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Think Like a Real Estate Mogul – and Become a Better Investor

Think Like a Real Estate Mogul – and Become a Better Investor

October 23, 2018

A Healthier (and More Realistic) Way of Looking At Investments

Investment experts frequently speak of the need to think long term.  To ignore the ups and downs of daily or monthly market movements.  And, while logic is on their side – it is hard to do!  Recent market movements (including today's) have reminded many investors that short term thinking can be hard to avoid.  The reason it is so difficult is that everyone – from the news to the posse gathered around the water cooler to the brokerage firm with its monthly statements or performance reports – even your financial planner is complicit - seems to be conspiring to focus you on the here and now and speculating "what will happen tomorrow".  It shouldn’t be so hard to develop a long term focus. In fact, it seems that with another type of investment, such a healthy focus comes naturally.

Do Real Estate Investors Have a Healthier Perspective?  Let’s imagine you own a different kind of investment – something everyone can relate to.  An investment property, let’s say.  You have owned the property for 10 years.  It is in an increasingly popular neighborhood, and provides a healthy positive cash flow to your family.  Knowing people who own such properties, if I were to ask you “what’s it worth” – you would probably shrug.  “I don’t really know – I bought it for $500,000 10 years ago – I guess it might be worth quite a bit more by now.”

Is this just blissful ignorance?  No – it is how a good investor would tend to think about his investment.  It is generating strong profits, it generates income, and my expectation is that it will continue to generate profits in the future.  What it is worth today isn’t nearly as important to my retirement plan as the profits (which I can reinvest) and the confidence it gives me that I know I can sell it at a profit some distant day in the future should I need the money.

Suppose the economy hits a rough spot and you find it hard to rent one of the apartments.  You might even have to cut the rent.  With other landlords in the same position, the market value of similar properties is likely to fall.  How likely would you be to rush and put the property on the market?  Not very.  Most owners will retain confidence in their investment.  “The economy will pick up” you might say “it’s just a rough spot.”  When it comes to real estate, most investors naturally take a very healthy long term view.

Why Do Investors Think Long Term with Some Investments and Short Term with Others? 

Logically, stocks and bonds should be no different than real estate.  For generations stocks have generated returns far in excess of real estate, and bonds returns have probably matched those of the average investment property.  Both can fluctuate in value, both will lose value in an economic downturn.  So why are we so patient with real estate investments (or a small business enterprise?) but so impatient with stocks / bonds.  I offer several thoughts.

Liquidity.  One very simple reason you don’t rush to sell real estate at the first sign of trouble in the market is that selling is a lot of work and costs a lot of money.  Knowing this before you buy, you go into the investment already committed for the long haul.  In contrast, you know you can sell out of stocks and bonds with the push of a button.  Liquidity is desirable in an investment – but it tends to also reduce commitment. 

Reality check.  This is really about confidence and patience.  And building confidence in stock and bond investments comes with knowledge and experience.  The most patient investors tend to be those who have a) a good working knowledge of what markets are and how they work and/or b) have lived through market cycles before and come out ahead of the game.  There is a tendency to think that the current trend will continue on forever.  When stocks are going up – investors pile in, as if they will continue up forever.  When stocks fall, fearful investors imagine losing all their money.  Well, trees don’t grow to the sky, and business downturns eventually end and recovery comes.  Impulsive or emotional buying or selling (just because you can!) is where financial plans go awry.  Working with a fee only investment professional or financial planner can help you avoid such emotional reactions during challenging markets.

Transparency.  Every month the value of your investments stares you in the face.  In contrast, it takes a real effort (ordering an appraisal, doing extensive market research) to determine the current value of your real estate investment.  This is why you might even shrug if I ask you what it’s worth.  You probably don’t even know for sure.  In contrast, it is hard to ignore the changing value of your investment portfolio.

Reality Check.  The value assigned to your stock and bond portfolio may change from day to day or month to month – but this is not really that different than real estate.  It is the value to SOMEONE ELSE at THIS SINGULAR POINT IN TIME.  If you aren’t planning to sell – TODAY’S MARKET PRICE IS COMPLETELY IRRELEVANT.  It takes a bit of fortitude at times – but you will be a better investor if you can shift focus away from the current market value and think more like a real estate investor.  Don’t cling to tightly to today’s gains – don’t get emotional about today’s losses.  In either case, there will be a new value tomorrow.  Better to focus deeper on the underlying money earning potential of the investments you own over the long run – just like the real estate investor.    

Cash Flow and profit visibility.  The tenants in your investment property send you checks every month.  You can see how the investment generates income.  The profits generated by your stock and bond investments are difficult to see.  Especially if you are reinvesting dividends and interest income – there is no visible income to your household – so your focus shifts naturally to the value on the investment account statement.

Reality Check.  Owning a stock index fund means you own a share of every dollar of profits earned by every single corporation represented in the fund.  You can see the dividend and interest income on your monthly statement – but did you know that represents only a portion of the profits earned by the companies you own?   Behind the scenes, “you” are investing profits for future growth by investing in research and development, expanding operations, and even buying back stock.  Just as with the apartment building, profits may suffer from time to time, and stock values as well – but over the long term corporations generate profit – and lots of it!  This is the power that has driven stock market returns over generations – and it is unlikely that corporate obsession with profits (ultimately for YOUR benefit) will end anytime soon.  Economic downturn coming?  Recession?  Corporations will do what they always do to protect profits – cut staff, shelve expansion plans, etc.  When you own stocks, all of corporate America is going to work for you every day, regardless of what the economy is doing, to protect and grow your investment.  That knowledge should help you sleep at night.

As for bonds – the value of a bond fund may swing up and down somewhat with interest rates and economic conditions, but it is the interest being paid month after month, either reinvesting and buying more shares, or distributing out to fuel your spending needs – that is the true driver of long term value.  No different from our real estate investment generating rent – just not as visible or obvious.

Paper vs Bricks and Mortar.  You can see, feel, and touch your investment property.  This inspires confidence.  You know there is something tangible in place, something you can always sell if needed.  A paper statement or image on the computer screen seems less tangible, and less comforting.

Reality Check.  Remember that stock ownership IS real.  It is no more a “paper investment” than the deed on your investment property is a “paper investment”.   Every stock represents a share of ownership in a company.  You are not only entitled to a share in that company’s profits – but you also own its assets.  Own Toyota stock – you own its factories, office buildings, and distribution network.  Own Apple stock – you own its intellectual property.  Own Merck?  You own rights to its drug pipeline and research facilities.  Own an index fund – you own a slice of the most powerful money making machine the world has ever known – the American economy.