The Six Immutable Laws of Real Estate Investing

James Montier, the well known author of "The Little Book of Behavioral Investing" recently wrote an article called "The Seven Immutable Laws of Investing."  In this article he identifies seven principles for sensible investing in the stock or bond markets.  I was intrigued by the title so I read the article and somewhere along the way I realized that 6 of these 7 "immutable laws of investing" also apply to investing in commercial real estate.  So I thought what the heck, maybe I should take a stab at writing an article on the "Six Immutable Laws of Real Estate Investing."  So here goes:

1. Always insist on a margin of safety.  In other words the goal is not to buy at fair market value but to purchase with a margin of safety as property performance, market conditions, etc. may not live up to expectations.  In our world of real estate this means finding properties that are under performing the market but with a change in ownership will turn the property's performance around. 
2. This time is never different.  The four most dangerous words in investing - "this time is different."  The dot.com bubble that occurred about ten years ago is a perfect example.  Investors were buying stock in companies that hadn't turned a profit on the expectation that they would be the next Google, or Amazon.com.  Stock prices soared and even though it made no logical sense the argument that was bandied about was, "this time is different."  The same was true of real estate.  How many believed that house prices could never go down?  In both examples a speculative fever resulted in a bubble causing stocks and house prices to plummet in value.  Whenever someone starts saying this time its different, get out of that investment as quickly as you can.
3. Be Patient and Wait for the Fat Pitch.  As Mr. Montier states in his article, "Patience is integral to any value-based approach on many levels... However patience is in rare supply."  In commercial real estate there is a time to wait and there is a time to act.  When things go bad, like they have for the last three years the tendency is to dump our real estate holdings as quickly as we can when the prudent thing to do is wait.  Most investors suffer from an "action bias" - a desire to do something.  But often times the best thing to do is to stand at the plate and wait for the fat pitch.     
4. Be Contrarian.  Humans are prone to the herd instinct.  When everyone is buying they buy; when everyone is selling they sell.  Last year the value of BP's stock plummeted due to the gulf oil crisis.  BP stockholders were dumping their stock and only a few contrarians were buying.  Less than a year later those that fought the urge to follow the herd have made a handsome profit while those who sold lost money.  Now's the time to be buying commercial real estate, especially those that have been hardest hit - office, retail and industrial.  Years from now we will realize that that there were bargains to be purchased in 2011.  Or we can go along with the herd and sit on the sidelines.
5. Be Leery of Leverage.  I really shouldn't have to say much of anything on this topic.  In many instances those owners with properties that were over leaveraged have paid the ultimate price - the loss of their properties.  Those homeowners who used their homes as ATM machines learned the hard way too.  Three years after the the collapse of the housing bubble about 1 in 4 homeowners have no equity in their homes.
6. Never Invest In Something You Don't Understand.  This is just plain old common sense.  It's not uncommon for for me to talk with real estate investors that are clueless about their real estate holdings which puts them at the mercy of their real estate advisors.  Many times these advisors have a different agenda than the owner but the owner not knowing the fundamentals of commercial real estate is unaware of the conflict of interest.  It's a simple truth: If you don't understand the investment concept, then you shouldn't be investing in it.

I personally believe that now is the time to be investing in commercial real estate as long as you follow these six fundamental principles.  Cap rates have risen significantly, the frothiness of the market has long since disappeared and  interest rates are low... at least for the time being.  Or you can be a part of the herd that sits on the sidelines waiting for a better day, a day that will likely never come.