Wednesday, August 15, 2012

Taking Emotion Out of the Deal

Throughout history, and indeed in today's markets, emotion drives the ebb and flow of the markets.  Whether we like it or not, this is a fact that has been much studied and has been discussed in countless books, newspapers, articles and speeches.

Depending on your preferred medium of investment, this emotional component can either help you or work against you.  Let me explain:

If one is Trading stocks, emotion is a massive factor in the movement of stocks.  As a stock investor, we can remove our emotional component as much as possible, however, we cannot completely eliminate it and we certainly can't control what the "crowd" does.  Determining the valuation of a stock at a particular moment in time is both an art and a science, so because it is typically difficult to determine future value, our emotions do come into play whether we like it or not.  There are a number of things we can do to limit or eliminate that and that is to have a system / game-plan and follow it without exception.  Even the brightest trading professionals are right only about two-thirds of the time, so losses are a part of the game regardless of how good we think we are.  There is no such thing as getting it right all the time.  These are the realities.

Now, moving onto real estate, when it comes to investing, we must limit or eliminate the emotional component also.  Because we know by doing our due diligence ahead of time, how much a property is worth (within a reasonable estimate) at the present time, we can ensure that by purchasing at substantially below that value that we are good, taking emotion completely out of the picture.  As in our stock example, we follow our game plan to to letter and ensure that based on the value today, that we are not paying more than that value.  In fact, as I mentioned before, our aim is to buy very much below today's fair market value and if we don't have that present, then we do not have a deal!  We then move onto the next potential deal.....

While we're on the topic of emotions, we came across a seller this morning who themselves presented a valuation in today's market for their own property that was based on an appraisal in current condition.  This appraisal reflected what we were going to offer him, so he knew what it was worth in the market.  However, he refused to accept market realities and wanted double the amount we offered. When he was asked what he felt the property was worth, he simply said that he knew it wasn't worth what he was asking, but that's "what he wanted" and that is that.  He proceeded to tell us how nice the property was, how nice the neighborhood was....We are not emotionally driven home purchasers.  We are numbers and facts only investors and you should be too.  If the numbers don't work, then regardless of how nice the property is and whatever other flora and fauna the seller and/or their agent is spewing, move onto the next potential deal and leave the non-deal behind.  Do not waste time on sellers that refuse to accept market realities.  They are betting that "it'll come back".  Let them gamble.  We don't do that.

Yes, this is an emotional seller who overpaid for his property at some point in the past, and now cannot live with a loss even though the economic reality is that his asset isn't worth what he wants for it.  So, it will sit and he will lose money maintaining insurance and paying property taxes and seeing his asset degrade further due to weathering / wear and tear with no other hope than potential appreciation down the road which most likely would not cover his mounting losses.

Do not become one of those statistics where you are only betting in market appreciation to salvage your investment.  Sometimes, looking at a short term game plan makes much more sense than waiting to see what the distant future holds.  As I've said before, nobody has a crystal ball, so why bet the farm on future appreciation when this is not a prudent approach to investment in real estate.  Certainly, many other options are available to us.

If we're talking stocks, we need to have a bias whether the stock will go down or go up.  This bias determines our  potential profit or loss.  In real estate, we lose money if the value goes below our purchase price, so price appreciation is only one of many exit strategies that we can use, and it is the most uncertain and volatile strategy available.  There is no need to rely on price appreciation when buying real estate assets, so focus on other exit strategies that are available to you with some we have discussed in previous articles of this blog.  This limits risk and increases potential profitability by buying well below current fair market value and knowing what your exit plan is before you sign the Purchase & Sale Agreement.

Remember, emotion has no place in real estate investing.  If you buy low enough, and use the right exit strategies, you will be just fine almost all of the time.

Until next time....

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