296: Is Now a Good Time to Invest in Real Estate?

SHOW NOTES FOR EPISODE 296: IS NOW A GOOD TIME TO INVEST IN REAL ESTATE?

Bill gets asked a lot by people, “Should I buy now if there is a major recession on the horizon?  Wouldn’t it make more sense to wait for prices to drop and then buy when properties are cheaper? In today’s podcast, Bill takes a hard look at the loaded question – “Is now a good time to invest in real estate?”

Introduction

I can understand why people have this attitude, as I would much rather buy properties when real estate is cheap, after a crash, than now when prices are higher.  The problem I have with this viewpoint, however, is that we have no idea when there will be a housing market crash and how can you know where the bottom hits?

There are many elements to consider when deciding when to invest in real estate.  Investors can find the answer to “Is now a good time to invest in real estate?” based on how much these factors impact you.  While no one can say for certain how things will play out in 2019, good research and a study of key market trends will get you close enough. Take a look at these factors and decide if real estate is the best investment for you in the coming year.

Affordability

The US housing market has been facing a problem with affordability over the past decade. A lot of people want to buy property, but don’t seem to have the financial resources to do so. Affordability is defined as the percentage of one’s median household income spent on the median household mortgage in a particular area.

Many investors prefer investing in their local market. But buying a rental property could prove to be more expensive than what you can take on if your market’s affordability is going down.

Affordability is one of the main reasons behind the slow down in the housing market this year. Many potential home-buyers are now more inclined to rent instead of buy.

So, is buying real estate a good investment when taking it from the affordability scope? Well, it depends on the investor. Home prices are just as high for real estate investors, but they’re buying this property as an investment. Owning a rental property in the right market could pay off with all the new renter demand.

If your local market is too expensive for you, you have the option of searching elsewhere.

Home Sales and Property Prices

Yes, affordability is a problem in many markets, but in 2017, 10 of the top 100 metro areas saw prices soften. Now what this means is that growth was at least 1 percent slower than annual growth over the past three years. So that begs the question, is buying real estate a good investment in 2019 compared to prior years?

Home sales usually increase as the aftermath of the recession starts to wear off. Well, current home sales are looking similar to what we would’ve seen in 2003, but household growth has increased by 13.5 percent over the last 14 years. That combined with increased construction can lead to increased buyers in the 2019 market.

As the market begins to slow down on the national scale, take a closer look at local conditions. After all, real estate is local. When there’s economic volatility, you can expect to see different trends even among neighborhoods in the same city. This is why it’s always good to actually understand the different performance levels of the sub-markets in your area.

Mortgage Rates

They are on the rise. So here’s what we know. Current mortgage rates continue to be lower than they were during most of the recession and are actually below average considering the type of strong economic growth the US has been experiencing. However, this will change in 2019. Forbes predicts the 30-year, fixed rate mortgage will reach 5.8 percent.

What does this mean? Is buying real estate a good investment with mortgage rates increasing in 2019? Well, some people might be discouraged to buy property, whereas others (who already experienced the mortgage rates of the recession) won’t be too worried about this.

Housing Inventory

Inventory levels remain low and owning property under these conditions is desirable to many investors. According to Forbes.com, national inventory increases are expected to remain low in 2019. The majority of inventory increases are expected in:

• San Jose, CA
• Santa Clara, CA
• Nashville, TN
• Seattle, WA
• Boston, MA

Best Real Estate Investment Strategies

You can also answer the question “is buying real estate a good investment?” depending on your investment strategy. Rather than investing in property following the fix and flip strategy, how about you invest in property for income. Investors should invest for cash flow, not appreciation, in the 2019 market. With younger generations staying in the rental market longer, investors could expect strong returns with income property.

Should You Wait To Invest In Real Estate Until The Housing Market Crashes?

Will there be another housing market crash?

Before the housing market crisis from 2008 to 2012, the banks were being foolish. They were making outlandish loans to just about anyone who wanted a house or even two houses. I know an investor in northern Colorado who bought hundreds of new houses using hardly any of his own money. Because there was so much demand, houses were being built rapidly. Many areas of the country saw record amounts of building.

Then the bottom fell out when we realized the banks were creating toxic loans that had a good chance of never being paid back. Lending guidelines changed overnight and builders were left with tons of inventory and no buyers. The crash ensued because there were so many homes for sale and not enough people to buy them.

This time around, the banks have not been issuing these unwise loans. Lending guidelines are still very strict and while you may hear of some subprime lending going on today, it is a fraction of what was going on before the crash. New construction for single-family homes (download required) still has not returned to its average pace even after years of record-low building. There are simply not enough homes for buyers and that is what is driving up prices this time around.

Affordability and interest rates could slow down the market, and we may even be seeing the start of that now. However, those things do not cause a crash. They could cause a slowdown or even a slight decrease in prices, but many other countries have less affordability than the U.S. for decades.

A crash could occur, but I would not say it is imminent.

Is it smart to wait for the housing market to crash before you buy?

It is easy to look back on the last crash and say that I should have bought 100 houses right at the bottom. I know people who bought quite a few homes at the bottom of the market, but also on the way down and on the way up. They bought houses based on their own investment criteria whether they were flips or rentals, without assuming prices would increase. They also left plenty of room in my purchases for prices to decrease.

Timing the market is a very tough thing to do. Some investors bought houses at their low, assuming they would jump back up in price. They could make money if prices stayed right where they were, and if they went up in value that was a bonus. The same thing can be done in any real estate market. But it is much scarier to buy houses when prices have been increasing for seven years straight.

If you are sitting on the sideline waiting for a crash to occur, do you have a plan for when that happens or are you just waiting? How low will prices have to go? How will you know when the bottom hits? Are you waiting for a decent deal or an amazing deal? I think many people who are waiting for a crash have not thought these questions through; they just want to buy at the bottom and sell at the top. (And it is just as tough to know when the top is.)

Something else to consider is that there are thousands of other investors waiting for prices to drop, including huge institutional buyers. There is a really good chance that if prices start to drop, the other investors will jump in and purchase enough homes to keep the markets from dropping very far.

What can we expect for the future of the housing market?

I try not to predict what will happen. I can make a guess, but I do not base my investment decisions on whether the markets will increase or decrease. I never thought prices would have risen as high as they have, but I also would have thought the builders would have built many more homes than they have.

I really liked buying rental properties in 2010 through 2014. I wish I could buy houses in that price range again in my area, but I can’t. We will probably never see prices as low as they were 10 years ago, unless there is some kind of massive economic or natural disaster that will have most of us forgetting about housing altogether. That leaves us investing in other asset classes like commercial buildings or going to other markets. I am certainly not sitting on the sidelines hoping for a crash that may or may not happen, and neither should you.

Should You Invest in Real Estate Now—Or Wait to Buy?

Remember the 2001-2006 years, when everyone was buying houses? Conventional wisdom at the time said you should buy before prices got much higher. Housing values skyrocketed and loans were given away like candy on Halloween.

Everyone was making money—until they weren’t.

By 2009, the music had stopped and the same people who were excited about buying were starting to get a little worried about holding. By 2010, those “smart” people were looking pretty stupid. Foreclosures dominated the marketplace, for sale signs sprung up everywhere, and the economy went from soaring on the wings of eagles to a pure nosedive into peril.

Now it’s 2019, and things are starting to look a little familiar. In some markets, like here in California, homes have been consistently selling over asking price for years—until now. An increase in interest rates caught buyers off guard, and many have checked out of the game until they can stomach the new normal of rates over 5%.

While California may have cooled, many markets across the country are still rising in price faster than rents can support. It’s so bad in some places that the local investors are left shaking their heads at how much an out-of-state investor is willing to pay for traditionally conservative value neighborhoods.

So, what should you do? Should you buy now before prices rise, or wait to see if there’s going to be another crash coming? Is it like 2012, when prices had just begun rising again—or is it more like 2005, when they were at their peak?

If you want to make the best decision, you have to consider all the facts. Before I make a black or white suggestion, let’s take a second to consider several market factors, strategies, and possibilities. There just may be a way to invest now and still be primed to take advantage if the market crashes later. I always recommend looking for ways to have our cake and eat it too when possible.

Are We at the Top of the Market?

When we say the word “bubble,” we are typically referring to an unrealistic, unsustainable value in an asset class we can’t reasonably expect to continue. In 2005, home values weren’t based on affordability; they were based on horrible loans that allowed people to borrow much more than they could afford. When those loans reset, nobody could pay them, and the market was flooded with foreclosures.

Today’s market is different. I haven’t seen any of these dangerous, adjustable loans that were prevalent during the last bubble. The majority of today’s loans have fixed rates, 30-year terms, and are based on a reasonable portion of the buyer’s income. Of course, home prices have risen since 2006, but so have wages! People often complain about how expensive housing is, but when is the last time you heard someone complain their job is paying them too much? Wages have increased right alongside home prices. If we are going to complain about real estate prices, we have to be fair and acknowledge wage increases as well.

So, are we in a bubble? In some areas, possibly. Does that mean we are headed for a crash like 2010? In order for a housing collapse, we’d need to see something more like overall recession.

What could cause this?

• A hit to the job market (tech bubble collapsing)
• A spike in interest rates to slow the economy (monitored and controlled by the Fed)
• A national disaster like a war (beyond any of our predicting or control)

If this happens, many asset classes are going to take a hit, not just real estate values. It may feel “safe” to avoid the real estate market, but where are you putting your money instead? The stock market? Bitcoin?

Are those assets guaranteed to be protected if the economy recedes? Don’t be lazy and assume just because home prices seem high it automatically means we are headed to a repeat of 2005. It’s not that simple.

What If I Invest Now and the Market Crashes Later?

If you invest too early and the market crashes later, you’ll be kicking yourself when homes are cheaper. If you wait for the market to crash and it doesn’t, you could spend years not making any financial progress. I’ve heard people saying the market is about to collapse for five years now. Meanwhile, it’s just trucking forward and growing each year. There is really no value in using the market as your excuse not to buy unless there are clear, objective, and sensible signs the economy is unhealthy and heading towards a correction.

This question also assumes real estate markets are the same across the country. They’re not. A “crash” in one area doesn’t always mean there will be a crash in another. Some markets are driven by specific economic factors that aren’t affected by the rest of the country. Example? Texas. In 2009-2010, when much of the rest of the country (CA, AZ, NV, FL, to name a few locales) was losing value, Texas went by relatively unscathed. The same goes for parts of the Midwest and South that tend to operate independently of coastal markets.

So what’s the solution?  Should you buy now or buy later? Wait for a market correction or focus on a great deal instead? The trick is understanding why it is you’re afraid to buy now and miss out later. If you’re asking me it can be summed up in two words…

Opportunity Cost

Opportunity cost is an economic term that refers to the price you pay when you miss out on one option in order to commit to another. In this case, buying House A can be a problem if you miss out on House B. If House B ends up being better (as in, you bought it after the market crashed and paid less), your opportunity cost would be the money you lost that you could have made if you’d waited for house B.

Think of it this way. Let’s say you have an opportunity to go work overtime at your job and make $200 or go to a concert that costs $100. Most people who go to the concert think it’s setting them back $100. That’s because they’re not factoring in opportunity cost. The reality is that the concert is setting you back $300—$100 for the ticket and $200 in lost wages you could have made while working. That $200 is your opportunity cost.

Many haven’t heard it called “opportunity cost” before, but they instinctively understand if they make one choice, they miss out on a better choice later. This creates the dreaded analysis paralysis that holds so many investors back. So how do you beat it? The BRRRR method.

What is the BRRRR Method?

BRRRR is an acronym that stands for “buy, rehab, rent, refinance, repeat.” It is the order by which you conduct the various stages in the “investment cycle” (my phrase) when you buy a rental property. When you BRRRR correctly, you can end up buying an investment property with zero money down. This often ends up resulting in a cash-flowing property that’s been fully rehabbed and sometimes puts more cash in your pocket than you put in.

How is this possible?

When you buy a house traditionally, you put a hefty down payment into it, then include money for closing costs and the rehab. The total of this money you’ve invested makes up your investment basis. This is used to calculate your ROI (return on investment). With the traditional model (non-BRRRR), there is always a heavy opportunity cost. If you put $35K down, pay $5K for closing costs, and have a $10K rehab, that’s $50K of your money you cannot invest anywhere else.

In this case, if the market crashes, you don’t have that $50K to invest in the down market, so your opportunity cost is high, as you miss out on the killer deal you could have got had you waited. This is the reasoning behind the “fear of missing out” that keeps investors from getting started investing in real estate. So, how do you overcome this? My solution is to remove the opportunity cost. If you can buy a property and recover the capital you used to buy it, what stops you from buying the next one too?

BRRRR-ing successfully is the way to accomplish this. In a hypothetical BRRRR deal, you would buy a fixer-upper property for $60K that needs $40K of rehab work. Throw in the same $5K for closing costs, and you end up with a total of $105K, all in.

At a loan-to-value (LTV) ratio of 75%, if the property appraises for $135K once it’s rehabbed and rented out, you can refinance and recover $101,250 of the money you put in. This means you only leave $3,750 in the property, significantly less than the $50K you would have invested in the traditional model.

It’s not too difficult to save another $3,750—and it’s definitely significantly easier than saving $50,000. This means you’ll have all that money to put into the next house when the market crashes. If you do this effectively, you can pull out even more money than you put in, growing your capital and the ability to invest in future properties.  Voila! No more opportunity cost.

How Do I Know Which Market to Invest in?

While no one has a crystal ball to tell you where the market will crash and when, there are some pretty standard metrics you can use to hedge your bet against a crash.

Diversified Economy

You want to avoid any area that is dependent on one employer or economic driver. Detroit is a great example. When the auto industry failed, so did all the home values. With no one able to find work, all the rentals went vacant (and so did everything else). Other examples would be North Dakota (oil dependent), an area known only for tourism, or a coastal village in Alaska that is completely dependent on fishing.

C-Class or Better Neighborhoods

Real estate investors tend to evaluate neighborhoods like school grades. A-class properties are the best spots in town, B-class is where the upper-middle class lives, C-class neighborhoods are your average areas with lots of renters, and D-class properties are problematic with high crime and high vacancy rates.

You want to avoid anything less than a C-class neighborhood. By investing in nicer neighborhoods in economically diverse markets, you avoid the worst of the negative factors when a market turns, and you’ll be able to ride out the storm.  For more information on how a property is classified, ask a local top-producing real estate agent or property manager.

Cash-Flowing Properties 

If your property cash flows (brings in more income than it costs to own), it doesn’t really matter what happens to the value. If prices drop, that doesn’t impact you unless you sell.  Experienced investors buy properties that produce income—and only experience price appreciation as icing on the cake.

Look for properties in areas that meet the 1% rule. If a property will rent for 1% of the purchase price every month (a $100,000 that rents for around $1,000 a month), it is very likely to cash flow positively. If you focus on buying in areas like this and avoid bad neighborhoods and non-diversified economies, it won’t matter what the market does. Your investment will be safe.

Well that’s it for today!

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