Understanding and Navigating the Market Cycles

Today, I wanted to share a highlight from our meeting regarding understanding where we are in the economy and the positions you can take to make the most of the current market volatility.

The Market is Shifting

We have an extensive network of connections in the real estate world – people we work with and have the option to invest with – in the alternative investment space from across the country helping us understand, in real-time, the changes occurring in different local markets.

This is a real time, boots on the ground feedback system for what is unfolding across the country. 

This is why I have a strong preference and alignment with alternative investments. It allows us greater proximity to our investment capital, and therefore more control.

As someone who has had his hands on the steering wheel of his own investments for over 40 years and has gone through multiple major market cycles, I believe we're in a major market correction right now.

The market is shifting, whether or not you want it to. Many believe that we’re heading into a recession. If we look at the data, the leading indicators show that we are heading for a “hard landing” or for choppy waters.

This will not be a short-term situation. No one can predict how deep the recession will go, but I have no doubt that we will NOT see a return to the exuberant market that we've had coming out of the Great Financial Recession some 15 years ago in 2008-10. 

Since that downturn, there has been a significant rebound and growth period, propped up by a flood of monetary fiscal policy that pumped up the financial and alternative market space.

Financial markets – stocks, bonds – real estate, Bitcoin, gold, and bullion prices were inflated substantially. Everybody felt that they could “do no harm.” And for the most part, that was true.

But times are changing. This was a major topic of conversation at our event this weekend.

A New World for Business Exits and Real Estate Equities

We discussed several concerns and challenges at our Member Event, including business exits and real estate equities.

Doctors and entrepreneurs, who have built and run their businesses with their own hands, have been looking for opportunities to exit. In the past 2-5 years, the multiples on business exits have been relatively high (10x) because there's been so much liquidity in the marketplace. But this is changing.

A similar challenge is occurring in real estate equities. In the past, you could invest in a multifamily or self-storage, or mobile home park syndication, and within 18-24 months, the operator would generate profit and investors would get a decent return on capital. That is no longer how it works. People who still think that's the case have, what I call, recency bias.

We are not going to see those same returns or large profits (if any) on the back end of short-term flips. Trading on a short-term or relatively short-term basis will no longer be profitable.

It is imperative to focus on operational efficiency today. Once nonessential in a greater fool theory market, operational efficiency is now the differentiator between those who will be profitable and successful and those who won’t.

Someone will always buy an asset at a higher price when there is cheap capital. But we no longer have cheap capital. In the last 16 months, we've seen the federal funds rate increase rapidly, affecting every sector of the economy and increasing the cost to borrow money.

We started at a 0% interest rate before ascending to about a 5% interest rate with the prediction that the Federal Reserve will have to push rates up another 50 basis points before the market has time to adapt to the last rate increase.

Many believe that the Fed is going to give up the cause and they will go back to lowering interest rates by this time this year, reducing their quantitative tightening. This is just another term for reducing the balance sheet debt that has been accumulated over the last several years, primarily with COVID going back to 2008-10. That's not going to happen. 

The Impact of a Rapid Rise in Interest Rates

The cause and effect of the rapid rise of interest rates is what changed the game. We're currently at a 5% interest rate. Historically, that's not a high-interest rate.

Over the average of the last 40 years, the long-term 30-year fixed mortgage rate has been around 7.75%. But this has no bearing on where we are today. It's the relative change in interest rates from zero to over five percent (and the speed with which this occurred) that has caused problems for business owners and investors today. There is also a lag effect in most markets which we haven't even begun to see the full effects of.

What does this mean for you?

If you are searching for your business exit right now, it means you need to think twice about the terms of the buyout. They promise you some of the money upfront and some of it in the future when there's another recap/refinance.

This is where you need to make sure that you understand the dynamics of the market cycle, the forecasts the buyer is selling you, and the impact on the terms of the agreement if things don’t go as predicted. Forecasts are things that can go awry very quickly. 

If you are investing in equities of any kind – stock market equities or real estate equities or participations – you need to be careful. These assets have been overinflated in recent years and their prices will come down. Make sure that the numbers work out in the long run (earning positive cash flow). And stay away from variable-rate financing, especially as rates are predicted to continue rising.

Currently, I am more invested in the debt side (being the bank). To a bank, debt is not a liability, it is an asset. I’m owning the debt. One way you can own debt with virtually no risk is by buying treasury bills. You can own that debt or loan to the US government. The government is paying over 5% today on short term treasury bills – 30 days or 60 days. That is 5% risk-free.

You better be getting something higher than that if you're going to put your capital into asset classes with any kind of risk.

In Freedom Founders we can do that as well. We can be on the debt side, owning other types of debt that are a strong play in this marketplace. It’s also a much safer position than equities.

The Right Time to Invest in Real Estate Equities

Will there be a time to go back to investing in equities such as rental properties?

Yes, there will certainly be a time to invest in equities but we need to get through the recessionary correction gap before we see those opportunities again. We’re currently at the beginning of this gap.

My point is, don’t let recency bias determine your business and investment decisions. Don’t use linear extrapolation, forecasting based on the recent history of successes, when looking at investments. FOMO has caused many investors to lose capital.

Learn to Read and Navigate Market Cycles 

Be wary of what you invest in today. Understanding when markets shift, why they shift, and how they affect investments is crucial in order to navigate the alternative investment world successfully. 

It would be extremely prudent to study them and find an expert who has been through them, who knows what to expect and how to be prepared. If evaluating a business exit, now is not the time to take capital or take equity off the table without first knowing where you will store it or invest it. 

These are tumultuous times. Not a time to be afraid, but a time to be discerning. Every time we have these major market corrections, a lot of wealth is transferred out of the hands of those who are not positioned well – not prepared – and into the hands of those who understand the market dynamics and have made steps to take advantage of the opportunities that appear.