I think we can make it official: the Real Estate Bubble has officially burst. Real estate data from several of the largest cities in America show home values steadying and, in some areas, beginning to decline. While this is bad news for the average homeowner, it’s even worse news for professional real estate investors that buy and sell real estate for a living. “Property Flippers”, as they are often called, purchase, renovate, and resell properties for a profit. They rely on rising and/or steady home values to maximize their return on investment, or ROI. While they have enjoyed rising values in most cities over the last 5 years, many are now faced with the reality that their current inventory may draw a significantly reduced asking price compared to what they anticipated selling their properties for when they purchased them. In Cleveland, OH, for example, the average home price has declined 3% over the last year. That may not seem like a significant decrease in value, unless you are the investor that purchased a $200,000 home counting on a modest 10% ROI (or $20,000), and now you are looking at making $14,000 for the same time and effort.
So is this a bad time to invest in real estate? This investor says no. It is a great time to invest of you keep a few things in mind:
Invest for the Long Term
In a down market, good investors return to the investing principles of yesteryear. Simply put, invest for the long term. The idea of buying, fixing, and “flipping” property was made popular during the years following the depression. The idea of investing for long-term profits is as old as mankind itself. While buying and selling property provides the potential rush that can only be created by the prospect of “instant cash”, I think it is safe to say that the Hilton’s made a wise decision by hanging on to the Waldorf for a few years! Now is the time to buy low (there are plenty of property owners out there with adjustable rate mortgages who are just dying to sell; and the foreclosure rate is really showing signs of life these days as well!) and hold on to your property (ies). As rates go up and credit scores go down, more and more qualified, able-paying renters will be opting to rent rather than buy. They are ready, willing, and able to pay down your mortgage balances and keep your investment cash flowing until the real estate market recovers and it is time to sell.
A New Market Yields New Opportunities
As I touched on in the previous paragraph, a down real estate market provides increased opportunities to purchase real estate from owner occupants at a discounted rate. Why is this important? The number one mistake inexperienced investors make is to exclusively search for properties that are being sold at a discount only because they need extensive repairs. Learned investors know to look for deals where real estate can be purchased at a discounted rate even though little to no repairs are needed. There is an old saying in real estate: Situations Make Deals. Over the last several years, many homeowners (I admit, I am guilty) have used interest-only or adjustable rate mortgages to purchase properties that were previously priced out of their price range. They are now are faced with either refinancing these properties or selling quickly to get out from under them as rates rise. Why does this matter to you? Properties purchased from owner occupants normally require significantly less work than properties purchased from banks or estate sales. You may be able to purchase a property and immediately rent it without spending additional money to fix it up. While you may pay a little more for this type of property than you would a foreclosure or estate property, you will make up for it by generating immediate cash flow and by realizing better long term appreciation, as these properties are often times located in stronger areas. Many investors look to make a deal with another investor who is forced to sell, which I suggest you avoid at all costs. Unless it is an unbelievable deal, buying properties from other investors is normally a bad idea. Investor-owned properties are managed and maintained in a way that will maximum cash flow. This normally means that the materials used in the renovation process (cabinets, flooring, roofing, furnaces, etc.) and the craftsmanship used to install these items will be second rate and will need to be replaced sooner. If you are investing in residential real estate, it will more than likely be cheaper in the long run to purchase properties from owner occupants.
Get By With a Little Help From Your Friend – Your Accountant!
Every once in a while, we could all use a little help when the taxman cometh. A down real estate market creates opportunities to purchase properties at a discount (creating instant equity) and still depreciate them to help reduce your tax obligations. Simply put, if you are able to purchase a property and save $2000 a year on your taxes for 10 years, that is a $20,000 non-cash return on your investment. A non-cash return is just a good as a cash return because it increases the amount of cash in your pocket. Assuming the market recovers within those same ten years and you break even on the property itself by renting it out, you will be very happy with your investment. The combined benefits of tax savings, appreciation, and the equity created by paying your mortgage down with someone else’s money for ten years will all work together to create a solid long term investment.
Let’s Make a Deal
A down real estate market often times signals a down economy. When homeowners have less cash to spend, it affects many other industries, especially the mortgage and home improvement industries. Lucky for us, investing in real estate requires a lot of help from both of these industries! When home sales and home improvements projects are down, mortgage brokers and contractors are looking for cash any way they can get it. This is a great time for the savvy investor to save money by shopping around for the best deals. Mortgage broker fees and construction labor costs represent a significant percentage of the costs incurred when buying and renovating investment properties. If you have cash and credit in a down market, you have a great amount of control over what you are charged for these services. Large home improvement stores are also forced to lower their prices on materials and goods to prevent their inventory from sitting on their shelves. A down market is a great time to save big, which will only increase your ROI when you are ready to sell a few years down the road.
In summary, a down real estate market does not mean that investing in real estate is a bad idea. It means that, like any business on earth, nothing stays the same forever. A changing real estate market just means it’s time to change your approach and adopt new strategies. If you do this, you will be successful in any business.