This is an interesting perspective. It is from Fred Wilson’s annual what-happened-this-past-year post:

But here is the thing about speculative frenzies – they are generally directionally correct but off in their order of magnitude. And they finance the trend that they are directionally correct about. It may be the case that Tesla’s market capitalization is too high, but that allows Tesla to raise $10bn without diluting more than a few percentage points. And that $10bn will go towards accelerating the conversion of the auto industry from carbon-based fuel to renewable energy. And that is a good thing for society.

When I first read this my mind immediately went to tulip mania. Was that directionally correct? Did tulip bulbs ultimately rebound and maintain their value over the long-run? I actually don’t know.

But if you think about the dot-com bubble, that was directionally correct. Sure, infamous “companies” like Pets.com never ended up going anywhere, but the idea of tech and the internet becoming dominant was absolutely right.

Fast forward twenty years and you can be sure that many people are now buying their pet supplies online, along with pretty much everything else. Sometimes we simply overshoot and get the timing wrong.

This is perhaps a good thought for all of us to consider as we welcome 2021 and say goodbye to what was one weird and terrible year.

Being directionally correct means that it’s okay for there to be bumps, mistakes, and speculative frenzies along the way. They are expected. What matters is the path forward.

Happy new year, everyone.

Fred Wilson (New York VC) wrote a post on his blog this morning called The Bubble Question. In it, he talks about how everyone asks him whether or not there’s a tech bubble, which he has been asked for the past 4 years now. It reminded me of the debates that are also happening in the real estate community (particularly in Canada).

The thesis of his post is this:

I learned in business school that the multiple of earnings one should pay for a business is roughly the inverse of interest rates.

In other words, as interest rates drop, people are willing to pay more for the business or asset in question. And it’s because they can’t find the yields anywhere else.

The same phenomenon, you could argue, is also happening in the real estate space. Typically, income producing real estate assets are assessed using capitalization rates (or cap rates), which is defined by the Net Operating Income (NOI) of the property (revenue - expenses, but excluding financing costs), divided by the price of the property.

The real estate equivalent of what Fred is talking about is cap rate compression. When cap rates drop it means you’re paying more for the same amount of yield (or NOI). One of the reasons that might happen is because people are anticipating that the asset will appreciate. But it could also be because interest rates are so low that investors will take whatever returns they can get.