“Be greedy when others are fearful and fearful when others are greedy.” —Warren Buffett
Wait, don’t click that back button. (I saw you look at it.) You probably think you know where this article is going. You’ve heard this famous Buffett quote before, and you assume you know what you need to apply it to your situation.
No offense, but you probably don’t really know how to apply this rule to your investing career. But you will if you invest the time to read this post.
Did I hear you say, “How dare he make such an arrogant claim? He doesn’t know anything about me.”
You’re right. I don’t know about you. But I do know about human nature. And I do know about me.
As a Finalist for Michigan Entrepreneur of the Year, a two-time author, and a real investor for two decades, I know how many times I’ve failed at this. And though I’ve been aware of and quoted this many times, I didn’t know what I didn’t know about it until I dug in deeper. And that’s exactly what we’re going to do below.
Did You Know?
- In the wake of the Great Financial Crisis, Buffett made several investments that illustrated he acts and lives by his famous saying to “be greedy when others are fearful.”
- These investments were in Bank of America and Goldman Sachs when no one else was willing to touch financial firms with a 39½-foot pole.
- The returns associated with these investments (still unrealized to-date) prove that you can be very successful by ignoring the crowd and being greedy when the time is right.
Great News: You Don’t Have to Predict the Next Downturn to Profit by It
Here’s how Buffett phrased it in his 1986 Letter to Shareholders:
“What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
4 Takeaways From This Epic Buffett Quote
- Fear and greed (aka market cycles) are as sure as death and taxes. Just because the last financial crisis was a decade ago does not mean we are cured of the fear contagion.
- Predicting when and how bad (or good) these market cycles are is a fool’s game. And Buffett says it’s easier than that. Just act appropriately when the time is right.
- As an investor, you simply need to know that these cycles will come, and when they do, you need to be prepared to act counter-intuitively from most other market participants and pundits.
- Here’s the problem: Your psychology and instincts will try their best to persuade you not to act counter-intuitively. Reading and agreeing with my mentor (Buffett) is worlds apart from acting like him when faced with a situation like investing in banks right after the largest financial crisis in our country’s history.
So, What Does This Mean for Real Estate Investors?
- Where are we now? Recognize and understand where we are in the market cycle. Don’t try to predict the top, nor anticipate the bottom, but rather have an objective view of prices, values, and your instinctual “fear and greed” meter.
- Be prepared. If you truly want to be greedy when everyone else is fearful, then you’d better have the capital available to deploy and you’d better have your buying criteria and target assets identified. And it won’t hurt to get some experience under your belt before then to convince the lenders that you’re credible.
- Stick to your principles. Staying true to your principles as a disciplined investor will serve you well in times of excessive fear or greed. Never straying from your principles will help ensure that you are not persuaded by the fear of others or the showboating greed of your neighbors. (So, when you see me pass you in my Ferrari, keep your eyes fixed on the road. That was a joke. I drive a Ford Flex.)
Smart Doesn’t Equal Rational
From a Buffett talk with students in 2005:
“How people react will not change—their psychological makeup stays constant. You need to divorce your mind from the crowd. The herd mentality causes all these IQs to become paralyzed. I don’t think investors are now acting more intelligently, despite the intelligence. Smart doesn’t always equal rational. To be a successful investor you must divorce yourself from the fears and greed of the people around you, although it is almost impossible.”
My friends, this is why I urged you not to hit that back button. It’s not enough to know these truths. Our brains (at least mine) have a funny way of tricking us into thinking that just because we read a book, went to the seminar, or bought the t-shirt that we will act accordingly. But that’s rarely the case. Buffett himself says this is almost impossible to pull off.
3 Takeaways From This Buffett Quote
- Buffett’s antidote to the fear/greed contagion is to act rational at all times. But this is harder than it seems due to the innate psychology already hardwired into your brain.
- You cannot always outsmart a situation that calls for rationality. But staying rational helps to divorce you from succumbing to fear or over-extending yourself (and your capital) through greed.
- Don’t be part of the herd. Rather, recognize when the herd exists and when you could fall prey to it—then run the other way with all your energy.
So How Does This Apply to You, Mr. and Mrs. Real Estate Investor?
- Don’t get wrapped up in comparing yourself to others in your network. This will only feed your greed and cause you to not act rationally. I’m all for networking, mentoring, brainstorming and the like. BiggerPockets is a great place to do that. But I’m urging you to keep your cool and follow your principles at every point in the cycle.
- Read stories and examples when rationality (not excessive greed or fear) prevailed in a deal. Talk with your mentors and contacts about the deals they passed on due to rational thoughts as opposed to focusing home-run deals that were caused by more luck than rationality.
- Prepare yourself for fearful times. Your mind must be conditioned to act rationally… so test it. What would you do if a property that you’re looking at dropped price by 30% and all other buyers walked away? And your lender became more discriminating? How would you react?
“If Something Can’t Go on Forever, It Will End.”
From Buffett’s 1988 Annual Letter:
“We have no idea how long the excesses will last, nor do we know what will change the attitudes of government, lender and buyer that fuel them. But we do know that the less the prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs. We have no desire to arbitrage transactions that reflect the unbridled—and, in our view, often unwarranted—optimism of both buyers and lenders. In our activities, we will heed the wisdom of Herb Stein: ‘If something can’t go on forever, it will end.'”
My friends, in our heart of hearts, most of us knew the run-up that led to the 2008 meltdown would not last forever. But many of us ignored this fact.
Are we in a similar situation today? Or is this just the “new normal” for multifamily and single-family investing? Some demographics would suggest that we are in the new normal, and this is not really a bubble.
But I’m not even sure I believe that myself. There will be no way to be certain of market timing except in a rearview mirror.
The great news is that you and I don’t have to predict market timing to benefit from the market today. Mr. Buffett has taught us well!
I Am Making a Pivot
I learned my lesson in the last recession. I recently told my multifamily investing team that if we are the high bidder on any deal, even an off-market deal, then there is something wrong. I just spoke to a wonderful lady from Denver, and I told her that if a broker is courting her (as a relative newbie) to buy an off-market multifamily deal, the broker may be looking for a sucker.
I spoke about this in detail in a different post. It’s been painful for a guy who wrote a book on multifamily, but our firm is making a pivot. We are expanding our portfolio outside of multifamily. We are investing in self-storage.
We made this initially painful move because investor optimism and competitive pressure in multifamily signaled us that it may be time to be “fearful when others are greedy.”
Though self-storage is heating up as well, the ownership is highly fragmented on a national basis. And there are thousands of facilities that are not professionally run and can be upgraded. This has provided a significant opportunity for relatively low risk, highly profitable investment opportunities for us and our investors.
While I was researching self-storage, I came across a story told by self-storage expert and fellow BiggerPockets brother, Scott Meyers. This brief story shows the power of 1) self-storage value-adds, 2) acquiring self-storage right, and 3) acting according to the greed and fear cycles we’ve just discussed.
Scott and his team acquired the Indianapolis Enterprise Center for $1.5 Million in 2005. He financed 80% and raised 20% ($300k) in equity. He proceeded to raise $400k more to convert this warehouse space to storage, with a little bit of office space, then leased it up.
The real estate market was near the top in 2007, and he sold it for $3.9 million, a $1.9 million profit. Keep in mind there was only $700k in equity invested, so the return on equity was 170%, or 2.7x ($1.9mm ÷ $700k) in about two years. An 85% annual ROI if my numbers are right. He took some risk to get there, but this is obviously a great return for investors.
But This Story Wasn’t Over
This deal was the gift that keeps on giving.
The crash of 2008 happened. The new owner’s optimism had turned to fear. He apparently had a portfolio that wasn’t performing well overall, and he had allowed this facility to fall into mismanagement and disrepair.
He offered to sell it back to Scott’s group in 2012 for—wait for it—$545,000. (Recall he had recently paid Scott $3.9 million).
The owner had really let the facility slide over five years, so Scott raised $200k extra ($750,000 total) and purchased it for cash (another lesson from this post—have cash available for down cycles). Scott installed LED lighting and made other improvements, significantly increased lease rates, and leased it up again.
When Scott acquired it in 2012, the net operating income (NOI) was only $39,000 per year. At the time of this post, in 2018, the NOI is $278,000 annually and the facility is currently listed for sale at $3,004,000.
Another lesson is the power of commercial real estate. The value is based on the income and cap rate, not neighborhood comps like the residential world.
If Scott refinanced it along the way, his investors were probably paid out long ago and stand to make a stunning profit when this sells. (Most syndicators leave investors in when refinancing.) Even if the investors still have their cash in, their profit will be very substantial.
Scott and his investors learned a valuable lesson from Warren Buffett: “Be greedy when others are fearful and fearful when others are greedy.”
Let’s Apply This
Right now, times are booming for most real estate sectors—some say at an unprecedented level.
Earlier in the post, we said, “Prepare yourself for fearful times. Your mind must be conditioned to act rationally… so test it. What would you do if a property that you’re looking at dropped price by 30% and all other buyers walked away? And your lender became more discriminating? How would you respond?”
So, tell us—how you would respond? (I realize you may have to know a lot more details, but either make some up or answer in general terms.)
I’m really eager to hear from you!