How to Make Millions by Escaping Mr. Market’s Devious Spell

by | BiggerPockets.com

This post is the 6th in a series that Bryan Taylor, John Jacobus, and I affectionately call “Warren Buffett is my Real Estate Mentor.” We hope his timeless wisdom impacts you like it has us.

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Have You Ever Been Under a Spell?

One of the definitions of a spell is: An ability to control or influence people as though one has magical power over them.

Most of us haven’t. Or at least, we don’t know we have. (That’s the problem with spells. The person under one is usually the last to know. Dang it.)

But we all know others who have.

Like your husband who sits spellbound every Sunday afternoon all fall watching his favorite eleven NFL teams.

Or Frodo Baggins in the epic final scene at Mount Doom when it seemed like Middle Earth would be cast into darkness for another age. (They could have done that whole movie in about 17 minutes if the eagles would have just flown the ring from the Shire and dropped it into the lava river. That would have saved a ton on their $281 million production budget I’m thinking.)

Warren Buffett says that almost all investors are under a spell. And after reading his commentary, I realize that I’ve been under a spell for a lot of my investing career.

It’s the spell cast by Mr. Market.  

From Buffett’s 1987 Berkshire Hathaway Annual Letter:

Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game.”

Well that sounds harsh. Really Warren? I don’t belong in the game?

Yes.

Buffett understands that markets consist of highly emotional participants whose perspectives on the value of assets can swing wildly based on recent positive or negative news, irrespective of the underlying fundamentals. In his mind, the purpose of the market is to SERVE investors, not to GUIDE investors.

What Does Buffett Mean by This?

I love this perspective, and though it seems obvious now, I don’t think I ever thought of it just this way. (And I’m sure I never called the market “Mister.”)

Related: What Would Warren Buffett Do? 12 Quotes for Smarter Investing

  • Buffett encourages investors to buy assets when they’re selling at discounts to their intrinsic value. A disconnect between price and value can work in an investor’s favor when other market participants are overly pessimistic. Investors should be most active with their acquisition activity when pessimism is rampant.
  • In times of optimism, market participants tend to bid up prices to levels that exceed underlying asset values. This is when investors should exercise extreme caution, resist the temptation to follow the crowd, and avoid overpaying for assets. The current real estate market cycle is clearly on the optimistic side. Investors should adjust their behavior accordingly.
  • Warren encourages investors to remain aware of the behavior and emotional state of other market participants. To him, investors can create an advantage by adjusting their behavior to seize opportunities to buy undervalued assets when others are pessimistic. Similarly, he encourages investors to avoid activity when prices become inflated as a result of others’ optimism.
  • Buffett encourages investors to notice cues from other market participants and behave in ways that are contrary to the crowd. In his mind, the fact that others are buying with reckless abandon should be a signal to curb behavior and exercise caution.

I already suspected it, but I’m pretty sure Warren’s mama told him, “If everyone else is jumping off a bridge, does that mean you should?”

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So, How Does This Apply to Real Estate?

  • Investment real estate markets are cyclical and are driven by economic activity, availability of credit, and investor outlook. At the top of the cycle, unbridled optimism leads investors to ignore warning signs and make unrealistic projections about the future. This leads to inflated prices and creates a contagious feeling among investors who fear sitting on the sidelines in fear of missing out on returns.
  • Many investors decide to enter the real estate market at the wrong time (i.e., at the top of the cycle when euphoria is at its peak). Unfortunately, when optimism is extreme, value is difficult to find. Similarly, even seasoned investors are influenced by the optimism of others and take undue risk during times of heightened optimism due to short memories and the emotional pull of the market.
  • Although it’s hardest to exercise caution when seemingly everyone is on a buying binge, it’s often best to ignore the crowd. Similarly, while it’s very difficult to take action at the depths of the market cycle, unbelievable deals can be found during this period. Some of the world’s legendary real estate investors have built substantial wealth buying real estate at fire sale prices when other market participants are highly pessimistic (e.g., Sam Zell, Conrad Hilton, etc.).
  • Contrast today’s market to the market in 2008-09. It’s difficult to find value in today’s market despite the fact that many seem very upbeat about the prospects of the industry. Yet great deals were abundant in 2008-09 despite the fact that many were scared to take action due to financial wounds incurred during the financial crisis.
  • Compressed cap rates, “hard” earnest money deposits requested on day one of due diligence, and the abundance of capital chasing fewer deals are signals that greed is the flavor of the day in the multifamily market and elsewhere. In light of the diminished prudence with which others are conducting themselves in the multifamily market, Mr. Buffett may suggest that now is a time to exercise greater prudence with your own affairs.

The Rubber Meets the Road

I said this was particularly applicable to me, and I’m excited to share it with you.  I’ve had my share of success and mistakes in this arena. Like…

  • When the world was chasing waterfront properties, my partner and I jumped on the bandwagon. We got in about the middle – not too early or too late. We made a lot of money buying overgrown waterfront lots at Smith Mountain Lake starting in 2004. When Fortune magazine’s cover said, “The Real Estate Bubble is about to burst,” we eagerly read the article. We believed it (generally). But we had a pipeline of great deals, so we bought a few more. Then the market turned. Which led to my famous (in my own mind) story of going $2.5 million into debt in the midst of the recession. You can read how I got out here.
  • In the midst of the Bakken oil boom in 2011, we saw a huge opportunity to build high-quality multifamily, hotels, and “man camps” in northwest North Dakota. We got in fairly early. We built the nicest place in town, ran it profitably for years, then sold if for a great profit. If a little “greed” worked, more would be better, right? We went on to build a very large, very nice hotel. It was said to be the nicest in North Dakota. That’s great, but when oil prices did the unthinkable and dropped from the $90s to the $30s, so did oil exploration and business travel. (That was more like a bad idea in any economy honestly. Depending on oil prices for your success is speculating, not investing.)

A Quick Test

There are probably many ways to test to see if you may be falling under Mr. Market’s spell. Here are a few sample questions to ask yourself and your trusted advisors. You should certainly come up with your own to fit your situation.

  1. You’re about to buy a multifamily asset. If the BiggerPockets forums and news headlines light up with people saying that it’s time to sell multifamily now, would this change your mind?
  2. Are you counting on appreciation and the potential of refinance to make your deal work? Or does it work well as a cash flowing deal now, with or without appreciation?
  3. If it was 2009 again, and there were plentiful deals to be had for 40 cents on the dollar but no one else wanted in, would you consider buying?
  4. In the midst of a recession do you think like many: this is the big one, and the market won’t ever go back to normal?
  5. Similarly, in the midst of a bull market, do you think this is the new normal. Cap rates will continue to compress and this buying binge has no end in sight. I want in at almost any cost?

Related: What Warren Buffett Just Told Me About Real Estate is Great News for Investors

And remember, before you buzz through a list of questions like this, the words of the famous physicist, Richard Feynman:

“The first principle is that you must not fool yourself, and you are the easiest person to fool.”

Getting Personal

In my last post, I told the story of how Warren Buffett truly lives by his own teaching. He bought financial companies when virtually no one else would touch them. I hope that you will follow in his footsteps. I plan to.

I really do believe that I’ve learned my lesson. My team and I are not overpaying for apartments. There are plenty of others doing that, and I hope you’re not among them. We’re still bidding on apartments, by the way. Just not willing to consciously overpay.

And I didn’t chase the speculative crypto market. Though when my close friend, a 60-something doctor, made millions under his Millennial son’s guidance, I must say I was tempted. And a little jealous.

And like I’ve been talking about for a few months, our team is currently investing in a less sexy asset class. And we’re really excited about it!

And after that one, we may even look at mobile home parks. As you may know, Buffett and Zell were way ahead of us on manufactured housing, so it could be a good bet.

If it’s not too late that is.

By the way, if you hear about them selling, please let me know. I’d rather be under their spell than that of Mr. Market.

So what about you? What are you doing to protect yourself from being under Mr. Market’s spell?

Or are you ok just going with the crowd and hoping it works out? Share below!

About Author

Paul Moore

Paul is author of The Perfect Investment – Create Enduring Wealth from the Historic Shift to Multifamily Housing, which you should probably get if you want to learn to invest in multifamily. He is a Managing Partner at Wellings Capital, a multifamily and self-storage investment firm, and hosts the How to Lose Money podcast. Paul was 2-time Finalist for MI Entrepreneur of the Year, has flipped 60 homes and 30 waterfront lots, developed a subdivision, and appeared on HGTV. Paul’s firm invests heavily to fight human trafficking and rescue its victims.

23 Comments

  1. Christopher Smith

    Been a student of Buffett’s for awhile, reading “University of Berkshire Hathaway” as I type this. Bought heavy into East Bay CA real estate during the 2010 – 2013 time frame at about 35 to 40 percent of pre crash prices. Been a really great ride and made a truck load on rent and much much more on appreciation since then.

    But as you note these types of moves take real intestinal fortitude as the herd was in full panic chicken little mode at that time. I can’t begin to tell you how many folks thought I was the village idiot for aggressively buying at that time. Ironically those same folks are now standing in line to pay 2 1/2 times what I paid then.

    When you think it out it’s not really all that complicated. As Buffett says, someone with an IQ of 130 performing basic due diligence and possessing rock solid emotional stability will outperform an emotional flake with an IQ of 160 Everytime.

    • Paul Moore

      Christopher, it sounds like you made a few great investments. Timing your real estate purchases is important, but unfortunately it is not always repeatable. I 100% agree that successful investing is not really complicated, it is simple. But it is often so simple that smart people miss it.

  2. JL Hut

    What motivates us to action? To know thy self is the most important quest you can achieve. To look in the mirror and see ourselves accurately, it best to have someone you trust there beside you to telling you what they see also. We tend to see what we want to see in ourselves and the markets. Seeing an accurate reflection in the mirror is much more difficult than any challenge in we will encounter in real estate, but mastered it will be there to aid us in every area of our life. Knowing ones true motivation for our actions is priceless in the markets.

    As for Real estate, in the past year I have sold several properties I have owned for 30+ years, I am working to diversify, as I still have a large percentage of assets in real estate. . The government loves to make bubbles that pop. I believe the biggest one of all is in the future. The bond markets have been in a 30 year bull market, it is time for it to correct or pop. All the liquidly the government has pumped in the markets has to be corrected sooner of later. How will that effect real estate? I will let all of you think about that. In the intervening time, buy low and sell high. Thank you Warren and Paul for your life lessons.

    • Paul Moore

      Doug, I always love your comments. I will never underestimate the power of bringing someone else more experienced into my decisions. I would say big decisions I make on my own without any input are generally unsafe. Decisions I make with multiple sources of wise counsel are generally safe decisions. I say generally because there are always exceptions. Have a great weekend!

  3. Elliott Huffard

    Thank you for your article. I am a fan of Buffett and try to follow his wisdom. I have always been aggressively invested in stocks since my late 20s, I’m now mid 40s. I was able to somewhat time the last crash, hide 40% in bonds while stocks bottomed, then reallocate 100% into stocks by May 2009. Have ridden the ride up and have again started to divest from stocks into cash (30%) the past year- assuming a crash within the next 2 years- statistically speaking we are overdue.

    I think reading your article is good timing for myself. Because the past year I have been researching rental income options and have been nervously excited to start this new chapter for myself, rental properties. The problem is, it is hard to find cash flowing rentals in urban Houston (yes they exist, but hard to find). The emotional part of me wants to buy now and start learning, the Buffett rational side of me says to wait till the next crash when more opportunities arise. Your article helps to reinforce the rational side.

    Thank you!

    • Paul Moore

      Elliott, thanks for your comment. Congrats on being able to time the market, not many folks are able to successfully do that. I know many people who have found great success with SFRs. But I also know many people who have been burned in SFRs for various reasons. I agree there will be a major real estate correction, but no one knows when. It could be a few more years, or it could be this year. If you ever want to talk more, feel free to message me via BP.

  4. Jim Fredo

    Great article. My favorite real-life line, which makes me want to run in the opposite direction, is ‘This time it’s different.’ When people use that line, they are clearly under the spell of market mania. Rational discussions usually fall on deaf ears in those situations.

    I remember Los Angeles developers in ‘05-‘07 telling me that this time it was different because demand was higher than supply. I tried explaining that it was speculating investors who were buying the supply, but it was a fruitless discusson. They kept building until lenders started pulling funding and the market imploded.

  5. James Gregg

    Great article Paul! How would you address the Devil’s Advocate perspective that would say: demographic trends (less interest in homeownership in younger generations, more immigrants who tend to rent longer, population shifting toward cities, etc) indicate an increasing need for rentals, which means now is (could be) still a great time to invest in multifamily?

    • Paul Moore

      James.

      That is of the main premises of my book, and of course I believe that. But the deals have to make sense. Each deal has to cash flow on its own, and cannot rely on appreciation which is often subjective, which means it could go south.

      Nice to hear from you. I appreciate your podcast!

  6. ahmed abutaleb

    Paul,
    Excellent article, just as everything you write is well thought out, very rational, and chock full of wisdom. I don’t think we’ve discussed it before, but I’m also a huge Warren Buffet groupie. I had been reading his nuggets for years, and finally (wish I had woken up sooner) came to the conclusion that there was no value and tons of unnecessary time wasted in trying to figure out which stocks to buy and sell. In 2009, I started purchasing Berkshire Hathaway shares and since then have routinely gotten rid of all other shares and mutual funds and rotated the money to Berkshire. The only other shares I now own in my retirement account are with Amazon.

    Like you, I see direct parallel with Buffet’s philosophy applied to commercial real estate. Like you, I see many folks (even ones I had respect for) chasing what I would consider bad deals that may end up okay but likely will not when one of the planets goes out of alignment (interest rates, unemployment, cap rate expansion, trade war…).

    Thank you for shining a bright light here and being the adult at the party…

    [I will call you so we can catch up – my 1031 was a bust so I’ll be even more generous to Uncle Sam come April]

    Ahmed

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