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Where will you be when that next storm blows in?

A few years back, I took a trip with my father-in-law and my brother-in-law. We decided to hike across the Bitterroot Mountain Range between Washington State and Montana, hiking through Idaho along the way. We had a map of the first few miles and one of the last few miles, but nothing in between. We had to pick our way through the mountains.

The last 24 hours had us scurrying through ice and snow to cross a ridge line before a front carrying hard rain caught us in a very exposed position. By the time we made the pickup point, we were tired, cold, wet, and ready to call it a day. There was talk about taking less strenuous hikes in the future. We were feeling our age. At least my father-in-law and I were. My brother-in-law was much younger and seemed much less bothered.

We had to wait for a few hours before our support group, also known as my wife and mother-in-law, arrived to pick us up.
On the way back to their house in Spokane, we stopped to get something to eat at a restaurant on the Montana/Idaho border. About halfway through dinner and a change of clothes in the bathroom of the restaurant, we begin to feel better.

By the end of dinner we were talking about where we might go next time; the hike quickly turned from hard times to good memories.

A few hard lessons

That’s how we are hardwired. We forget the hard times much more quickly than the good ones in most cases.
Unfortunately, that holds true in the investment world as well. We seem to rarely learn from our mistakes, at least as a group.

Its been just over five years since the technology market came crashing down on its investors. It was a hard lesson to learn, but there has been much talk about how much our generation of investors learned from this costly event. I would bet that the next time the technology market gets out of whack, people will remember.

But what about the other markets? Doesn’t the same lesson apply for them?

Considering real estate

Obviously not. Just listen to investors talk about real estate. Everyone, it seems, knows someone who bought a beach condo last year that is now worth twice what they paid for it, or had some of their money in a publicly traded real estate investment trust. (The public REIT market was up more than 30% last year.)

The biggest question I get lately is about raising my clients’ exposure to real estate. Everyone wants in on the easy money. But chasing those kinds of returns is very dangerous business.

The real estate gurus will tell you about the Baby Boomers who are flooding down the Florida turnpike at retirement just looking for a beach house to buy with their retirement money. But does that really justify the astronomical increases in the price of real estate, not just in Florida, but in many parts of the country?

The price of real estate could reflect that an enormous amount of real estate has been bought through interest-only loans and at market values based on the future sale price as opposed to the current buying price.

And, if that is true, what happens to market value of real estate if those buyers can’t get what they need come sell time, and they don’t have the money to pay off their l00% loans? In that case, all the Baby Boomers in the pipeline couldn’t save the real estate market from the dreaded bear.

I’m not saying that real estate won’t go up over the next year. I’m just saying that the higher the price, the less sense it makes on a fundamental basis. And I have come to believe in the accuracy of fundamental analysis over the long run. The less sense it makes fundamentally, the more risk there is in participating.

I’ve heard all the clichés like, “They aren’t making anymore land.” But that still doesn’t justify the kind of increases we have seen in real estate lately.

In order for people to continue to pay a lot more for real estate, they are going to have to make a lot more money, and that’s not what’s happening right now. The financial institutions are making it very easy for people to afford the payments on expensive real estate, and when that ends there won’t be much in the way of fundamentals to stand on.
Doesn’t this sound an awful lot like what was happening to the technology sector in the late ‘90s? We are a “reversion to the mean” business. When things get too high, they come down. That doesn’t mean you can’t win or win big.

We won on the hike when we decided to make a sprint for the other side of a ridge 300 vertical feet higher than where we stood as the storm approached. We ran for cover on the other side and set up our tent in a torrent. I would have hated to see what would have happened if we had been caught on top.

The old timers saw the storm brewing for technology in the late ‘90s. Only a handful of the young investors can make that claim. It looks like there may be another storm brewing, this time on the real estate horizon. The question is, “Can I afford to be on the ridge when it gets here?”

Contact MBJ contributing columnist Scott Reed, CIMA, CWA, AIF, of Hilliard Lyons, member NYSE & SIPC, in Tupelo at mbj@msbusiness.com.

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