Bubble Proof?

Question

What is the safest type of Real Estate investing? Who were the investors that still made money in the crash of 2008? I am new to this game and am hoping to be a passive investor doing buy and hold on property that cash flows. What are the market implications on a buy & hold investor that bets on cash flow not appreciation? Did these type of investors survive the last bubble burst? Is there something safer out there?

Sorry for the noob question but I guess this is the "starting out" forum

Jordan Thibodeau · Answer

@Kerry Hennessy Welcome to the forums!

IMO: You have 2 types of risk:

Market Risk - The general direction of real estate prices, vacancy rates, jobs growth, and other macro economic factors that are outside of your control.

Personal Risk - The actions you take that can directly affect your risk profile. Deciding to set cash reserves for a rainy day, 100% leveraging, understanding of the market, etc.

As far as the safest investment, it all depends on yourself and your experience. A flipper will tell you that buy and hold is risky, while a buy and holder will tell you the opposite. Or some people will say real estate in general is risky.

Being that every market is different, and certain strategies are highly profitable in one area and unfeasible in others makes it hard to develop a blanket strategy without knowing your particular market.

The best thing you can do is: 1. Listen to as many podcasts as possible (I would listen to a podcast focused on: Wholesaling, Flipping, Buy & Hold, Tax Liens, Commercial, and etc). 2. Read the blog posts and devour as much info as you can before deploying capital. 3. Continue to post.

Once you determine which area in real estate interests you, then you can decide what your risk profile will be.

Happy hunting my friend!

Eric Fernwood · Answer

A lot of good comments and thoughts on this thread. I thought I would add my opinion which may only be true for Las Vegas.

Rental property stability during times of financial turbulence is dependent on the stability of jobs for the pool of tenants. If the pool of tenants for a given property remain employed at a similar income, they will scale back discretionary purchases but have to live somewhere so they will continue to pay the rent. This is especially true in the case of single family homes which are usually occupied by families with children. And, if families lose their home in foreclosure they will likely chose to rent a home similar to what they had.

We did a study on how Las Vegas rental performed during the period from 2008 through 2014. Below are our findings.

MethodologyOne of the challenges we have with most reporting sources is that they use metro averages which combine different types of properties (single-family, condos, multi-family) in very different price ranges and different areas. In order to avoid such practices, we based our investigation on a specific area (see the map below) with a specific configuration: 3 bedrooms 2 car garage, 1,200 to 1,500 SqFt.

Property PricesBelow is a chart showing the monthly average $/SqFt sale price between 2008 and 2014 by month for conforming properties. As you can see, properties were selling for an average price of approximately $120/SqFt at the beginning of 2008 and by 2012 the average price fell to approximately $70/SqFt. The falling prices were largely due to a large surplus of homes coming on the market due to foreclosures and that people did not have the desire or income to buy them. During the early part of the 2008 to 2014 period over 4,000 foreclosures per month was not uncommon.

Rental RatesWith so many properties coming onto the market we expected that rental rates would also fall along with property prices. In short, they didn’t. Below is a chart showing $/SqFt rental rates during this period. As the graph shows, rental rates were virtually unaffected by the market crash.

What this meant to investors was that if property was generating an 8% return in before 2008, it would still be generating an 8% return in 2012 even though the market value of the property went down by over 40%.

Class C PropertiesWe did not do the research on class C properties but based on the vacancy rates during this period, class C properties did not fare as well. We believe that many of the class C properties were occupied by construction related workers. Construction was one of the hardest hit segments of the Las Vegas during the crash.

Additional ThoughtsAs several people in this thread stated, you can not prevent crashes. Crashes are going to happen. Hopefully the next one will not be as severe but they will happen. I believe that the best way to protect yourself is to buy properties with a tenant population that is less likely to be crushed. This is why our  clients were relatively unhurt during this period. Of course, they would have lost a great deal of money if they choose to sell during this period but few people willing choose to sell a performing asset. Today, property values are approaching pre-crash levels and rents are increasing.

SummaryRental price stability is totally dependent on the jobs the tenants have. If their jobs go away, you are going to lose a lot of money. So, when you are considering a property, consider how the tenant population for the property were affected during the previous crashes. The events of the past will not necessarily be repeated in the future but are the best indicator of what might happen.

Oren H. · Answer

When I bought my first property a few years back I went through the following thought-process that might help you:

1. Understand the worst case scenario - I asked myself how much money I'll lose if it goes bad - I can't rent it, the market goes down 40%, etc. I came up with $20,000 loss for the type of SFH I intended to buy. Putting this "worst case" scenario on paper made it look less scary. It helped to quantify the opportunity vs. the risk - I am going to invest in RE so I can achieve financial freedom and I will risk $20,000 to do this.

2. Mitigate the risk - as a newbie I decided to put a larger down payment and keep reserves in my savings account to carry mortgage and expenses for around a year if the property is not rented. That helped me get to the comfort level I needed to get started and "just do it".

3. Have a strategy - for me, buying a single buy-and-hold or doing a one-time flip is very risky. But if you plan on buying 20 buy-and-holds over a 20 year period (which was my goal) than the risk is averaged even in extreme situations. You buy your first property now when the market is high but if the market crashes you will also buy a property 10 years from now when the market is low. Overall, some properties will perform better than others and your portfolio will do fine.

After I purchased my first property I realized it wasn't as scary as it seemed and that my worst-case scenario will probably never happen. I felt more confident, refinanced the property, took money out, and accelerated my plans.

Good luck!

Jay Hinrichs · Answer

@Dmitri L.

granted 07 to 2010 was unprecedented.. however those 4 plexs in PHX  ( an agent in PHX used to have a fly buy program in SF bay area) she sold literally hundreds of these and unless you paid cash .. you were bleeding... many went 100% vacant and stayed that way for a year or more... so even conservative fundamentals would not have helped.

same with multi in some market like today we get 70% leverage on most multi.. well in Vegas many multis could not service 70% debt given the vacancy rate and many lost those to foreclosure... those that put 50% down or better probably rode it out.. or those that paid cash... Or in some markets like here in PDX were we had no issue with rentals falling or vacancy you were fine.. it was market specific for sure.

Jay Hinrichs · Answer

@Oren H.

good plan and I agree I don't think we will see and epic meltdown like the GREAT GFC again at least in my lifetime.. if we do I may not survive another one... :)

Dmitri L. · Answer

That is a great point.

I guess you have to draw the line between "buy and hold" investors who are really just speculating and hoping the property appreciates while bleeding money each month, and the ones who are in it at the right purchase price based on fundamentals.

If you buy everything based on solid fundamentals (positive cashflow after ALL expenses, reserves, etc) - the market swings of value don't affect you as long as you can keep your units full.

But certainly, some markets are riskier than others, even for buy and hold. There are many specific risk factors to watch out for, to help mitigate some of that - the biggest question you want to ask is, who is providing the jobs in the local area, and how sustainable is the rental demand?

Really the cash flow vs appreciation question is the wrong question to be asking. You want BOTH. The key is to:

a) buy at a price where you will be cash flow positive and therefore able to weather any storms (RE market, or personal ones for that matter) - this is preserving your capital,  and

b) buy in a quality location where you are well positioned for future appreciation if and when it happens - this is growing your capital.

Finding the intersection of those two factors is where the art, challenge, and fun of REI comes from!

-D

Jay Hinrichs · Answer

@Brant Richardson

this was true in some markets.. but not all... ask anyone who bought a 4 plex in Phoenix in 04 for 350k and they were worth 60k in 2009 and all vacant and almost all investors who bought those lost them.

Ask many who had rentals in Vegas... lots of carnage there. .there were issue in every market... and of course many of those were over leveraged and did not have adequate reserves and walked.. I personally foreclosed on over 200 investors who walked because the properties were not performing like they should have pre 08... so it was all across the board.. just depends on when you bought.. and what your debt load was.

Allison Karrels · Answer

I only had 1 rental prior to the RE crash and it didnt slow down at all.  Now I own 6 rentals and I am going to relax for the 6-9 months  and put some excess cash flow towards my mortgages since I think the housing market is heating up a bit right now.  Balancing your purchases with your amount of leverage will help keep you in check and prevent you from crashing & burning.

Good luck!

Brant Richardson · Answer

If you were a buy and hold guy during the crash you just kept cashing rent checks and making money right through it.  Equity dropped and then slowly came back.  They survived just fine and hopefully scored some great opportunities to add to their portfolio.

Kerry Hennessy · Answer

Thanks for the insight and advice. I'm down 47 podcasts and counting (I listen at work) in the last week. Gonna start making my way thru blog posts and try and soak up this great info. Thanks again

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