We tend to think of most investors as rational beings who think through each situation and look for the best economic solution for a given investment.
But if that were true, there would be very few good deals on the market. There must be something else in play.
The root cause of good deals is a human emotion called pain. There are two types of pain. There is acute pain. This is the kind of pain that results when you hit your thumb with a hammer by accident. In that moment, the throbbing pain in your thumb is all you can think about. Your child asking for an ice cream cone won’t get your attention. The phone ringing won’t get your attention. Your entire world is your thumb.
That’s acute pain.
The second kind of pain is chronic pain. This is when you have a pebble in your shoe. It’s annoying. You might limp a little or rotate your ankle a certain way to avoid the pain. But it’s not bad enough to consume you. It’s not even bad enough to get your focused attention.
Chronic pain is not usually enough to cause people to take action.
So what does this have to do with real estate?
One of the fundamental human needs is for certainty. If a human is experiencing financial stress, they are probably experiencing uncertainty along with it. They might be able to pay the bills this week, but what about next month? What if there’s an emergency? Will they have the funds to cope with an emergency, even a small one?
That feeds directly into their decision making process. Let’s look at a purely fictitious example. Let’s say Fred owns a couple of rental properties. His wife is undergoing medical tests and may have to take an extended medical leave of absence depending on the outcome of those tests. He has a decent amount of equity in the rental properties, but they have not been producing a lot of cash flow. In fact, he recently had to replace the water heater in one home, and the air conditioner in another. Then Fred gets the news that a tenant is going to be moving out. That’s going to mean spending more money on paint, cleaning, carpet replacement and dealing with at least a month of vacancy. Fred is feeling financial stress.
Fred decides that he’s going to sell one of the homes. We think that investors make rational decisions that are based on maximizing investment returns. But in Fred’s case, his return on investment isn’t even on his radar. His over-riding concern is bringing certainty to the situation. That’s more important to him at that moment than maximizing his return. He is experiencing acute emotional pain. That pain isn’t real. The origin of that pain is his own mind. He doesn’t know what’s going to happen. His wife might be fine. He might find a tenant quickly who is looking for a home in a great location. But Fred is consumed with fear. His mind is projecting into the future all the things that could go wrong and he is experiencing them very vividly as if they are happening right now.
Fred probably won’t even evaluate a spectrum of solutions to his financial predicament. He could refinance one of the properties. But he doesn’t know how much more equity he can pull from the property. He’s pretty sure he can get some, but will it be enough? He is likely to pick the first solution that will restore financial certainty to his life.
The marketplace is full of vultures who are waiting to pounce all over guys like Fred and take advantage of them. They’ll play mind games with them and further exploit Fred’s fragile emotional state to get a lower purchase price. Fred is what the vultures call a motivated seller.
Make sure you are sitting on some cash and have the ability to maintain financial certainty for yourself, and have the ability to restore financial certainty for someone else should they need it.