Here we go again. We can't seem to stop talking about the imminent or non-existent
"real estate bubble." Most financial planners would have you believe that it will
spell certain doom for real estate investors. On the other hand, most real estate
agents would have you believe that your properties will continue to appreciate every
year forever. So what do you do? Dig a hole and bury your money in it? Savvy investors
know that is a losing proposition thanks to inflation.
In my business, structuring retirement accounts to invest in real estate and businesses,
we get questions about a potential "real estate bubble" everyday. I tell our clients
that if you're a smart investor it doesn't matter if the real estate market slows
down or not, you can still make money. Real estate offers multiple ways to bring
in revenue. As the get-rich-quick junkies that we often are, however, we get caught
up in appreciation as the only important variable to look at in investment real
estate. With that in mind, what would happen if the market does slow down considerably?
Which groups would benefit and which would suffer?
The Survivors:
Homeowners without Adjustable Rate Mortgages
Most current homeowners would make it through a market downturn without much
of a hitch. They would continue to pay their same mortgage payment and live in their
home. Unless they were forced to move because of a family emergency or job transfer,
they could wait it out until the market rebounds. Of course they might have to downsize
their lifestyle if they have relied on mortgage refinances as supplementary income
during the last few years.
Cash Flow Investors
Cash flow investors make money based on the rental value of the real estate. Appreciation
becomes the icing on the cake. These investors could afford to wait out any market
downturn because they could still make money while waiting. In fact, most cash flow
investors would find their cash flow increases if the market slows. Why? If less
people can afford to buy, there is a larger volume of renters. The law of supply
and demand says that a larger volume of renters equals escalating rents. Don't believe
it? Keep in mind that our 4-5 year string of record low mortgage rates has equated
to a decrease in rental rates since 2000.
Cash Investors
Cash investors purchase real estate using little or no leverage. In the case
that mortgage rates continue to rise and home values do not escalate, there will
be plenty of opportunity for cash investors (i.e. those using retirement funds)
to cash in on "distressed sales." Lower appreciation and rising rates would also
mean less competition from other investors. There would again be instances of sellers
taking less than asking price for their homes... a welcome treat for anyone who has
tried to buy a home in the last year.
The Casualties:
Speculative Investors
If you find yourself justifying a $600,000 purchase in Bellevue with "I can afford
to lose $2,000 a month because I'm gaining $60,000 in appreciation every year,"
then you are a speculative investor. Be careful. Speculative investors would stand
to lose the most in a market downturn, especially if using high amounts of leverage.
It may be hard to pass up some of the great opportunities in a market that is moving
as quickly as this one. If a property can be turned quickly it might still be worth
the risk, but these investors should make sure they have a viable back-up plan in
case the home does not sell or appreciate.
Those with Family Emergencies or Job Transfers
The real casualties of a real estate market downturn would be those that are forced
into job transfers or that incur family emergencies. If the market slows, these
individuals may find their homes in foreclosure without home equity on which to
fall back.
Adjustable Mortgage Holders
In case you did not see the Fortune magazine article earlier this year, Seattle
came in #1, for the second year in a row, as the most expensive city in which to
live. Based on the median income of our area, our cost of living is the highest
in the nation. Yes, even higher than San Francisco or New York. That means many
homeowners in this area have stretched their pocket books to the max to afford as
much house as possible. Those homeowners with adjustable mortgages may find their
pocket books stretched even further as mortgage rates continue to rise. Those with
already high debt to income ratios may find they can no longer afford their home
and cannot sell it for enough to cover their closing costs.
No one knows for sure where the real estate market is headed. All markets go through
cycles, including real estate; however, there are ways to limit your risk and plan
for factors outside of your control before they happen. The biggest Bubble Trouble
will occur for those who are scared away from investing any of their money (losing
to inflation) and those who invest blindly without considering the risks.
More Information: Self Directed IRA LLC & Small Business Financing