Economic theory and academic practice spends a lot of time on the subject of the business cycle and how to smooth it out. The idea is that there is going to be a natural up and down to the economy, but that by having appropriate policies in place (monetary, fiscal and legal structure) this up and down can be “smoothed” out a bit so that major upheaval stemming from huge economic swings does not cause collateral damage to individuals. As a Realtor (with a background in finance), I am always keeping an eye on the broader economy while applying the principles to real estate.
Yeah, that first paragraph is scary enough, but we need to discuss just a little more of the basics of economics to eventually get to a very important point. Keep one technical detail in mind: demand for an asset causes that asset to rise in price. Keep this psychological detail in mind: the vast majority of the population makes economic decisions with far too much emphasis on the short term. This psychological phenomenon leads to irrational panic and irrational euphoria.
What does all of this mean? It means that if you can think about what you are investing in on a 5-10 year horizon and use a little common sense, there are opportunities galore (especially in down economies).
Let’s take, for example, a big trend in real estate from 2006: house flipping. A lot of people were under the impression that they were doing a successful job renovating a house and getting a great return on their work when the house was flipped. Experience shows that what they were actually doing was buying in an appreciating market and selling as overall market prices were increasing during a bubble. If you can time “bubble trades” really precisely, more power to you. However, most people do not have the time or resources to do this effectively.
Right now we are experiencing the opposite of what happened in 2006. Back then, the needle had moved to far into buying mode, and now we are in the middle of a serious selling mode. This happens for reasons that have NOTHING to do with the fundamentals of the market. When someone buys a new Land Rover, then has to take a lower-paying job, they will start to liquidate assets to make the car payment. This leads to people selling assets at low prices due to a desperate situation. In other words, real assets become under priced.
Because of the state of the economy, interest rates have also dropped to record-low levels. A bear market in housing coupled with dropping interest rates is a very rare combination of events. The smart investor has a 5-10 year outlook right now (maybe longer) and is clamoring to buy well-located properties.
The economy will recover at some point. This may not happen next year, or the year after that. It will happen, though. When it does, interest rates will rise (to fight inflation) and demand for already-high-priced commodities will rise, too. Think of gasoline as a great example. Who stands to gain when energy and commodity prices rise? The person who owns multi-unit property (read: energy efficient) that is close to public transportation or within walking distance of important amenities. Also, keep in mind that with higher interest rates, more people will be compelled to spend a couple extra years renting (increasing demand for well-located rental units). The cherry on top? Most central city areas have a shortage of rental units right now.
This is just one example of an investment strategy that might not pay off next year or in two years, but could set an investor up incredibly well 10 years from now. During the Great Depression, people with some extra money bought stocks on the low and made out like bandits. As the world panics and sells, the smart contrarian is digging in and getting ready to buy and wait. The time of the counter-(economic) cycle culture has again arrived.