Bob Farrell’s 10 rules for investing…applied to real estate

It’s worth remembering that when it comes to getting perspective on current events, humans have several major flaws.  For starters, we have an uncanny ability to project our current reality into the indefinite future.  In a related manner, we tend to believe that the era in which we are living is ‘normal’, when a study of history tells us otherwise.  Even when we can clearly see that we live in extremely anomalous times, we can easily be convinced that we live in a ‘new era’ where the old rules no longer apply.

This is particularly true of markets, be they stock, bond, or real estate.  It’s worth heeding the advice of those who have a lifetime of experience in such markets, particularly when their track record puts them among the best of their time.

Bob Farrell was a Wall Street legend who was the chief stock market analyst for Merrill Lynch & Co. for several decades.  Farrell was at the helm of Merill during the booming market of the 60’s and mid 80’s.  He saw the ‘new era’ Tronic bubble and witnessed the brutal markets of 1973-74, and the Black Monday October 1987 crash.  Although he retired in 1992, he continues to be an active voice of reason to the investing community, warning of the Dot-Com bubble in the late 90s.

Farrell created 10 rules for investing.  They are worth considering as we examine any market.  Although he created them specifically for the stock market, there is great wisdom to be gleaned with regards to our current real estate market.

1. Markets tend to return to the mean over time

  • Canadian real estate has massively outpaced its long-term rate of appreciation over the past decade.

2. Excesses in one direction will lead to an opposite excess in the other direction

  • Self explanatory

3. There are no new eras — excesses are never permanent

  • Worth considering if you are drinking the “Rich Asians will keep real estate permanently high” cool aid

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways

  • Wisdom here for both the bulls and the bears.  Real estate was clearly overvalued to me back in 2007.  Yet here we are in 2011 sitting substantially above those heights.  In defense of the bear crowd, had the government not stepped in to stem the tide in 2008-2009, we would probably be nearly back to the fundamentals today.  Momentum is easy to under-appreciate.  The psychology of rising prices begets further price increases as people increasingly believe that there is only one direction for real estate.
  • To the ‘soft landing’ crowd….take note.

5. The public buys the most at the top and the least at the bottom

  • True in any market.  Sad, but true.  The clearest indication of a top or a bottom in any market is widespread sentiment.  Right now Canadians are wildly bullish on real estate.  At the risk of sounding condescending I’ll suggest that when people who have no business giving financial advice start telling you that something is a sure thing, get out of it!  It may run further for a while, but you can be assured that the pool of greater fools is getting very shallow.
  • Of those who escaped the great market crash of 1929, some indicated that they became very wary of the sustainability of the market when shoe-shine boys started talking about their favourite stocks.  The same was evident back in the late 90s when virtually everyone in an office was talking about the next big dot-com stock.
  • Anecdotally, I can’t count the number of times I’ve had conversations with people who try to convince me that real estate never loses value.  When I ask them to explain what factors drive real estate values, they typically have no idea.  This weirds me out.

6. Fear and greed are stronger than long-term resolve

  • It’s exceptionally difficult for people to see the paper gains made by many during the current real estate boom.  It’s easy to capitulate and join them.  Use your head.  Emotions will cost you.  Greed and fear are your ultimate enemy.  There will be a time when sentiment towards real estate changes and many will change their outlook on the prospect of future gains.  It will be difficult for many to pull the trigger and make the purchase when sentiment is stacked against them.

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.

  • Most relevant when applied to stock markets, though it certainly is worth watching the number of entry level homes selling in any market.  First timers drive sales.  Without them, there will still be some residual buying and selling, but it is not sustainable.  When entry level home sales stagnate, it’s an early warning of future weakening in sales.

8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend

  • VERY interesting in the context of our current stock market.  We’ll see just how true this plays out.

9. When all the experts and forecasts agree — something else is going to happen

10. Bull markets are more fun than bear markets

  • I guess that depends on your cash position.  I had a blast during the market crash of 2008-2009 when many stocks were trading for less than the cash they held on their books.  Huge future gains are made by buying “when there’s blood in the streets”.  Those who are actively preparing to take advantage of future real estate market weakness might manage to squeeze out a smile.



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6 Responses to Bob Farrell’s 10 rules for investing…applied to real estate

  1. Brad on Cowtown says:

    Ben – you should write a book. You are one of my favourite reads of the day. You and Turner. Both extremely gifted writers and sharp, sharp men.
    His only downfall is that he can be a little grumpy and downright mean sometimes, even to his supporters! lol
    Anyways, please keep up the great work. Your insight is extremely valuable. I almost feel guilty that high quality education like this blog is free!

  2. Michelle says:

    Cannot agree more! We must always embrace the fact that any ” Bubble” has ending.

    We must always be true to our feelings, are we acting out of fear that we may miss something, and the rest of them will be rich while we sit and do nothing.

    Listen, after doing your homework and came to the conclusion that the calculator does not lie, then, promise yourself that you will ‘ never ‘ follow the crowd. NEVER!
    In the end, you will be able to pickup bargains.

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