Don’t Forget to Swing

Anyone who has played baseball at any level, from Little League to the majors, knows the feeling of stepping up to the plate and seeing the perfect pitch coming their way. Those of us who didn’t get out of elementary school ball might even close their eyes and hit one. The better hitters know the uniquely satisfying feeling of marrying a good swing with a great pitch and will often chase that feeling by swinging at balls they know they shouldn’t from time to time. The best hitters, the ones that make it to the majors and into the record books, know exactly where in the strike zone they have the greatest odds of getting a hit and have the discipline to wait for a pitch that works for them. Ted Williams famously broke the strike zone into 77 baseball-sized sections and knew his batting average for each one. Put enough good swings on fat pitches, and you become a legend.

Source: The Science of Hitting 

The best investors, like the best hitters, know their strike zone and what a fat pitch looks like. They think about, in advance, the types of investments they are going to focus on and the characteristics they are targeting. For real estate investors, it may be value-add apartments in secondary markets in the Midwest. It may be stabilized neighborhood retail centers in the Southeast. It may be less specific, like core-plus properties in major markets with certain risk/return profiles. Whatever the strategy looks like, the important thing is having the discipline to not chase opportunities that don’t fit the bill.

The rules of baseball force hitters to swing at strikes. Let too many fastballs down the middle go by and you strikeout. Strikeout too often and you’re on the bench or out of a job. So passing on the first or second strike to wait for a better pitch requires confidence and conviction that a) the next pitch will be as good or better and b) you’ll be able to hit it. Ironically, letting those pitches go by puts the hitter in a worse position, since standing in the box with two strikes means you are forced to swing at anything close to the plate, even if it isn’t an ideal pitch.

Investors don’t have any rules forcing them to swing. In general, that works to their advantage as they are never forced to chase marginal opportunities. But sometimes that means they let perfectly good pitches go by while waiting for something even better to come along.

I saw this play out in real time in the wake of the GFC. After the crash of 2008-2009, most institutional real estate investors were either licking their wounds, focused on addressing problems in existing portfolios, or sitting on the sidelines waiting for the next shoe to drop. “Never catch a falling knife” was the overwhelming sentiment among investors with cash to deploy. And for a while, there was no penalty for thinking this way because the investment markets were generally frozen.

But eventually, those frozen markets began to thaw. And while I didn’t realize it at the time, I had a front row seat to a stark behavioral comparison that was invaluable to my growth as an investor.

We happened to be working with two clients with similar portfolios, strategies, and investment mandates. One took a rules-based approach, primarily focused on rebalancing to target allocations when the portfolio weights got out of whack (which they certainly did during the GFC). The other had a looser mandate, and while they had a clearly defined investment plan there was no requirement that they follow it.

The rules-based investor spent the months and years following the GFC urging us to buy real estate so they could get their portfolio balanced. I vividly remember speaking to my counterpart on a particularly ugly day in the stock market and asking how he was hanging in. His response? “I just closed my eyes and bought a bunch of stocks. Now go buy me some property.” He followed up with a chart showing our real estate benchmark in free fall. The buildings we bought in that timeframe, often with little competition, turned out to be some of the best investments in their portfolio, even though they were underwritten conservatively and still felt like a reach at the time.

The second investor, on the other hand, spent the months and years after the GFC coming up with reasons NOT to buy. Once we saw that the world wasn’t ending, we started to see opportunities that fit the client’s core strategy well and would have been solid additions to their portfolio. But time and again they passed, instead choosing to wait for even better deals they were certain would be coming along in the future. This went on for years until they eventually realized that those better deals weren’t coming and found a way to get comfortable buying properties again – at much higher prices, and with significantly more competition, than they could have if they had the courage and conviction to act earlier.

It is easy, especially in a volatile market, to let perfectly good opportunities pass by in the hopes that even better ones come along later. Waiting for the proverbial fat pitch is incredibly tempting and regret minimization is a powerful motivator. But timing markets is extraordinarily difficult, and the truly exceptional opportunities are exceedingly rare. Real estate investors with a long-term time horizon can take comfort knowing that there is little downside to adding a solid property to the portfolio, even if not at the absolute bottom, and keep enough liquidity on hand to be able to jump on future opportunities that may be even better.

The lasting lessons I took from watching those two investors side by side? Know your strike zone and stay disciplined. Keep liquidity on hand for future opportunities. And when you see a pitch down the middle, don’t forget to swing.