March 29, 2020

Sketch Guy: Some Investing Stories Sound Good Until You Analyze Them

Making smart money decisions is an incredibly difficult way to behave. So after my post last week about buying a house based on your situation, my jaw dropped when I saw an article in The Wall Street Journal about young home buyers.

“A new generation is skipping the ‘starter home’ and betting heavily on high-end real estate.”

Seriously? We’re back to “betting” on real estate?

Now, the stories are incredibly persuasive, but hidden within them is something else. When asked why they are buying an expensive home, or even buying multiple expensive homes to rent, young buyers say they are doing it as an investment strategy.

“Buying real estate has grown more attractive, these young buyers say, compared with the stock market, which appears riskier to a generation that entered the work force during a market correction,” the article in The Journal says.

This reminds me a lot of what I have referred to before as “that guy.” It’s the guy at a neighborhood barbecue or in the office who always has a story to share about how easy it is for him to make money. The problem is he only talks about the times he made money, not the times he didn’t.

The stories of these young real estate buyers, like Matt Winter, follow a similar theme.

“ ’I have always felt that having your money in property is the safest and best thing to do if you want to grow your personal wealth,’ says Mr. Winter, who founded his design company at 23. None of Mr. Winter’s assets are in the stock market — he says the market ‘spooks him’ and that he prefers to invest in real estate,” the Journal article reads.

Stop and think about this for a minute. Mr. Winter is now all of 28, and the story he is telling is that property is the safest place to increase your wealth. But I suspect that if you ask anyone dealing with real estate in the last 10 years (or who is over 40), they would disagree with the idea of it being safe. So why is our attention caught even though our experience tells us something different?

When we hear stories like this one, about young, beautiful people spending a lot of money, it’s easy to go with the assumption that they must be making smart decisions, too. After all, who doesn’t want to buy a house on the beach? And in our desire to be like what we see in those glossy beauty shots, we ask the question, “Shouldn’t I be doing that, too?”

We remind our children all the time, “If your friend jumped off a cliff, would you?” And yet when we ask that question, we are engaging in similar herd behavior. We need to recognize that we aren’t those people, and whether they are making a good decision isn’t the point. All that matters is whether it is actually a good decision for us, and these stories can make it difficult to reach this conclusion.

So lest you think I’m picking on these people only because they are young, beautiful and wealthy, let’s take a look at what are some flat-out questionable arguments.

Buying real estate is a safe way to build wealth. Because most people don’t hand over a sweaty wad of cash, real estate usually involves leverage in the way of a mortgage. While leverage can be good, it’s a double-edged sword. There are certainly home buyers in Phoenix and Las Vegas who would argue with the idea that property is the safest investment.

You will get hurt in the stock market. I get why real estate looks so attractive, especially to younger buyers. As the article noted, it is hard to trust the stock market if what you have seen to date hasn’t been wonderful. But it takes a willingness to ignore history to go with the story that real estate represents a sure thing in comparison to the stock market.

It makes sense to buy a second property as an investment. If you’re thinking about becoming a landlord, think again. Barry Ritholtz captured the problem with the rental market perfectly: There are a lot of rental properties just sitting on the market. And with a lot of people playing the rental and investment game at the moment, can you afford to have your investment property sitting empty? Don’t assume that a home you have bought to rent will actually generate rent every month to justify the purchase.

Buying real estate may turn out to be a great decision for the people profiled in The Wall Street Journal. But the notion of real estate as being somehow a better or safer investment than the stock market doesn’t add up based on what we know.

We know that the weighty evidence of history tells us that having a low-cost, well-diversified portfolio has been the better investment in the long run. We know that we probably don’t want to become landlords, either. And most important of all, we know what matters most when it comes to investing success: behavior.

So the next time you see stories like this one, keep in mind that you know better. You know what questions you need to ask before buying a house. You know what kind of investments you need to reach the goals that matter to you. And you know that what might work well for someone else isn’t guaranteed to work for you.

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DealBook: Groupon Narrows Losses Ahead of Its Pitch to Investors

Groupon's chief executive, Andrew Mason.Asa Mathat/All Thing Digital, via ReutersAndrew Mason, Groupon’s chief executive.

6:14 p.m. | Updated

Groupon is entering the final leg of its long journey toward an initial public offering.

On Friday, the daily deals site disclosed that it had narrowed its third-quarter losses, to $1.7 million, and that its North American operations turned a profit.

The results are an important milestone for the company, which has been trying to quell concerns about its business model before going public.

Groupon, according to its revised prospectus, expects to sell 30 million shares and fetch $16 to $18 a share, valuing the company at as much as $11.4 billion. At the midpoint of that price range, the company could raise $510 million. Its underwriters could also sell an additional 4.5 million shares if demand exceeded expectations.

Friday’s revision was filed as Groupon and its cadre of bankers prepared for a two-week road show with potential investors, hoping to generate excitement over the company’s forthcoming I.P.O. The company had been especially keen to prove that it was at least close to profitable before it began its road show, according to people who were briefed on the matter but were not authorized to speak publicly.

Groupon expects to price its offering around Nov. 3.

Since its founding less than three years ago, Groupon has become one of the stars of the new generation of Internet start-ups. By pioneering the market for deep discounts at local restaurants and stores, the company has grown at a remarkable speed, attracting hundreds of millions of subscribers and posting sales at stunning rates.

The site now has 142.9 million subscribers, according to its latest filing, a sevenfold increase from last year. As of the third quarter, about 29.5 million of those people had purchased at least one deal.

Yet soon after the company filed its first prospectus, it attracted harsh scrutiny from skeptics of its business model and its accounting, which critics said gave a misleading impression of profitability. Groupon amended its prospectus several times, restating its revenue and removing a controversial financial metric.

It addressed apparent breaches of a mandatory “quiet period” for companies preparing to go public. The most widely known of these was a memorandum to employees written by the company’s chief executive, Andrew D. Mason, that was quickly leaked to the news media.

Though Groupon’s growth has slowed as it has grown larger and more diversified — its net revenue grew only 9.6 percent over last quarter, to $430.2 million — the company disclosed in its latest filing that it was still attracting new subscribers and converting them into paying customers.

Readying itself for potentially tough questioning from investors, Groupon’s highest priority has been to show that its business and growth are sustainable. In prospectus on Friday, the company said that the amount of coupons sold per customer had grown 27 percent year-over-year, to about 4.2. And the company’s average revenue per deal had grown about 31 percent over the same time last year, as well as about 7 percent over the second quarter.

But critics have worried that Groupon is doling out increasingly huge sums to attract new customers. In the first nine months of the year, Groupon spent $613 million on marketing, compared with less than $90 million in the same period of 2010.

The company is looking to reduce those expenses. Groupon trimmed its marketing budget in the third quarter, from the previous three months, according to a person with knowledge of the matter. Mr. Mason has promised a significant cutback in marketing expenses in the future.

Over the last year, Groupon has introduced new offerings that expand its business beyond daily deals, including travel packages and ticketed events. Those new products have diversified the company’s operations, although they often carry lower profit margins that have weighed on sales growth.

Revenue per subscriber fell 15 percent to $3.30 in the third quarter, from the previous quarter, and the company’s deal margin, or revenue divided by gross billings, shrank.

This trend is likely to continue in the near term as Groupon attracts a broader mix of consumers who may not be as engaged as the first wave of early adopters. But the company also expects deal margin to pick up again in the next quarter.

Though Groupon will spend most of its road show highlighting its growing profitability, it is also likely to trumpet one zero: the number of insiders selling shares. While earlier filings referred to “selling stockholders,” the company recently stripped that language from its prospectus, indicating that its shareholders would not sell any shares in its offering.

In recent months, the start-up has been harshly criticized for letting its founders and early investors profit, through hefty stock sales, well ahead of its I.P.O. In January, for example, Groupon raised $950 million. Of that, $810 million went straight to its shareholders.

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