We've officially passed the peak of the real estate housing market cycle. You'll discover 3 changes to make during these times as well as what's going to happen next.
Real Estate Market Cycle
This real estate cycle has been on an upward trend for over 11 years and what a great run it's been! But what happens now that we’ve past the market peak? Well, we know how the market behaves from historical data and it typically trends upward with peaks and downturns. Now, just because we can track the trends doesn't necessarily give us a crystal ball on will happen next in the real estate market – a question on everyone’s mind right now. Will it drop significantly or somewhat level off? Is it a tiny trough and we're already about to go back up again? There's plenty of people predicting doomsday right now. But what will happen next is difficult to determine for three reasons:
- Market and Price Point
Time: We don't know the length of time it will take for the market to go from a trough to a peak. The stats show us that in the most recent market cycle the trough was 2011 and the peak was May/June 2022. But we can’t predict the length of the next cycle. Is it eleven years, four years, seven years? We just don’t know.
Significance: It is difficult to predict how significant the cycle will be. How high prices will climb or how low the downturn will go. Case in point is the market in 2019. There was a lot of big data and intelligence predicting the market was starting to peak. Interest rates were creeping up and they had analytical data to prove their argument. Plenty of people got on the sidelines to wait for prices to drop. Well, what happened that no one could have predicted? That's right, the pandemic and real estate prices appreciated more significantly, more rapidly than in the history of American real estate. If you got out of the real estate market in 2019, you missed the big one.
That’s why I’m active all the time. Regardless of where we are in the real estate market cycle, I'm always incredibly active either doing short-term deals or long-term deals. With short-term deals I'm getting in and out. My long-term deals, those are my trophy rental assets that I continue to acquire. I'm not timing the market, neither should you, because it's too difficult to predict the future.
Market/Price Point: It's not just that we don't know how long or significant the cycle will be, it also depends which market or price point you are in. In my video Real Estate Market Update, I talked about how affordable housing will remain strong and won't necessarily peak. Whereas with higher price points above the median, that market might experience a significant trough, which they are. And so, it depends. This cycle is completely different depending on the market and price point you're in.
Since it's difficult to predict the future; we operate based on where we are on the curve, but we stay in the game, so we don’t miss opportunities like what happened in 2020 to the first half of 2022.
3 Rules to Follow During this Cycle
1 - No Major Rehabs
Even in a peak market, I advise against doing major rehabs when flipping houses. There are too many risk factors that are hard to predict and for most people it's better just to flip those to someone else. You’ve often heard my phrase; a quick nickel beats a slow dime. The problem with major rehab is it usually isn't a slow dime, it's a slow nickel. Major rehabs need permits, different tradesmen, and have a lot of other variables that could take a very long time.
The reason why you need to be so careful in this area right now, is that we have one major X factor that doesn't care about you and certainly doesn't care about the real estate cycle. They're the local government that issue permits and the building inspectors that look at the progress and find new problems. They don't care about your success. In fact, many of them probably would love for you to fail because they're jealous of all the work you've done. There are a few good local government officials out there, but it's the few, not the majority. Instead, what happens is they can slow you up to the point where your hands are tied and there's nothing you can do.
It's best just to avoid the situation where local governments could completely ruin your deal by keeping you locked up for months, if not a year. One of my people took on a little bigger rehab than he should have because “he wanted to expand his horizons”. It ended up taking him about 12 months. Thankfully he sold it in May at the peak, but why did it take 12 months?
It's because the city made his life miserable. It took him four months to get the utilities turned on because he purchased the property in an LLC. There were a whole host of ridiculous rules; he had to set up a business license, and go to these meetings and these hearings, it was unbelievable. You really do need to be careful with bigger rehab projects. Better to get in and get out on short term deals.
2 - Put More Weight on Active/Pending Comps
The second rule to follow during this real estate cycle is to put more weight on active/pending comps than closed comps when you're evaluating the deal. I put together a training many years ago called Predicting Final Sales Price, where I argue that it's more important to estimate the final sales price than it is to simply appraise a property - to look at some closed comps and determine the after repaired value. That's not the focus of a real estate investor. What we care about when we're getting in and out on a short-term deal is what it will sell for. As investors we want to know the final sales price when that property is put up for sale, either as is, or after we fix it up.
So, the final sales price is a different determination than simply looking at closed comps. It includes closed comps, but if you're trying to evaluate a deal right now, put more weight on the active listings and the pending listings in your marketplace. In many instances, you'll see the actives are lower than the closed.
Prices Are Dropping
Now that creates its own conflict when you communicate with the seller, because the seller is still thinking that we're still in May 2022. So, in many cases you need to show them this evidence to say, "You're wrong." A house may have sold for that amount in May, but it's not selling for that right now. In fact, prices are dropping, and we use that as a negotiating tool right now. We tell the sellers, "Look, this is where things are going right now. You are going to make a mistake if you sit on this house and try to get that final, big number you want. You need to sell this and sell this fast."
And that's good advice, but it helps both of us. It helps the seller and helps you get a deal, and you can get in and out quickly. So put more weight on active/pending comps when you’re estimating the final sales price.
3 - Magin of Safety
In this time in the cycle, you need a margin of safety. Meaning you build in a safety cushion in any deal you're putting together so that you are prepared in case there is a drop between the time you lock it in to the time you get it closed.
Margin of safety is not always a lower price, although it can be, and it oftentimes is. But it also could be the creative terms that you structure (whether it's subject to, or a combination of subject to and maybe owner finance second). The lower the down payment the better, the less money you put into the deal, the safer it is for you. So, the margin of safety can be several different versions of safety, but the idea is that you give yourself a cushion right now. Because again, we must prepare for the worst, that maybe the market drops in the 20 - 40 days that you’re in the deal. Remember, you want to compress that timeframe as much as possible and get in and get out.
There's still a lot of money being made right now. I prefer these circumstances because I feel like a lot of the competitors run away and that leaves the market more open for us. That happened in the early part of 2020 when the pandemic hit. Everybody disappeared from the market, and we just went and did a bunch of deals. I'm also a hard money lender to my apprentices and I’ve never had so much hard money business in my entire life. Suddenly I had every hard money deal I could ever want because every other hard money lender shut down in March 2020.
So, build in your margin of safety, but don't be in a position where you just don't do deals because you're quote, "worried about the future." You make these three adjustments and you're going to be just fine. You can make a ton of money right now. So be excited and you'll have less competition.
Do You Want to be a Successful Real Estate Investor?
As you can tell, this is not my first rodeo. I've been through troughs and peaks and there's ways to make a lot of money at each part of the real estate market cycle. Obviously, this depends greatly on your area, but the great news is there's always plenty of opportunity. If you want to learn more about how we do what we do here at Freedom Mentor, pick up my free book, How to Be a Real Estate Investor. And if you're looking for someone to help you navigate through these frothy waters so that you can make a ton of money right now, consider my apprentice program, where my team and I, we mentor and train our people into first-class money-making market leading machines.