During a crisis of any kind, people tend to act in panicked fashion. This includes making quick decisions with only a short time horizon. We also become more conservative, less willing to take risks, even if this was as advantageous or even more advantageous than before.
We tend to act together, and do as others do, as this gives us a sense of security. Seeing others repeat our panicked actions, lulls us into a false sense of doing the right thing. Because it can’t be possible that all these people are also doing the wrong thing, right?
Contrarians eat panic for breakfast
Well, the history of the financial markets shows us that crashes do generally start for good reasons – i.e. they begin as a pricing correction when the price of an asset becomes overvalued and no longer offers an attractive return. We can see this by plotting the prices of the property or stock markets against long run averages. Once the short term trend sits above the long run average for too long – a crash ensues to bring it back down to earth.
Only, these pricing corrections tend to go too far – shooting past the long run average and bringing the market to a valuation level which could be described as ‘cheap’.
Contrary investors look at this type of data to decide when to enter or exit a market. They know that the most effective time to invest in property, is when everyone else is selling. Likewise, the most profitable time to sell is when everyone else is buying. This is easier said than done, but we’ll get to that point later.
Fear is good
Once we understand this aspect of human psychology – that loss aversion causes investors to panic in crowds and over-sell assets during crises – we have a way to detect good buying opportunities – we look for fear.
During a property market crash, fear is palpable. Unlike in stock market crashes – where investors tend to be wealthy and can afford to bear losses, a crash in the property market has more ‘real’ repercussions.
For one, the market participants are everyday folk who may be very risk averse and who only own a risky asset (residential property) because it’s a part of everyday middle class life.
Secondly, some homeowners will need to sell their house to be able to change location, move in with a new partner and so on. A crash at the wrong time could ruin long term plans.
Therefore when the property market wobbles – you’ll hear about it. You’ll feel the fear. Headlines will begin appearing, tracking national property prices as if they’re sports scores. Banks will begin to restrict their mortgage loans to fewer customers with higher credit scores.
Is investing in a property downward market a good idea?
So it’s quite easy to decide if the market is in a pessimistic and panicked state. But is it a good idea to invest?
Firstly of all, you should consult with charts to understand how far the market has fallen. Has it fallen to below a long run moving average? If not, then in principle the market could still have much faller to fall before it’s objectively fairly valued, never mind undervalued. This would not be an opportunistic time to buy, and indeed you could be buying a plummeting asset.
Ideally you would want to step in when several indicators are clearly showing that the asset is cheaper than its historic average.
This isn’t to say that it won’t fall further. There will also be crashes where the price doesn’t even reach this low (in which case it will present no opportunity to buy). But occasionally you may find that all the stars have aligned, and you are in a position where:
- The market has fallen significantly
- It’s trading below its long run average
- You have liquidity and the cash to be able to buy a property without relying on sources of finance
This could be the right time to strike and invest.
Be aware that a falling market can be an unusual time to invest as the market isn’t functioning normally. Some sellers may help expedite any sale, so that they can offload the property for fear of it falling further. However some sellers may refuse to acknowledge that the price of their asset is worth less than they listed it for 3 months ago, and may be unreasonable in negotiating for a lower price.