The real estate market has rebounded rapidly in the past 5 years and house prices have reached record highs in some areas. Many home sellers are experiencing multiple offer situations and prices are bidding up above list. Reality TV abounds with house flipping shows. And there's probably a get-rich-quick real estate seminar coming to a hotel near you soon! Students of the real estate collapse of the late 2000s point out that the very same financial derivatives that intensified the last crash are beginning to trade again. Should real estate investors be concerned? Are we in another real estate bubble? Find out what you need to know about the current market, where it's going and how to invest during uncertain times.
Are We in a Real Estate Bubble?
In United States and Canada, the real estate market has rebounded dramatically since the real estate bubble a decade ago, and some markets, are at all-time highs. I just put a property on the market thinking it would make me around $8,000, and I ended up making double that, over $17,000 because there was a huge multiple offer situation.
Things are booming right now in the real estate world and there are many signs that prove this. For example, reality television abounds with house flipping shows, and there is certainly one of those get-rich-quick real estate seminars coming to a hotel near you. So should real estate investors be worried? The larger global markets are seeing that the stock market has not done as well in 2015 or 2016. The movie “The Big Short,” talks about the credit default swaps that the market bets against CDOs, and that started to activate again, so there are certainly many people out there that are concerned. Should you be?
Forecasting is the ability to tell the future, especially with financial markets. Forecasting is, very, very difficult. In fact, I think it’s been proven that humans are not very good at forecasting. In 2011 the real estate market was not doing very well. Now there is this fear of “double-dip recession”.Which is a a double-dip in the drop of the market, because there were a ton of foreclosures that the banks now owned, and needed to do something with, because the more they piled up, the more the banks had to remove them in order to re-lend. The concern was if all of those foreclosures went into market at the exact same time, there would be an issue of supply and demand. There was a lot more supply, a lot less demand, and it would bring down the values of real estate that much more.
This was argued clearly everywhere in 2011 but it's not what ended up happening. A bunch of hedge funds actually bought thousands and thousands of single family homes for the first time in history. We have no idea how they planned on managing, or organizing them, but they obviously figured it out. They bought up a ton of shadow inventory, and rather than 2011 being a double-dip, it ended up being the bottom, so I want you to put yourself in the shoes of somebody in 2011.
In 2011, there was so much fear that real estate was going to double dip and that the economy was going to go into deep depression, but it didn’t. It’s because we’re lousy at forecasting.
The market behaves in what we call “Cycles.” Although I don’t necessarily like the word “cycles”, this is what it looks like from the value standpoint. The market usually climbs very slowly from its bottom point until it finally gets to a high point, and then it drops quickly, but begins to go back up at some point. At least this has been the case for the majority of our financial history.
It might sound contradictory to be terrible at forecasting but be able to forecast a market cycle. This is because we are fairly certain that there’s going to be market cycles. There’s going to be a climb and there’s going to be a drop, but there are two parts to this. The first part is the length of time it takes to go from low to high, and there's no way to know how long that’s going to be. Secondly, we don’t know how high the high is and how low the low is. These are the two issues that we are unable to forecast.
There’s one more layer to all this, and that is the local real estate. International markets might be changing and locally, your area might be booming, with a whole lot of new industry moving in. Where I used to live in Nashville, Tennessee, we did not see a big drop when the real estate collapse occurred in late 2000’s. This means, Nashville was such a booming economy that it was able to keep the real estate prices strong, and now, it’s doing even better. Location can have a huge impact. Even if the market is booming in certain neighborhoods, the housing market can still go down in value.
If you want to learn a little bit more about market cycles, check out a video called “How the Economy Works by Ray Dalio.” It gives you a great understanding of how the overall economy works because we have the certainty that there are different market. There's the real estate market, stock market, and bonds. There are all of these markets and they do not always match up perfectly.
Where Are We Right Now?
How are you supposed to invest if you do not know what is going to happen in the market. Furthermore, even if it was 2011, you wouldn't know it was the bottom of the market, because no one knows it was the bottom until you can look back at it. Just like you can look back and say, “That was the top,” but you probably didn’t know that it was the top before. How do you invest when you don’t know the future?
Start by focusing on time frames and investing horizons. The two in real estate that work, are short-term and long-term.
Short term is wholesaling or flipping houses. If you bought a property at the perfect time, which would be at the bottom of the market, you could then hold onto it and sell it for a little bit more once the market picks up.Unfortunately this does not always work out, because the world is not perfect. Often you buy at market value and then have a problem selling for profit. To avoid that problem you should always buy your short-term deals way below market, so you have time to fix it up, sell it, and make a little bit of extra money on it. You get in, you get out, and don't have to really worry about what the market is doing. This is exactly how I've been making money for 15 years.
My team and I are making money at the bottom, top, and in the middle. We’re always making money because my apprentices get deals really cheap and then we flip them fast.
I do not have a middle-term because I do not think that’s something you should even remotely consider. I think it’s a lot better to get in and get out, or go for a long-term deal. You might sell a long-term after a year, but the long-term fundamentals will still be there.
On a long-term deal I practice a Charlie Munger style of investing. He’s the partner of Warren Buffett and his goal is to buy good properties and businesses at fair prices. You might get it just a little bit below value, but the key is to have“cash flow.” There must be monthly income coming in from tenants in case the market drops. One of the great things about real estate is that the rental rates don’t fluctuate much, in fact they stay pretty steady. When the real estate bubble burst around 2011, the rental rates actually went up because there were so many foreclosures. People needed more places to rent, so rental rates stayed a lot more steady, which is going to help when you own properties on long-term.
Dollar Cost Averaging
Have you ever heard of the phrase, “Dollar cost averaging”? This is a financial term to describe when people take a certain amount out of their paycheck every single month and put it towards some sort of stock. If a person was to buy $100 worth of stocks a month, they would be buying at different points of the market cycle, so sometimes they're buying at the top, which means they are buying fewer stock and sometimes they’re buying stocks the bottom of the market, so they're buying more stock.
This is important because we do the same thing as real estate investors. We have our own fundamentals on how much a property needs to cash flow or how much we need to get it below market. We know what those fundamentals are, and we stick to them, so that when the market is getting to a high point and its becoming harder to get a steal, you might not take on any any short-term deals because you won't pay market value on an investment.
It’s like dollar cost averaging. It prevents you from doing stupid things and not having to necessarily worry about what’s happening with the market. Now, when the market starts tanking and people are freaking out, that’s when it’s easy to get a steal. When you’re at the bottom of the market, you can get massive bargains because people are so scared and fearful, that they are willing to sell way below market value. It’s always going to be below the market value at that moment in time for your short-term deals, and for your long-term, regardless of the value, it’s needs to be able to cash flow at that point in time. In some cases and some markets, you need to wait for the market to collapse a while before you can get back to cash flowing properties in those areas.
This is extremely valuable information that can frame what you do moving forward because in the real world when the market is high, that’s usually when you have the most money in your bank account. And when the market is low, that's when you usually have the least amount of money. When the market is low you will also have the least amount of ability to get the credit to get the loan for the property, so it’s actually much easier to buy in a higher market.
If you stick to these fundamentals long-term, you will have some extra money when the market starts to drop because you would’ve saved it from when it was higher. When the market was at its peak, you couldn’t get the numbers to fit so you saved. Now, what’s interesting about right now is although we’ve had a nice run, we have very, very low interest rates, so that helps us with the cash flow. Even if you’re concerned that you’re buying at the top of the market, your interest rates are so low, you can cash flow strong. In the United States, we have 30-year fixed rate interest rate loans.
Do you see the power of this methodology? It allows you to win both short-term and long-term at any point along the market cycle because we don’t always know what’s going to happen, so to the question, “Are we in a real estate bubble?” My answer is I don’t know, but this is how I operate in an uncertain world.