan where your financial parameters are clearly defined and you have financial risk management to tell you whether you are in a position to buy.
Our recommendation for the second question is to buy properties which are at least 30-50% under-valued at any given time. For example, you may buy a property at $400k knowing the residents in the suburb on average can afford to buy a $600k property with their current income level. It will only be a matter of time before that $200k increase in value will show up in your bank account.
Over the last two years, the property market has shown different performance in different areas so buying value becomes even more important as most properties don’t present themselves with an intrinsic value based on my calculations.
I have spent considerable time explaining how and where to find this value gap in your property purchases in our Wealth Acceleration Workshops. If you select the properties that are under-valued, they will go up quicker than other properties during good times, and they will also drop less than other properties during bad times. Most importantly however is knowing that you have bought value from day one and that value will be realised sooner or later.
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