Don't be the Greater Fool!

Don’t be the greater fool!

Why does one own something?  Well, I can think of a few good reasons:  1) it gives you pleasure such as a house, TV or car, 2) someone gave it to you as a gift, 3) you think its value will go up and 4) you think it will return dividends of some kind, cash or value in kind.  Why does one get rid of something?  You know the answers but #1 is that it causes you discomfort.  The capital markets, including stocks, bonds, commodities, real estate, art and crypto follow the exact same principles. 

I recall when interest rates were near 1%, many real estate friends told me that the cap rate on their recent building purchases was 2% or so.  It took a minute or so for me to process this and I shot back: “that’s the equivalent of a 50x p/e for a stock right?  The real estate friend shot back: “yeah, but I think the value of the property will go up a lot to get me to 10% returns.  We left it at that.  I said to myself, hmmm I guess that’s possible, but to this day I don’t see how that can work for most situations.  After all, the value of a hard asset like real estate should be the sum total of the cash flows received over a time period with discounts for risk, leverage and unexpected costs.  Plus, real estate isn’t liquid.  If the 2% annual return on your building sees some excess rent roll appreciation, it might be worth more in the future, sure.  But the value to the next buyer, especially when rates go up like they have, isn’t likely to find interest at 2-3% cap rates.  That is, unless you have some knowledge a developer has to own this property for their other projects and will buy you out at some higher price.  Long winded, maybe, but do you see my point?