Wow! The irony of my previous blog post….writing about the importance of capital preservation in mid-February 2020.  This was only days before the Black Swan event of the COVID-19 pandemic sent the global economy into a tailspin.

What is a Black Swan? A black swan is an unpredictable event that has potentially severe consequences. Black swan events are extremely rare.  What is particularly interesting is that a black swan event is thought to be obvious in hindsight.  Hindsight is 20/20.  This term was coined in 2007 by Nassim Nicholas Taleb, a former professor, writer and former Wall Street trader.

The COVID-19 pandemic has resulted in historic drops in the stock market. The S&P 500 peaked at 3386 (February 19) and plummeted to 2237 (March 23), dropping approximately 33% in one month. The Dow Jones was even worse with a peak at 29,551 (February 12) and a valley at 18,591 (March 23) – a 37% loss in value. It was impossible to not lose money if you had money invested in stocks during this timeframe. Who knows how many months it will take to get back to the early February 2020 market levels?

I unfortunately know several people who are near retirement and now have to delay that event because they had all of their eggs in the 401(k) basket, and their 401(k) plan had too much exposure to the US and International stock markets.   They didn’t have investments outside of the public markets.  This pill is tough to swallow and just emphasizes the importance of having some investments outside of the stock market to provide true diversification.  Having multiple streams of cash flow is critical.  Direct investments in real estate, although not as liquid as stocks, are not nearly as vulnerable to the violent swings that can occur in the public markets. In fact, illiquidity should be considered a strength in terms of capital preservation.  Check out this article.

This black swan event is currently creating a market correction. We experienced firsthand the market correction situation last month as a passive investor.  We were looking to invest with a seasoned multifamily investment group.  We loved the deal because of the sponsor group’s track record, their property management team, the great submarket in Dallas, and the business plan. They got under contract before COVID-19.  When they re-evaluated their financial forecasts considering the COVID-19 situation, their purchase price no longer worked. It was too high. In other words, they would be buying the property at a pre-Coronavirus price and operating the property in a post-Coronavirus environment. They canceled the transaction. They had spent a lot of money in inspections and earnest money (“at risk”) deposits considering the purchase price was about $60 million. They decided to pull out of the deal which meant returning about $20 million to the investors. Not an easy situation to deal with, but certainly a good example of a great sponsor group. We want sponsor groups to make investment decisions based on sound investment fundamentals and a strong focus on investor capital preservation.

The silver lining in all of this is that as markets cycle from “seller’s markets” to “buyer’s markets”, it will create tremendous opportunities for new acquisitions at prices that will yield significant returns to investors who are ready while also doing what these types of investments do best: preserving capital.

As Warren Buffett has said, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”