Melt Up

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My inability to remember facts does not remove the ability of the past to influence my choices.

I want to move closer to my kids’ schools. The idea is to free up time, enable them to socialize with their pals at our home, and cut my annual car-hours.

Win, win, win.

Thing is… my local real estate market is not acting appropriately.

  • Median prices up 35% year-on-year (sustained upwards price momentum)
  • Lowest inventory on record before…
  • We lost 1,000 homes due to the recent Marshall Fire (constrained supply)
  • Mortgage affordability at multigenerational lows…
  • With a near-term expectation of increasing rates

It’s a perfect storm and creating a frenzy of FOMO-driven bidding.

It’s not just in real estate.

Three-year total returns on SP500… 31%, 18%, 29%… a dollar invested at the end of 2018, now priced at two dollars.

If you rode that wave at 2:1 leverage then you’re up 4x. Nice work, especially if you’re taking a share of profits on other people’s money.

The above puts 7% inflation in its proper context.

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I need to allocate capital in 2022. I’ve asked a wide range of contacts for ideas. One buddy responded with a series of questions:

  • What did you do the last time you had to make this decision?
  • What did you learn from your prior choices?
  • What is the impact of being wrong, both today and in the future?
  • Where are the sunk costs, and FOMO, in this decision?
  • You have time to make these choices, be wary of collapsing your decision timing, maintain your freedom of action as long as possible.

The questions above are the value for you. The next section is notes for my future self.

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At the last peak, just before the 2008 credit crisis, I bought a really big house (about triple the size of what we needed). I over-bought because I felt flush, after a liquidity event. Fortunately, I held a chunk of my investment capacity in reserve and was able to buy into the recovery (2010-2012).

It would be nice if a “buyer’s market” was around all the time. Life doesn’t work that way. In my lifetime, buyer’s markets happen six months per decade. Families need strategies that work for the other 95% of the time.

One of my goals is to avoid strategies requiring directional calls. In our case this means we will sell an investment property, before purchasing a new residence.

Downsides with selling: (a) the potential to “miss out” on the continued run up; (b) crystalizing tax liabilities; and (c) being priced out of the market if there’s another 35% pop.

The downsides are real but they don’t have any impact on our quality of life. This is a lesson. Identify fears, concerns and risks… write them down, make then real and ask… what are the true costs associated with them and does that matter to what the family is seeking to achieve.

Accepting the downsides enables us to avoid things that would impact our lives: being over exposed in a downturn and risking a future cash squeeze.

Also, think about family “problems” from a non-ownership point of view. Having “ability to own” creates a bias towards ownership. Many goals can be reached without deploying capital.

Take my desire to reduce time spent driving the kids around… $9,000 per annum buys me a lot of driving support, Looking at the problem in terms of money and time, I’m $25,000 away from having a third driver (our oldest) living with us.

I also know that I don’t need to remove a problem to feel a lot better… $100 a week worth of driving support is going to make me feel a whole lot better. So $10,000 of spending could solve a “problem” that’s nudging me to move across town.

…and I don’t need to place a large, new bet

…and I don’t need to go through the hassle of moving

Related to my story about solving problems without capital / ownership…

  • The joy from “being a coach” is different than the role of running a coaching business.
  • The satisfaction of teaching is different than the reality of running a school.
  • Purchasing assets nearly always constrains freedom of future action, in a world that’s constantly changing.

If you are a skilled practitioner then be wary of placing yourself in an administration role.

You don’t need to own it, to benefit from it.

Something about this melt up… Family net worth has exploded upwards but there hasn’t been big changes in family balance sheets.

Put simply… real estate is worth a lot more but it’s the same addresses, it’s the same assets.

The capital stock is the same, all that’s moved is the price.

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Another way I look at wealth, cash flow. Take the SP500… it’s doubled in price.

  • End 2018, $100 generated $2.14 in dividends.
  • End 2021, the $100 is now worth $200 and generating $2.54 in dividends

The 100% increase in price, is associated with a 19% increase in cash flow. One could argue that 80% of the increase in “wealth” has been a price move.

Using earnings yield, the numbers are different but the message is the same. There’s been a large price-driven move across our portfolios.

I see the same thing with real estate, a disconnect between price and cash flow.

When we look to the crypto-bros and think their gains aren’t connected to reality… humility could be in order.

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Here’s a boom-time risk assessment you can do…

Consider risk in terms of time (more detail here)…

  • Look at family assets in terms of years current spending.
  • Re-price those assets on a lower-multiple of cash flow, then see the impact on time (measured in years current spending).

You still OK?

Consider: What might this choice cost me, and my family, in terms of time?

My best decision of the last 20 years was moving away from a path that could wipe out my (enviable) lifestyle. I was in the middle of the 2005-2007 boom so the risks seemed very remote.

I made two changes: (a) banked the equivalent of ten years family spending off the table; and (b) removed all personal recourse funding from my life.

Then, as now, I didn’t have to make radical changes. I made adjustments to limit the downside from external financial circumstances.

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My points…

  • Consistent upward price moves are impacting our collective psychology.
  • These moves are mostly price driven.
  • Because price moves can happen in both directions… consider risk in terms of how much time you lose with an error.

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Finally, raise your prices!

If you can generate recurring cash flow (for yourself, or others) then there’s never been a better time to re-price your services.

$100,000 of cash flow is being priced at $3-5 million by many markets.