In early summer of 2005, I sent a warning to the Rich Dad community that the real estate market was cooling down. After all, we know that all booms go bust eventually, and every party comes to an end.
While many readers thanked me for the words of caution, many others sent me hate mail. An angry real estate broker called me and said, "Are you trying to ruin my business?" The angry readers should draw insight from something Warren Buffett said: "For some reason, people take their cues from price action rather than from values.
What doesn't work is when you start doing things that you don't understand or because they worked last week for someone else." The sage of Omaha sums up pithily: "The dumbest reason in the world to buy a stock is because it's going up."
Personally, I would say, "The dumbest reason to buy anything is because the price is going up." Yet that's what people do when they invest. They generally don't buy high-priced things when they shop.
Fools Rush In
For example, if Safeway had a sale -- 25% off everything in the store -- the supermarket would be swamped. Yet, when the stock market or real estate market has big discounts (often called a crash or a burst bubble), that same shopper runs away from an asset sale. Instead, they wait until prices are high and other fools are bidding them up further to finally buy.
I estimate that 90% of all investors invest for price movement, not value. If prices begin to escalate, as they did in real estate from 2000 to 2004, amateurs turn pro and begin buying real estate to flip -- for example, buying a home for $200,000 and then selling it for $250,000 a few months later.
Most stock market investors do the same thing. In investor language, flipping is known as "the greater fool theory of investing" -- you're buying something not to own, but in the hope o selling it to someone who's a greater fool than you.
The Coming Crash
We all know a real estate crash is coming. The problem is we don't know when. One of the more popular predictions floating around is that investors are now moving out of real estate and back into the stock market. Another prediction, which I think is valid, is that the real estate market is set to crash because of the high costs of building materials. But such rumors only affect those investors who, as Buffett says, "take their cues from price action rather than from values."
During such periods of high prices and volatility, it's even more important to pay attention to value, more than price. Yet, it's one of the toughest things to do -- stop and focus on value -- especially when prices are volatile in either direction. It's difficult to resist the urge to sell when prices are dropping and buy when they're rising.
The Best Time to Buy
Take market crashes. I love them because that's the best time to buy -- finding true value is a lot easier during such periods. And since so many people are selling, they're more willing to negotiate and make you a better deal. Although a crash is the best time to buy, the market's high pessimism also makes it a tough time to do so.
I remember buying gold at $275 an ounce in the late 1990s. Although I knew it was a great value at that price, the so-called experts were calling gold a "dog" and advised that everyone should be in high-tech and dot-com stocks. Today, with gold above $500 an ounce, those same experts are now recommending gold as a percentage of a well-diversified portfolio. Talk about expensive advice.
My point is that this current period is a tough time to buy or sell. Real estate is high, interest rates are still relatively low, the stock market is rising, the U.S. dollar is low, gold is high, oil and gas are high, and there's a lot of money looking for a home.
So the lesson is: Now, more than ever, it's important to focus on value, not price. When prices are low, finding value is easy. When prices are high, value is a lot harder to find -- which means you need to be smarter, more cautious, and resist your knee-jerk reactions. A final word from Warren Buffett: "It's only when the tide goes out that you learn who's been swimming naked." In my opinion, there are many naked swimmers, especially in the real estate market.