Contrarian Approach | What. Why. How.

Lenders are stricter, debt is more expensive, and investors are wary of which assets they should plant capital into. What if investing in “low on the totem pole properties” is the best option? This investment strategy is called the contrarian approach: investors find value in the “undesirables” to navigate an uncertain market.

Scavenging: Chasing the Undesirables

The contrarian approach is an investment strategy characterized by purchasing and selling in contrast to the prevailing sentiment at the time. The objective is to focus on creating long-term value by investing in less popular real estate opportunities and identifying hidden value. The contrarian approach assumes that the market often overreacts to negative news or events, causing assets to be oversold and undervalued.

Contrarian investors believe that eventually, the market will recognize the true value of these assets, and the price will rise, generating significant profits for the investor. Value investors may look for undervalued assets based on financial metrics or earnings potential. Growth investors may focus on assets with a high potential for future appreciation. Contrarian investors are more interested in buying asset classes that the market has beaten down to the level where they now have potential for future growth.

To be a successful contrarian investor, one needs to have a deep understanding of the underlying assets and the market forces affecting them. This requires extensive research and analysis of financial statements, economic data, industry trends, and other factors that can influence the asset’s performance. Additionally, contrarian investors must have a strong sense of discipline and the ability to resist the urge to follow the crowd and invest in popular assets.

Contrarian investors often look for opportunities in assets that have experienced significant price declines or are currently being ignored by the market. An example of the contrarian approach would be to consider that an office building is being looked over because of the popularity of work from home — the contrarian might find value in a subset of office buildings that require workers to show up for work daily, like medical or healthcare providers.

Why Use Contrarian Investing?

Contrarian investing is not without risks, as the market can continue to undervalue an asset for an extended period or force an investor to experience prolonged price declines. However, if done correctly, contrarian investing can be a profitable strategy that allows investors to capitalize on market inefficiencies and generate significant returns long-term.

The Advantages

•  Potential for Higher Returns:

This investment involves buying assets at a lower price and selling them when market sentiment improves; it can result in higher capital gains.

•  Reduced Risk:

By avoiding popular assets that are already priced high and therefore have less room for growth, contrarian investors may be better positioned to weather the storm if the market declines.

•  Avoiding Herd Mentality:

Contrarian investors avoid the herd mentality that often leads to overvalued assets because they focus on assets currently out of favor. This approach can help investors avoid making emotionally-driven investment decisions.

•  Lower Competition:

Contrarian investing can help investors find undervalued assets the market has overlooked. By identifying these hidden gems, investors can generate higher returns by investing in assets that have significant growth potential and less competition.

The Disadvantages

•  Difficulty in Timing:

It can be challenging to accurately time contrarian trades. Determining when a particular asset has reached its low point and is likely to start rising in value can be difficult.

•  Potential For Extended Periods of Underperformance:

Contrarian investing can result in extended periods of underperformance, especially if the market sentiment continues to move against the asset for an extended period. This can be challenging for investors who are looking for short-term returns.

•  Limited Liquidity:

Contrarian investing often involves buying assets that are not widely traded, which can make it challenging to sell them quickly if market conditions change. In addition, because the investments are riskier in nature, financing may be difficult to secure.

• Lack of Information:

Sometimes, the reason for an asset being out of favor is not apparent, and contrarian investors have limited or inaccurate information about the asset’s value and potential.

Takeaways

Overall, contrarian investing can be a powerful strategy for generating long-term investment returns. Still, it requires a patient and disciplined approach to identifying undervalued assets and avoiding the herd mentality. As the queue of capital continues to build and the opportunities for finding yield or creating value dwindle, real estate investors may consider contrarian or difficult-to-underwrite asset types. Working with an experienced capital markets professional will help navigate the unique investment strategy and evaluate the potential upside to betting on the underdog.