From the Ash's

The general consensus of the U.S. populace, including "experts" at Harvard Business School, CNBC, and of course those that stand to benefit most: REITs is that real-estate is a new asset class, liquid in the same way as stocks and bonds.  What the hell?  Do you mean to tell me that I can trade my home on the NYSE?  Of course not!  While REITs have certainly been securitized, thereby reducing the risk to investors who by shares of the REIT (because many are now traded on stock exchanges), the inherent risk to most investors in real estate is still the same.

Let's look at it.  Real estate is an illiquid investment: you pay a purchase price for it, which sets the value of the property, then every couple of years the property is appraised based on the sale prices of other properties in the area and the size, quality, and amenities of the property.  If you decide you want to get out of the property, you have to put up a "For Sale" sign, call a real estate agent, and wait until you get a few offers.  Then, after you've got some offers, you have to accept one and negotiate the terms of the sale (and there are lots).  This process is pretty different from the sale of a stock or bond!

A wise man once said, "If you see everyone doing something, do the opposite there's money to be made".  Think about it: when people got excited about the Dot.Com bubble, the money had already been made.  As more and more people flocked to Dot.Com stocks, returns diminished.  The same is happening to real estate: people think it's a sure-fire investment because so many people have made money in the past few years.  Oops!  Let's forget market fundamentals, forget that the Federal Reserve is raising interest rates at every meeting, forget that half of all mortgages are Adjustable Rate Mortgages or Interest Only Loans, forget that the national average mortgage rate has risen over 180 basis points in the last year.  What do we have then?  Well, rent right now in most major U.S. cities is 45-60% the cost of an equivalent mortgage, residential properties in great locations are sitting on the market for over 4 months, there's a ton of properties for sale in New England in the middle of January.  That doesn't seem like opportunity to me, it seems like a peak in the market.

The major question is how is the downturn going to come about?  Will it be quick or a gradual process?  And how can you capitalize on this knowledge?

The easiest way to capitalize on this market is simple: stocks and bonds.  During the Dot.Coms bonds were the place to be.  Did you know that the bond market outperforms the stock market virtual every year, even during the Dot.Coms?  With interest rates on the rise, you might want to think of how you can trade bonds to capitalize on this market.  Maybe it's time to take out a long-term loan and start planning on how to use that margin to make money elsewhere.  On the other hand, you can always just negotiate IOUs when the time comes to make a purchase, which is probably safer, although it only works for real estate.

Andrew Kessler says "go into the Fog".  The Fog is that place where no one else is, so it's uncertain - you can't see anything, just shadows and illusions - but if you can make out a distinct object before anyone else does, you're going to make a lot of money.  I like to relate it to my youth sailing in the San Francisco Bay.  We went into the fog all the time.  It's part of racing in the Bay.  The trick was to identify the super-freighters in the fog before it took a radical action to avoid them.  The racing teams that make the course adjustment the earliest usually win because they don't lose time and distance from evasive maneuvers.

Fear

On the other hand, sometimes a ballsy skipper could win by going in close to the freighter.  If the wind was right it could be extremely profitable.  But even still, that skipper knew ahead of time that the freighter was there.  He planned ahead to use his competitors' fear of the freighter against them, either leading the pack towards the freighter until they had to engage evasive maneuvers (a devious technique) or simply going where no one else wanted to go.

This is an important lesson in fear.  Most people are driven by fear, whether they realize it or not.  Why is real estate so hot?  "Oh, duh, it's the lure of get-rich-quick."  Is it?  Look deeper: people are getting rich in stocks and bonds every day, just look at Google.  So is it the hype of easy opportunity, or is it the fear of uncharted territory?  Stocks and bonds make more sense to invest in, but the market's scary to people because the Dot.Com crash still burns bright in their memory. 

All of the sudden, by avoiding the "lure" or the song of the sirens you can conquer your fears and make a ton of cash doing it!  In fact, in conquering your fears you're going to realize that you've found safer territory than everyone else.  Real estate looks safe, but it's not, the fundamentals (I'll go into this in a later article) indicate that it's ready to tank - in the next 3 yrs count on it.  So frankly, the stock market is a better place to be.  All of those companies with strong fundamentals will suddenly look attractive to all of those mainstream people who are about to get burned in the real estate market.  It's called value-investing and it's how Warren Buffet, the greatest living investor, made his money (more on this later too).

So for today I'll leave you with this: go into the fog and approach your fear.