Are You Scared On The Sidelines?

The Real Estate Espresso Podcast

Are You Scared On The Sidelines?

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Are You Scared On The Sidelines?

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

On today’s show, we’re talking about investor psychology during uncertain times. If we look back over the last five years there’s numerous excuses for making no decision. Back in 2019, there was drop in lending liquidity, it spooked some investors. Then in 2020, 📝of course, there was the pandemic. Then came the supply chain shortages and the labor shortages. Of course, there was price inflation and eventually higher interest rates. Then came the war in the Ukraine, then the war in the Middle East. There was worry of supply chain shortages during extreme weather events. Then people wanted to wait for interest rates to get lower, then people wanted to wait for the outcome of the U.S. election. Then came the uncertainty of tariffs and trade wars. Then there was the rising dollar and then the falling dollar. There will always be something all the time, if you look for it. Investors seem to want the most boring, predictable environment. They want the certainty of a government bond with the yield of a unicorn tech startup. They want all the tailwinds and none of the headwinds.

See, real estate is hyperlocal. The supply and demand for real estate is based on market fundamentals. It comes down to being clear on what your criteria is for investing.

What is your investment horizon? Is the 5% to 10% increase in upfront cost going to fundamentally undermine your project?

If your investment horizon is 6 months and your profits are razor-thin, then you’re probably relying on macro market forces to generate your profit. You’re not really being a professional investor at that point. You’re being more of a speculator. But, if you’re viewing the market through the lens of fulfilling a demonstrable market need and you’re removing the speculative component, then you can do well.

Yes, all businesses have some risks associated with them. But, if your business case is compelling enough to withstand a few headwinds, then you should make the investment.

This means performing sensitivity analysis to see how bad things need to be before they turn from a compelling business case to maybe a marginal business case and, god forbid, a money-losing proposition. Investing is not just taking a flyer on a random bet. This is not an evening at the roulette table in Vegas. Investing is a profession. It involves doing some math.

See, some investors just look at historic performance as the best indicator, but the true professional aims to separate the market specifics from the market averages. And, yet if you want to look at the averages, you want to zoom way out.

Back in 2009-2010, many investors ran for the exits. Real estate was way too risky for them. We know, through the wisdom of hindsight, that only the properties that were allowed to get upside-down and became truly distressed were the problem properties. It took a full four years, from 2008 to 2012, for the bottom of the market to be reached.

Many people think the problems were confined to residential real estate during that period. And that’s not the case. There are many commercial and multifamily properties that also experienced problems during that period. Many properties purchased in 2006, at the top of the market, were clearly overpriced when you viewed them through the lens of 2008 and beyond.

But we need to zoom out and look at the bigger picture. Clearly, you would prefer to have bought in 2010 compared to 2006. All of those properties that did not go bankrupt are still doing just fine today, regardless whether they were purchased in 06,08, 10 or even 2012.

See, inflation is still a real thing. Inflation is the devaluation of the currency. It results in asset price inflation not just consumer price inflation.

Let’s do some math. If inflation is running at 2% a year then the value of the dollar will fall by one third over a 20 year period. This is the silent tax on everybody. Inflation is a wealth transfer. It wipes out the purchasing power for those on fixed income, it wipes out savings, but it also wipes out debt.

See, if inflation is running at 3% a year, which is closer to reality, then the value of the dollar is reduced by 45% over that same 20 year period. So, you have to ask yourself a few basic questions.

Is President Trump going to eliminate inflation for good? He’s going to try to balance the budget, which would be a good thing for the country. But is Trump really going to eliminate inflation? Of course not!

So what started out as a loan on a new project, might have been an 80% loan to value, after even ten years, because of rent growth, this is the magic of inflation, and expense growth, because of course you have both, you still have positive growth in the net operating income and therefore growth in the value of the building. The loan value in that first 10 year period will drop because of the devaluation of the deck with inflation, and the income will increase. The net result is a tripling of the value of the equity within that first decade and the major contribution to that equity increase is the result of inflation.

The loan to value ratio will decrease accordingly after 10 years on a 30-year loan where you would have started at 80% loan to value: you’re now at 42% loan to value. That’s the magic of inflation. It’s assuming that you don’t see any market appreciation or make any other improvements to the property that would bring you additional income in those first 10 years.

You see, you could be sitting on the sidelines for the past five years using all the excuses in the world and now using the volatility of the Trump presidency as yet another reason to sit on the sidelines.

But the most important thing is to pull the trigger and get in the game with a project that’s underwritten conservatively so that you’re safe from the negative knife’s edge of borrowed funds. When you have that, you get on to this train that is going to generate cash flow for you and generate value for you for years and decades to come.

As you think about that, have an awesome rest of your day, go make some great things happen! We’ll talk to you again tomorrow.

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