The Contrarian Investment Approach: What, Why, How

By Brian Brady, Matthews Real Estate Investment Services

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.

The contrarian approach is an investment strategy characterized by purchasing and selling in contrast to the prevailing sentiment at the time. It assumes that the market often overreacts to negative news or events, causing assets to be oversold and undervalued.

So the objective is to invest in less popular real estate opportunities with the belief that the market will eventually recognize the true value of these assets. The result will be an increase in price, generating significant profits for the investor. 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.

Scavenging: Chasing the Undesirables

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 asset 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 is an office building that is being overlooked because of work-from-home trends. But the contrarian investor might find value in a subset of office buildings that require workers to show up for work daily, like medical office buildings.

Additionally:

• 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

The Pros and Cons of Contrarian Investing

The Advantages

• Potential for higher returns. As the process focuses on buying assets at a lower price and selling them when market sentiment improves, this 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.

• Avoidance of herd mentality. Because they focus on assets that are currently out of favor, contrarian investors avoid the herd mentality that often leads to overvalued assets. This approach can help prevent emotionally driven investment decisions.

• Less competition. Contrarian investors can find often overlooked and undervalued assets. By identifying these hidden gems, investors can generate higher returns by investing in assets that have significant growth potential.

The Disadvantages

• Timing challenges. 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 tricky.

• Extended underperformance periods. Contrarian investing can result in extended periods of underperformance, especially if market sentiment continues to move against the asset for an extended period. This can be challenging for investors seeking 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, the riskier nature of these investments can mean difficulty in securing financing.

Using the Contrarian Strategy

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, investors in real estate 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.