As the commercial real estate market begins to pick up steam, beware the urge to follow a “momentum” investment strategy rather that a “value” investment strategy.
Momentum investing relies on market increases to generate a return on investment. It is the “rising tide floats all boats” investment model. It is the investment model of which all “bubbles” are made.
As momentum investing accelerates, investment fundamentals tend to get lost. Instead of evaluating cash on cash returns using discounted cash flows that underlie “value” investing, a casino mentality takes hold – whereby investors can justify acquiring assets generating even a negative cash return, with the notion that rising prices will yield a profit. As the saying goes: “Any fool can make a profit in a rising market – and many fools do”. The challenge, of course, comes when a market hits a plateau or, worse yet, the market declines.
As a general proposition, value investing is significantly more prudent. If a project is cash flowing, and generating a positive return on investment, today and for the foreseeable future – which is a fundamental precept of a value investment strategy – the potential added return of any increase in value in the underlying asset caused by the “rising tide” effect is icing on the cake. Choose your cake with care.
There are, of course, exceptions to every rule. But, employing an “exception” is wisely done only after sober reflection of the particular circumstance to determine that in that particular case the exception is warranted. When an exception is regularly employed, it is no longer an exception – but, rather, becomes the rule itself.
As in all markets, there will be winners and there will be losers. It makes sense in the coming commercial real estate revival to position yourself and your company as a winner. You may not get another chance.
Exercise all appropriate due diligence. Use readily available and appropriate asset protection strategies. Invest with intentional regard to reliably building wealth though a well conceived value investing strategy – not a roulette table strategy that, over time, is virtually certain to fail.
If this recent economic debacle has taught us anything, it has taught that bad things can happen to good people who lose sight of the fundamentals. Good deals – even great deals – can be made if reliable commercial real estate investment fundamentals are employed.
As a wise mentor once told me: “You have a good brain – use it.”
Good luck.
R. Kymn Harp
Robbins, Salomon & Patt, Ltd.
Chicago, IL
www.rsplaw.com
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REPORTING FROM THE FIELD. . .
Amen! Well said