Here is an excerpt from a link that Marcus or Muppet posted on the forum a few weeks back. I think this guy has some extremely valid points on 'market' prices, averages and what stops people investing.
Regards
Graeme Fowler
Regards
Graeme Fowler
Some of the most common questions I get from readers of my Investing in Land Home Study Course on the subject of real estate market prices and what is my opinion on the future direction of these prices, especially in light of the recent discussions of a "real estate bubble" in the media and certain predictions it may "pop."
Some of the questions and comments I have received on this subject in just the past week include:
"I'm afraid to buy property now. What if the bubble I read about bursts?"
"What is your opinion about the real estate bubble?"
"Market prices have risen sharply in my area and I'm concerned if I buy now I'm putting money to work at the top of the market."
"Lower interest rates can only drive market demand and market prices higher, right?"
"Since there is a shortage of properties on the market, the lack of supply should increase prices given stable or increasing demand. Am I right?"
"Real estate market prices have risen very rapidly across the nation and must return at some point to their mean average and a much slower rate of growth or even negative appreciation for a time. Is that is the time to buy?"
These are all the wrong questions to ask because these people do not understand the nature of real estate investment. They are focused on market timing and speculation rather than INVESTING in real estate.
Real estate market prices are IRRELEVANT
When people talk about "real estate market prices" what exactly are they talking about?
Traditionally they are discussing the mean (average) price of a typical type of property (say a three bedroom, three bath, single family home) in a given area over a stated period of time. Sometime the market price for this average but still hypothetical home is up, sometimes it is up sharply, sometimes it is not up at all. But does it really matter what the market price of this home really is?
When you buy real estate, you are not buying a "market." You are buying an individual and specific property with particular attributes from a unique seller unlike any other under very special circumstances.
Think of the difference this way. In the stock market you can buy a market. If you want to invest in the NASDAQ market, you can buy the QQQ. If you want to buy the Standard & Poor's Large Cap Market (S&P 500) you can buy a specific security known as the SPR or "Spider." In these cases and many others in the stock market, market prices are VERY important because that is precisely what you are buying, the market itself. You aren't investing in any one particular stock but a large basket or universe of them. You are betting on nothing more than market prices when you purchase the QQQ or the SPR or a host of other market-based securities.
But you can also buy a specific stock which is part of the broader market. The coffee giant Starbucks ("SBUX") is part of the QQQ market index stock. When you buy the QQQ, you are buying SBUX but very indirectly and each will not necessarily track the other. The QQQ market price could rise but SBUX's market price could fall on the same day or vice versa. So the market price does not necessarily set the price of each of its components. They may rise in tandem and often they do. But the reverse is quite true and very common. To be scientific about it, there is no linear correlation between the rise of any market's price and the rise of each of the market's components.
This also makes sense because a "market price" is really an average of all the prices of all the things that make up that market. Some components may be rising very rapidly while others falling at the very same time. Some of the great logical fallacies revolve around averages. Remember the story of the guy who read in an atlas that the "average" depth of a river was five feet so he decided he could walk across it----and promptly drowned attempting to do so? Yes, the average depth was five feet, but the river depth started at zero near the banks on either shore and was eighty feet deep in the middle. Add all those zeros, ones, twos, and so on near the shoreline with the 78, 79, and 80 feet readings near the middle and you get an "average" of five feet. See how genuinely unhelpful that average value statistic is? What good does it really do to know that the "average" depth of that river is five feet? It is a useless statistic, misleading like any average can be when misapplied.
Market prices when I read them give me a sense of the market's mood, nothing more. As the great investor and legendary author Benjamin Graham explained in his masterpiece, THE INTELLIGENT INVESTOR, think of the market as this man named Mr. Market who is psychologically flawed and swings between days of rank euphoria and optimism and bouts of depression and pessimism. Market prices when they rise tell me that Mr. Market is seeing the glass half full and when they fall Mr. Market is reaching for some Valium and is afraid of his own shadow. Does that mean that it is good to buy equities in falling markets since average (in other words, many or most) prices will be falling too? Sure, it is easier to get bargains in a buyer's market. BUT it is also more difficult to sell what you buy for a profit when prices all around you are falling.
The key is that market prices are IRRELEVANT. There is never any time better than any other time to invest. As an investor you are constantly trying to seek out flaws in the market, situations where as noted above a dollar of equity can be had for less than one dollar in cash. These situations occur in EVERY market at EVERY time, in bull markets and during bear ones. In illiquid markets like real estate it is much easier to find great intrinsic value bargains since they are less visible to the general public than a stock market bargain would be - although those exist all the time there too. Market liquidity acts like a check on the accuracy of any market, bringing out arbitrageurs, traders, and investors who can easily self-correct flaws between intrinsic value and market prices in the market. This simple fact explains why land investors get the best real estate bargains possible. Land is the most illiquid equity of the most illiquid market and therefore mispricings, panic selling, sales mistakes, and other flaws occur all the time and are the most opaque, hidden from most of the other market.
Some of the questions and comments I have received on this subject in just the past week include:
"I'm afraid to buy property now. What if the bubble I read about bursts?"
"What is your opinion about the real estate bubble?"
"Market prices have risen sharply in my area and I'm concerned if I buy now I'm putting money to work at the top of the market."
"Lower interest rates can only drive market demand and market prices higher, right?"
"Since there is a shortage of properties on the market, the lack of supply should increase prices given stable or increasing demand. Am I right?"
"Real estate market prices have risen very rapidly across the nation and must return at some point to their mean average and a much slower rate of growth or even negative appreciation for a time. Is that is the time to buy?"
These are all the wrong questions to ask because these people do not understand the nature of real estate investment. They are focused on market timing and speculation rather than INVESTING in real estate.
Real estate market prices are IRRELEVANT
When people talk about "real estate market prices" what exactly are they talking about?
Traditionally they are discussing the mean (average) price of a typical type of property (say a three bedroom, three bath, single family home) in a given area over a stated period of time. Sometime the market price for this average but still hypothetical home is up, sometimes it is up sharply, sometimes it is not up at all. But does it really matter what the market price of this home really is?
When you buy real estate, you are not buying a "market." You are buying an individual and specific property with particular attributes from a unique seller unlike any other under very special circumstances.
Think of the difference this way. In the stock market you can buy a market. If you want to invest in the NASDAQ market, you can buy the QQQ. If you want to buy the Standard & Poor's Large Cap Market (S&P 500) you can buy a specific security known as the SPR or "Spider." In these cases and many others in the stock market, market prices are VERY important because that is precisely what you are buying, the market itself. You aren't investing in any one particular stock but a large basket or universe of them. You are betting on nothing more than market prices when you purchase the QQQ or the SPR or a host of other market-based securities.
But you can also buy a specific stock which is part of the broader market. The coffee giant Starbucks ("SBUX") is part of the QQQ market index stock. When you buy the QQQ, you are buying SBUX but very indirectly and each will not necessarily track the other. The QQQ market price could rise but SBUX's market price could fall on the same day or vice versa. So the market price does not necessarily set the price of each of its components. They may rise in tandem and often they do. But the reverse is quite true and very common. To be scientific about it, there is no linear correlation between the rise of any market's price and the rise of each of the market's components.
This also makes sense because a "market price" is really an average of all the prices of all the things that make up that market. Some components may be rising very rapidly while others falling at the very same time. Some of the great logical fallacies revolve around averages. Remember the story of the guy who read in an atlas that the "average" depth of a river was five feet so he decided he could walk across it----and promptly drowned attempting to do so? Yes, the average depth was five feet, but the river depth started at zero near the banks on either shore and was eighty feet deep in the middle. Add all those zeros, ones, twos, and so on near the shoreline with the 78, 79, and 80 feet readings near the middle and you get an "average" of five feet. See how genuinely unhelpful that average value statistic is? What good does it really do to know that the "average" depth of that river is five feet? It is a useless statistic, misleading like any average can be when misapplied.
Market prices when I read them give me a sense of the market's mood, nothing more. As the great investor and legendary author Benjamin Graham explained in his masterpiece, THE INTELLIGENT INVESTOR, think of the market as this man named Mr. Market who is psychologically flawed and swings between days of rank euphoria and optimism and bouts of depression and pessimism. Market prices when they rise tell me that Mr. Market is seeing the glass half full and when they fall Mr. Market is reaching for some Valium and is afraid of his own shadow. Does that mean that it is good to buy equities in falling markets since average (in other words, many or most) prices will be falling too? Sure, it is easier to get bargains in a buyer's market. BUT it is also more difficult to sell what you buy for a profit when prices all around you are falling.
The key is that market prices are IRRELEVANT. There is never any time better than any other time to invest. As an investor you are constantly trying to seek out flaws in the market, situations where as noted above a dollar of equity can be had for less than one dollar in cash. These situations occur in EVERY market at EVERY time, in bull markets and during bear ones. In illiquid markets like real estate it is much easier to find great intrinsic value bargains since they are less visible to the general public than a stock market bargain would be - although those exist all the time there too. Market liquidity acts like a check on the accuracy of any market, bringing out arbitrageurs, traders, and investors who can easily self-correct flaws between intrinsic value and market prices in the market. This simple fact explains why land investors get the best real estate bargains possible. Land is the most illiquid equity of the most illiquid market and therefore mispricings, panic selling, sales mistakes, and other flaws occur all the time and are the most opaque, hidden from most of the other market.