So here we sit, a few months after the Bank of Canada has declared “The Recession is Over.” Technically they are right, but on the street many Canadians will continue to feel the effects for months to come. In fact, over the coming 12 months, Canadians will experience “The Big W” rollercoaster. On this economic ride we’ll experience one week where it seems we are on the top of the world (ex. OECD states that Canada’s economic growth will lead the G7 countries) followed by a fast ride down as negative news continues (ex. unemployment rate creeps up towards 10 per cent). This up-and-down cycle will continue throughout 2010 and by 2011 the ride will start to smooth out and return to normal. However, during these next 12 months, make sure you study the lessons learned during this past recession so you will not be destined to repeat the pain.
So, what did we learn from this steep downturn? The answer is most investors learned they didn’t really have their downside covered or their upsides maximized. The biggest, and most important lesson we can all learn is to never get too high when the market is good, or too low when the market underperforms. Letting the market drive your emotions is a sure-fire way to disaster. In order to ensure you never get caught again, heed these following market lessons:
1. Beware of Chicken Littles. On September 15, 2008 (only 16 months ago), Lehman Brothers declared bankruptcy and the ‘Chicken Littles’ hit the streets – the airwaves and the internet declaring that the world was about to end. Yes, it is true the picture looked bleak and some would say it still does. Fear is a very powerful emotion and one that these people used to grab your attention. However, the result of those rants and raves was that some Canadians froze in terror not knowing what to do so they got out. Sadly, many of these investors sold at the wrong time and now find themselves even farther into their financial hole. These ‘Chicken Littles’ did nothing but cause chaos and deflate the financial dreams of their fellow Canadians, all for the sake of a little publicity. Lesson learned – do your own homework and look for opportunity.
2. When opportunity arises, strike. Warren Buffet says it right when he preaches, “Be fearful when others are greedy and greedy when others are fearful.” Sure, it is difficult to take action when everyone around you is talking economic doom and gloom, but it is during downturns that fortunes are made. Look at history – downturns never last forever and this one will not be the last we see in our lifetimes. Use today’s fear and confusion to position yourself to prosper before the next one hits. Doing nothing will get you nowhere.
3. Follow a system. It may be boring but it’s proven profitable. Never think you are smarter than the market, especially in a positive market because eventually it will teach you a very tough lesson. Let’s be honest, anyone could have made money during those boom years – the market boom covered up any mistakes. Then reality kicked in. The boom stopped and suddenly anyone investing without a system found themselves in financial trouble. Once again, Warren Buffet says it succinctly, “You only find out who is swimming naked when the tide goes out.” In other words, if you aren’t following a system that works in all market conditions, you will be caught naked when the market changes. Following a system is often considered boring because so many investors have that entrepreneurial type personality and they don’t like so called restrictions. These were the ones caught swimming naked when the inevitable downturn arrived. If you prefer to have consistent profits and minimized risk, follow a system and stick with it through high times and low times. Make investing boring, so the rest of your life can be exciting.
4. Investing means never having to line up. Whenever you line up to buy anything in life, you immediately give all of your power away. The economic supply and demand pendulum swings way out of your favour, leaving you with paying over market price and having no control. Right before the downturn you would see people lined up around the block with dollar signs in their eyes, just hoping to put a deposit on a property that hadn’t even been built yet. Most were driven by the greed of making a quick buck. Wow, did that ever turn into a mistake for thousands across the country. I hope we all learned the lesson that buying in a frenzy leads to very little due diligence, no opportunity to negotiate and an investment that is totally out of your control (especially now that many of these projects have been cancelled, dropped in value or led to lawsuits). If the market stays hot, you might get lucky. If the market cools or drops, you are left with nothing but panic. Never give your power away to anyone.
5. Remember that you are in the business of real estate investing. Although CRA deems income from real estate investing as passive business income, the reality is that generating cash flow from property is anything but. From the moment you purchase your first investment property (whether with a corporation or personally), you are in business. You have revenue, expenses, customers, suppliers, market research and financing issues that you must stay on top of. Your job, as the president of your company, is to maximize profit while minimizing risk. If you kept that thought process during the boom times, you would have also protected yourself for the inevitable recession by buying strong positive cash flow properties. By thinking of investing as being a business (rather than a speculative gamble), you would never have been caught naked in the downturn and would have actually used the downturn to your advantage. Manage your business, whether it contains one property or 500, and invest for cash flow.
6. Invest in areas with a future, not a past. Choose your investment regions wisely. The region in which you invest is just as important as how you invest. But oftentimes, unsophisticated investors purchase properties because the property seems cheap. Sophisticated investors keep perspective and only buy properties that have fantastic potential. During this downturn, all regions across the country were hit. However, those with strong potential are the ones that will recover most quickly and have the strongest economic foundation. The rollercoaster ride will not be as dramatic in these well researched regions. The regions that were hot during the boom, yet did not have underlying economic strength, have left investors gasping for air during the downturn. Those who bought in regions based on economic fundamentals and research now look like investing geniuses. They may not have had as dramatic of an upswing during the boom, but during the downturn their downside has been muted as well and their positive cash flow helped buffer it all.
These are just six of the many lessons that I trust all Canadians learned during this deep downturn in the market. The pendulum swung too far into the positive during the boom, driven by greed, and it swung too far into the negative during the downturn, driven by fear. Learn the lessons that this recession has taught us and never let emotions drive your investment decisions.
Promise yourself that when the inevitable boom comes, you don’t get too excited and when the next recession hits (and you know it will) you can confidently smile because you learned the lessons that this deep recession has taught us all.
Don Campbell is a real estate investment educator, analyst and investor. He is Canada’s bestselling real estate author of Real Estate Investing in Canada version 2.0. Visit www.realestateinvestingincanada.com
From the January 2010 issue of CRE