You need to be an investor and NOT a speculator.

publication date: Oct 16, 2008
author/source: Guest article by Neil Lewis of Property Secrets

These are massively uncertain times for all investors. Many of the old debates about where you should put your money may seem obsolete. To many people it has felt over the last year or so, and especially right now, that there is no longer any basis for rational investment decisions.

Because uncertainty breeds the emotion of fear, and fear leads to irrational responses and decisions. Rather as greed can do! I want to explain in a moment why this is fundamentally wrong and that there IS indeed a way - and a PROVEN way - of making rational decisions about how and where to invest.

I also want to explain why this time of confusion and uncertainty is actually when real investment success can begin. Is this blind optimism?

I don't believe so, and nor do some of the most successful investors of all time. But first I'd like to make something clear: I am not looking to persuade anyone by argument here. What I want to do is to make our position clear and invite similarly minded investors to join Property Secrets. If you disagree with our investment framework, then fair enough. You must simply take the approach you feel is best, and I wish you luck.

I say this because this is not a time to spend trying to convert people by argument - there are more viewpoints around than ever, all busily guessing the near future, what will be affected by events and what will go up and what will go down in price - market price, in other words.

Few of these people are doing anything other than focusing on a few aspects of the moment. Some of them are no doubt very informed, very savvy. But, the fundamental difference between this approach and the Visium way is that we do not focus on the moment. We do not focus on market price, but Intrinsic Value. That's why Property Secrets are different.

So, to reiterate, there is really no real time for debate as far as we're concerned because the opportunity is Now and it is unlikely to be around for long.

At the moment there is over-reaction in the market for every asset class - seemingly bottomless pessimism, swiftly followed by groundless optimism. Neither perspective represents real or intrinsic value. The reason for this is these assessments are driven by fear and greed. And at such times the overwhelming tendency is to follow the flock, seeking safety in numbers, whether the driver is fear or greed.

Here's how one 20th century Wall St colossus, Benjamin Graham, put it:

"Prices are subject to irrational and excessive fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed."

And the more fear or greed there is, the more extreme and further removed from intrinsic value these emotional responses to investment will be. And the harder it is for an investor to know the intrinsic value of assets.

This is what economists call asymmetric information and a good example of this is the toxic debt in the US that no bank wants to hold: it's almost impossible for a potential buyer to know its real, long-term worth.
The solution then is to strip away emotion. Strip away all the froth or the terror - all the emotion, whether it's positive or negative - and focus on fundamental drivers. This is what our analytical framework does with property markets.

This does not mean that the property markets we focus on won't be affected by cyclical factors - of course they will. Cyclical factors include poor sentiment, interest rates that are higher (or lower) than a historic average, short-term over or under-supply of product.

These are important but temporary factors that impact on a market price, but not fundamental drivers of value. To find these we need to step back some distance and focus on key elements. Look at this:

Growth in relevant disposable income X Jobs X Credit growth
                             Growth in relevant supply

Stripped to essentials this is how to measure intrinsic value in a property market. These elements need to be placed in context, of course.

For example, we need to look at the potential (and probable) growth in credit markets by comparing with more developed markets (and then we need to divorce our projection from the fact that credit growth may be slowing because of currently higher interest rates because this is cyclical.)

Why then is property especially fitted to the Intrinsic Value approach?

1. Because there is a forecastable need for homes as a result of steady demographic changes (although
    prices may rise and fall) - in nearly all cases.
2. Because it has an enduring value (so long as it remains habitable).  
3. Because there is predictable supply - land availability, planning laws, and construction costs typically
    ensure demand is stronger than supply, in nearly all cases, over time.

What the intrinsic value framework does is to provide investors with the greater certainty of the long-term potential for price growth so that they can make better decisions.

Classically, investors are lulled into selling their best investments (be they shares or properties) and keeping their worst because it feels like they are making a profit. Instead, they should sell the weakest investments and keep those whose potential for future growth (based on a sound understanding of Intrinsic Property Value) are the strongest.

There is one factor here though that is absolutely essential, without it, the intrinsic value framework does not work - You!

You need to be an investor and NOT a speculator.

If you want to speculate, be my guest. But speculation is the equivalent of taking your investment and putting it on a roulette number. We see this approach as fundamentally unsound and certainly as wasteful when so much investment potential lies in taking the intrinsic value approach.

Here's the key to Property Secrets investment principles - real, sustainable wealth is delivered via long-term and consistent growth. And to deliver that it is necessary to look for markets in which we can see the obvious long-term, intrinsic potential.

And, you know what, this is not rocket science. And it certainly is NOT a formula - we don't believe in them!
This is about a set of investment principles that require only clear-sightedness when all around most other people will be driven by an emotional response to events - back to fear and greed.

The more we can remove these elements, the better and more logical our analysis will be and the more accurate will be our assessment of intrinsic value. And remember: there is a HUGE difference between price and value. This lies at the heart of Property Secrets investment approach.

Price fluctuates wildly due to market conditions and cyclical events. Intrinsic value can be plotted over time by analysing fundamental market drivers.

Here's another thing - if you take the long-term, intrinsic value approach, you also don't need stratospheric returns to become very rich indeed. £100,000 becomes £6.5 million in 30 years if you achieve an annual return of 15%. This may seem a high return, but bar in mind it's not an example of simple compounding, it would include some leverage. So, if we have £100,000 and borrow a further £100,000, the total return needs to be 7.5% for an investor to achieve a 15% return on investment.

Now, I'm not suggesting that you will hold all investments for 30 years, but this is the time horizon that's worth considering for a personal portfolio. Why do we choose a 30 year time frame? Simple, the wealthiest investors in the world are old - they are not burnt out Young Turks from the London financial trading centre. Success comes with age and with time.

And certainly any individual investment should always be considered as a ten year hold - enough to remove the effects of cyclical events on our analysis. Over a 10 year period the cycle of fear and greed will have worked through.

Whether you actually end up holding for ten years or are able to take profits much earlier is a separate issue - our approach is to PLAN for a ten year hold.

Fine theory. But does this approach work?

Well, it has for the world's richest man and arguably the greatest ever investor: Warren Buffett. Here's what he had to say:

"Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years."
                              "Price is what you pay. Value is what you get."

A time of confusion and uncertainty is, as all great investors tell us, an excellent opportunity to make extremely smart investments - so long as they are based on a careful assessment of intrinsic value.

Buffett again:  "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

But, bear in mind, we are NOT looking for 'cheap' buys here.

This is about buying into great quality developments, great investments with strong intrinsic value. But, during a depressed market, one that is, for example, temporarily over-supplied, buying below intrinsic value is possible, which represents a superb opportunity.

This period is especially attractive - or should be - to high net worth individuals able to use their higher purchasing power to leverage the best prices.

And this is where residential property has an advantage for high net worths - residential investments that are at all attractive to funds, of, say, more than £4 million, are rare and nearly always over priced. So, large funds are often generally excluded from such markets.

A great time to invest then - IF your time horizon is sufficient (ten years minimum) AND you are prepared to do the analytical work to ensure you are buying into a market at a price that is at, or preferably below, intrinsic value.

As I said, you don't need the IQ of a Nobel prize winner here, BUT you do need to be prepared to put in the work to apply the framework of principles and then look at the analysis and base decisions ONLY on that. And an investor certainly needs to be careful where they invest.

Look at the UK, Spain and Ireland right now - all markets with plummeting property prices; prices in all these markets as now being described as 'cheap' by many investors.

But 'cheap' relative to what? Relative to their previous prices, which were over-blown and part of an asset price bubble. Cheap is really not worth considering. It has nothing to do with intrinsic value.
What we need to look at instead is whether there is good intrinsic value in these markets. Are there wonderful assets?

Well, not if economic growth and therefore job creation is weak and credit availability is likely to shrink for the medium to long term - perhaps even permanently.

Look at Germany
It's certainly 'cheap' compared to comparative markets in Western Europe and has been for a long time - but there is little intrinsic value in an economy in which there is no increase in disposable income and no growth in jobs - Germany has spent the last ten years increasing production and competitiveness by cutting real wages.

Such things are the fundamental drivers of property markets, the determiners of intrinsic value and NOT subjective conclusions about whether a market is cheap based on a comparison with another market.
And this is why we favour specific CEE markets - because our analysis tell us that CEE markets - not all, mind, but some - can offer market prices at or near Intrinsic Property Value (IPV) - but with very strong and long term IPV growth potential. Plus, we have strong property rights and the reassurance of EU membership.

In these markets, and others, we are constantly examining the growth rate in Relevant Supply (meaning supply to the sector of the market we are analysing, NOT the whole market), relative to the growth of cash available in the same market segment.

To do this we need to look at RELEVANT disposable income, relevant jobs and the availability of credit to the relevant sector. Now, once we are able to establish these parameters, we are able to determine what price we need to buy at in order to build in a safety margin. This is crucial. It's not especially complicated, but it does require a great deal of research and number crunching.

The bottom line is that we will not invest where our analysis shows us that property prices have risen at rates significantly above intrinsic value.

So, yes, all this requires effort, it requires a framework and it requires strong investment principles in order to squeeze out the emotion. But it does not resort to some magic formula, it does not look to achieve quick gains and it does not rely on perfect timing in a market - because we are looking are fundamentals and NOT cyclical factors that can be discounted over a ten year time horizon.

And it may well be that our analysis reveals that opportunities are not actually market driven at all, but opportunity driven - and important distinction.

So, to sum up: history shows - through the most successful investors there have ever been - that only an investment framework based on Applied Value Investing will deliver consistent, long-term returns.

Effort is required. Luck doesn't count.

Property Secrets approach is to apply and seek out:
1. Residential property (in legally safe countries) with a built-in safety margin.
2, A clear investment framework founded on rational analysis and not based on subjective impressions. 
3. We apply measures of Intrinsic Property Value Principles with the aim of locating Wonderful Assets for
    the long term.

To optimise our approach investors must be ready to buy fast and buy big - because there are only short windows of opportunity when Market Prices are attractive relative to Intrinsic Property Value in legally secure, high economic growth markets.

And, finally, once again, can I restate: We do not want to convert investors to the Property Secrets way here. We'd rather expend effort on applying our investment principles to locate wonderful property assets. Instead we are looking to team with investors who examine our Intrinsic Value approach and see a confluence with their own. If that is you, then we want to have you with us.

For more information from Property Secrets become a member of Designs on Property see our member benefits including a massive 20% off Property Secrets Pro Life membership. If you are a member already, then to find out more and receive your discount, sign in and click on the members services from the members homepage.  

Please Note:-
The views expressed in this article are of Neil Lewis from Property Secrets and not necessarily agreed with or supported by Designs on Property Ltd


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