Idle Cash and the War Chest Strategy

[Mike Dymski]

A - Invest $100, add value to $120, market corrects to $100 in year 1, but you achieve an 8% return from cash flow and principal reduction.

B - Invest $100, add value to $120, market remains as-is (or it takes longer to correct), you achieve target returns of 15-20%

C - Invest $0, earn $0.

Substitute appropriate figures...just trying to generate dialogue.

It's hard to model things like a market correction or rising cap rates, get excited about lower returns, and make a purchase but idle cash and the war chest strategy (scenario C) can be costly relative to scenario A (except with an appreciation only/market timing strategy...let's ignore that one for simplicity).

Many of us have analyzed and turned down a ridiculous number of deals and we see a lot of posts about waiting for a correction but the math seems to suggest otherwise if investors are adding enough value (and generating cash flow, using long-term debt, buying in solid locations, or investing for the very long-term).  Please share your thoughts.

[JD Martin]

I have no answer. That's my honest answer. Last year I thought "well, I'll just slow down and wait for prices to get better", but because I'm buying so low already I might just be unrealistic. The tough thing about investment is getting past the psychology of past investment. If I bought a house at $25k, I think *all* houses should be able to be had at $25k, or thereabouts - so I tell myself I just need to 'wait for the right deal', or 'work the margins harder', or something similar. It may just be that I have to recalibrate to reality, and not the other way around. Of course, you never know for sure except in the rear view mirror. 

As an investor, you almost by definition have to believe that you're smarter than the other guy. And I say that not in arrogance, but just in the very nature of what we are doing. Anything you buy as an investment - if we define investment as increasing your overall financial stores, i.e. getting more money out than you put in - has to gain more value than its present day value, meaning that we have to believe that what we are buying is being sold at some kind of discount relative to its potential. If you believed the absolute ceiling on Apple was $500/share, it would make no financial sense to buy it for $501/share. That goes for everything - whether you think it's just undervalued in the first place or has lots of headroom to expand based on inputs. So we think things like "Oh, the market's overheated, I'll buy when it comes down", when in fact it may never come down. 

All of our guesses - and that's all they really are, educated or not - are based on our own experiences, values, financial position, abilities, etc. I may think a house that was $25k 2 years ago is a ripoff at $50k. Someone from another market might think they hit the lottery. If enough of them do, then my reality was wrong. Further, we are much better at remembering how right we were than how wrong we were. Everyone remembers how smart they were to get in just before everything took off. No one remembers all the stuff they were thinking about buying that tanked.