The Greater Fool Theory

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V.I.P. Trust Deed Company

As most of my readers know, real estate runs in cycles. This is the third time (in California) that I have, personally, experienced sustained real estate appreciation over a multi-year period. You may disagree with exact dates but the run ups that I am referring to are the late 70’s, the late 80’s, and the mid to late 90’s. Obviously, the recent run up has continued through today. The real estate appreciation in the 70’s was crippled in the early 80’s due to very high interest rates. The appreciation in the late 80’s was followed by a SUBSTANTIAL correction in the early 90’s, for a variety of reasons that are not relevant to this column. You may assume that I am predicting a major real estate correction – I am not. I am not an economist and, frankly, if I were, I probably wouldn’t know what I was talking about anyway.

The trick to real estate investing is just that – invest. Do not buy real estate just because your neighbor or mailperson made a “killing” on a duplex. Just like the stock market, plan long term.

If you are buying income, commercial, or industrial property, make sure that the property “pencils out.” If you are planning to hold the property long term, make certain that you get a fixed rate loan. This is an investment not a rush to slaughter. This brings me back to the “Greater Fool Theory” which is something like the stock market theory of the bulls, the bears, and the PIGS: the pigs get slaughtered.

If you haven’t heard the “Greater Fool Theory” it’s simple. In times of sustained, double-digit real estate appreciation it’s tempting to buy “anything.” Theoretically you can buy a $500,000 investment property and sell it in a year or two for $600,000. After all you could have purchased the same property two years ago for $400,000. Does this income property pencil out? If it doesn’t pencil out you must have a good reason to purchase it, OTHER THAN the possibility of selling it at a higher price two years from now: It STILL won’t pencil out. By now, you must get my drift: do not buy a property that doesn’t make sense (FOOL) in the hopes of selling it to a greater fool two years from now.

This column was specifically aimed at real estate purchases involving investment property and not a personal residence. If you want to buy a personal real estate, mortgage rates are abnormally low at this point and a long term, fixed rate loan will stay with you even if there is a downturn in the real estate market. On the other hand, if you went to a palm reader who convinced you that the real estate market is going to crash next month, then wait. Come to think of it, if a palm reader did convince you, I may write another column about an even GREATER fool. Believe it or not, I keep a real crystal ball behind my desk for questions like: Will these high prices continue, or what do you think interest rates will do next year?

I still love the old line from Hillstreet Blues, “Let’s be careful out there!”

Peter Rosenthal
VIP Trust Deed Company