credit cycle – LUCKY IDIOT

We have seen the financial cycle in the post of the credit cycle. Similarly, Real Estate also follows the same cycle as all the financial cycles follow, except one that real estate having a higher lead time to development takes place. Generally, real estate projects take a huge time to get constructed to get commercializes.

When the economy is bad at that time credit will be unavailable for the construction work and when time is a good credit will available easily. This impact on the real estate cycle. Better economic time causes an increase in demand and bad economic conditions led to a fall in the demand. Due to the higher lead time, supply & demand mismatch takes place which causes the rise in the rent and the sale price.

When projects got halted due to the credit unavailability then these situations invite a bust in the Segment. That will cause a fall in the price of buildings. Investors can get land less than what developers have invested in. Also, here, lead time reduces as approval got finalised in good time. It hurts to the projects of which construction started in the boom period.

When there is a demand for home and financing options available, builders decide to build a home and all builders decide the same which creates a surplus of home. Also, due to long lead time, demand gets soften then builders left out with the inventories which he has to sell at lower than the expected value. But the reverse of it, when the economy is slow, availability of finance is low and pile-ups of unsold inventories so that builders stop building a new home. This helps to slowly getting sold out of inventories. Now, when the economy revives again, at that time supply will be lower than the demand which brings prices to the upper level. So that building a home during the slowdown is a better way to reap profits.

People tending that real estate investment beat the inflation (same for common stocks) but we need to understand that if the price which we pay are too high then it will not beat inflation and in result, it will beat us.

Real estate

If we have bought real estate during a high price growth then we have to wait a little more while price growth has been slowing and many of the area it has been degrowth. So that not all price purchased of real estate result into the wealth creation.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mr Marks has mentioned that he has focused on the distress debt companies where he selects the company which is operationally well but having a debt-laden balance sheet. Means company has to work on reducing debt which will bring value creation for shareholders.

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So that we have to analyze thoroughly to identify the value of the company and at the end of resolution what we rewarded. If after resolution amount worth higher than the currently available debt securities price then we should buy those securities. This is difficult to play in India but we can play such where a business does not have a much problem but due to some problems the company has brought debt. When the company started paying debt, we can look into it. One of the air-cooler company has a track record of success in such a strategy.

Example of failure of this strategy in India – One of the Jewelry company in India

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If we see the above balance sheet then we can see that inventories of the company were higher than debt. If the company liquidate its entire inventories and pay the debt then also the company remains with excess cash. And company available below that value.

As we have seen in the credit cycle that when credit is easily available then everyone goes for it with the compromise on the standard. But when the economy starts to contract at that time, credit availability becomes tough so that debt-laden companies cannot able to refinance their existing debt. This incident brings them at the event of bankruptcy and that hurt the psychology of investors. Selling of the debt securities starts and prices falls as everyone starts avoiding it.

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