The Great Fool Theory of Investing in Real Estate is based on the real estate cycle. The book, The Bubble that Broke the Bank explores ways to avoid the greater fool theory. The greater fool in real estate is based on the transfer of risk from the seller to the buyer. The real estate cycle is signaling a 5-year downward cycle. The sellers of residential real estate or homes that are overpriced and have high interest rates.
Sellers have to find buyers who have no understanding of real estate positioning. The buyers are driven by unrealistic assumptions of the value of homes. Sellers working with realtors use various tactics to sell overpriced homes:
1. FOMO- The fear of missing out on the appreciation of home prices. Realtors sell the assumption of rising prices, refinancing, variable interest rates, and higher comparables as the basis for price.
2. The use of a lack of supply inventory to buy homes. The assumption is that a low supply of homes will create price appreciation and an infinite rise in real estate prices. Realtors used this to sell homes to foolish buyers. The buyers are unaware that the real estate cycle is in crash mode. The homes they buy depreciate in value from being overpriced and real value is found in the equilibrium for home prices based on income.
3. Sellers are faced with falling prices and realize they waited too long to sell their homes. They must use small price reductions and give inexpensive incentives to sell their properties. They work with realtors to find foolish buyers to buy their property. Sellers are in competition with home builders who have a comparative advantage.
4. Sellers use a special psychology on buyers during the downward trend. Buyers are driven by ego, self-delusion, heat seekers, and FOMO. The sellers use the fact that buyers have no market history or understanding of the real estate cycle. They will sell their overpriced homes and high-interest rates to foolish buyers.
The Sellers manipulate the real estate data to find buyers who are under the mistaken belief of an infinite rise in prices. The seller will use economic terms of supply and demand to fool the buyer into false assumptions. The longer they hold the homes that they will eventually go up in value and they recover their cost over time. This is the Herengracht fallacy which was exposed by the economist Piet Eichholtz.
Consequently, the sellers must use this crash psychology to unload the real estate at the highest prices. Realtors are used to market the property and the foolish buyer cycle creates the next wave of default and foreclosures. Buyers are unable to refinance and are forced to give up their properties. The buyers may recover their losses in the next 15-year upturn in the real estate cycle at much lower prices.
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