How should I invest my money?

Question

Okay, so I built a brand new home in 2013. Before I even broke ground my home was appraised at $161,000 on paper. I made some major modifications and some huge upgrades to my blueprint. I now have a new metal building with a driveway and a beautiful sidewalk.

Since I am very familiar with appraisals and because I went to real estate appraisal school several years ago, I know my home is valued at around $200,000 to maybe $220,000 because of the comps in my area selling for that much and some even more.

Now that I am in the process of making my home move and putting it on the market, instead of me taking my profit money and building bigger and better I want to invest in real estate. Either in flipping, wholesaling, rent to own, etc. I am a total newbie and amateur and never have done anything like this so I want to invest my money wisely and make residual income. I owe $127,000 to my house now.

What would you do? Of course, I am going to take some of my money and live in an RV for a timely season until I find somewhere I truly want to dwell.

Thanks

Brian

Jay Hinrichs · Answer

become a builder and build another new spec home sell it and make another 100k.. that's easy..

Arlen Chou · Answer

@Sam Barrow to add to what Account Closed have discussed, it is important to remember that real estate, especially in hot markets is not an efficient market and the political system which binds us all is not rational.  Look at markets like NY or SF, there are many irrational political decisions that keep the market from truly being free: rent control, limitations on building based upon arbitrary lot size limitations, off street parking requirements, the list of limitations that keep people from building and adding inventory are seemingly endless.  This is the inefficiency that is driving up prices.  The inflow of capitl is a byproduct. Couple that with the fact that the population of the United States as a whole has more then tripled over the past 100 years and it is easy to see that the balance between supply and demand have been tilting for a long time, and probably will for a long time.  These hand cuffs on the "free market" are definitely not felt as much in the mid-section of the US, but they do exist and they are getting stronger.  Unless those restraints on adding inventory are not eliminated, the imbalance between supply and demand will only grow.  Also keep in mind this imbalance is exaggerated in physically limited markets like SF or NY.

Account Closed · Answer

Well, past performance may not be guarantee of future results but you yourself admit to a 20-30 year run. That's a pretty good trend! I do believe the coastal markets have more inherent desirability. The weather is part of it but at least in the SF Bay area there is a whole eco system of finance, education, networks etc that are very hard to reproduce. How many cities have tried to be the next Silicon Valley? Can you name a single one that has come anywhere close to the scale of the Bay Area? Also compared to 2000 when the tech economy was driven by start ups now it is based around the largest companies in world like Google and Apple. Do you think they will go away soon? Both Google and Apple are building huge new multi billion dollar campuses in the Bay Area as we speak. So in a sense the jobs ARE attached to the dirt!

Al Williamson · Answer

Yes, it seems that your market is on fire. It's difficult to sell high and buy low in the exact same market in the same year.

I'd look for solid rental in an emerging market.

Often times, when new investors hit a home run, they think they're smarter than they really are.

For that reason, I'd find a seasoned investor to bounce ideas off of regarding your next move.

Sam B. · Answer

It depends on whats driving the trends and whether you believe drivers are sustainable. So if the prices are going up based on speculation like it was pre 2008, you are right to worry. If the price increases are driven by actual supply/demand of people wanting to actually LIVE somewhere, its different. I have a small 3/2 1500 Sq ft townhome that is now valued at say $1.1M. That's about the median price in the area.  In the rest of the country you may say that's insane. But when you look at what a dual income tech couple pulls in which is a minimum of $300K/year you can see why they can afford it. If the salaries drop substantially then yes, prices will fall. At the same time we have very limited land for new builds. And new builds are small and cramped and expensive. Also people are reluctant to sell because if they do they will forever be priced out of the market. So given all the above I can see why the market is doing what it is. There is of course an upper limit but I don't know exactly what it is. But maybe the median price exceeding 4X the average techie dual income may be a point. I know its hard for Midwest and other people to get their heads around but some markets will always have demand far outstripping supply. Manhattan and SF Bay are two of them.

There's a fine line between speculation and real demand especially in areas where FOMO is at play. A lot of these people are speculating. Not on nearly as large of a scale as they were in 2006, but in any locale where the average PITI payment exceeds rent, expectation of appreciation is likely some of the driving force behind these purchases. In addition, with FOMO, even when the primary motivation behind a purchase is not capital gains, it's still speculation because it is based on the same premise, that prices will continue to rise indefinitely.

But mostly what I'm saying is that what's not sustainable is not so much the current prices, although I believe them to be as well, but the idea that the performance last 20-30 years bears any relation to performance over the next 20-30 years. Just run the numbers at current rates of appreciation. It doesn't take as long as most people think to get to the point where that 300K/Y tech couple is homeless. In addition, the vast majority of Bay Area residents do not make that kind of money. These outliers can not be used to justify median prices.

That demand will likely outstrip supply for the near future. It may not outstrip supply forever. People argue against things like the EMH because people are not rational in every situation every time. But over the long term, in the aggregate, people are generally rational, and the economic fundamentals underlying all of this are pretty simple. Economics is the study of the allocation of scarce resources to their most efficient uses, and over time, free markets will virtually always trend in that direction. What we're seeing in California, huge amounts of capital pouring into small areas to fight over that limited supply of land you mention, to me, indicates some major inefficiency at play. The rational response to this is obvious. I think it's just a matter of how long it takes. Might be 10, 20, or 100 years. We'll see.

Sam B. · Answer

Well, past performance may not be guarantee of future results but you yourself admit to a 20-30 year run. That's a pretty good trend! I do believe the coastal markets have more inherent desirability. The weather is part of it but at least in the SF Bay area there is a whole eco system of finance, education, networks etc that are very hard to reproduce. How many cities have tried to be the next Silicon Valley? Can you name a single one that has come anywhere close to the scale of the Bay Area? Also compared to 2000 when the tech economy was driven by start ups now it is based around the largest companies in world like Google and Apple. Do you think they will go away soon? Both Google and Apple are building huge new multi billion dollar campuses in the Bay Area as we speak. So in a sense the jobs ARE attached to the dirt!

Such a long run is a negative, not a positive, in an asset class that has not appreciated, in the aggregate, historically. And in the grand scheme of things, it's not that long a run. For a period of time, Detroit was the place to be, and look what happened there.

Yes, very hard, and I'm not suggesting all of those tech jobs are going to move. But they aren't attached to the dirt in the sense that there's anything inherently special about the dirt in the Bay Area, except perhaps the location. It's more an issue of things being established. Inertia. I had a very good income in DC, but I didn't like it, and over the years I've found remote work to be much more available, hence my move. Thanks to technology. Say 10, 20 years ago, this would not have been possible. I only stayed in DC for 25 years because, as I said, inertia.

The more lopsided the imbalance, the more likely you're going to see people try to substitute, with varying degrees of success. This will keep prices in check. Unaffordability is already a huge problem, even for high paid tech workers, in the Bay Area. Current rates of appreciation are completely unsustainable. A lot of investors lose sight of the fact that the people on the other end of these transactions to rent and buy from them are actual people, doing what's in their own best interest, and they have a limit to how much they can take before it becomes more rational to go elsewhere, or to be unwilling, or unable, to pay a price that will make said investor as happy as the guy who bought 30 years ago and is selling now. Have you ever had a wholesaler bring you a deal, and it become very quickly apparent that they had decided what their fee should be before thinking about your motivations for buying the deal? A lot of investors think this way, but I try not to do this myself and I think when people spend more time thinking about valuation graphs than the actual humans on the other side of the table, they're missing the forest for the trees. Sometimes it works, luck, market conditions, whatever, but sometimes it doesn't.

I don't have a good outlook for California in the short term just because we're likely at a cycle peak, although in the medium term, I'm sure it will remain a hell of a lot more expensive than Indiana. In the long long run however I think we'll see the huge imbalance we have right now level out to some degree. In the interim, I feel much safer here, and while I am leaving a lot of money on the table I sleep very well at night.

Sam B. · Answer

I totally agree with you. If the best you can get on your rentals is 6-8%, which was what a typical home following in the 1% rule is about, then there are easier ways to get that. One caveat though is that 6-8% is mostly tax deferred so equivalent passive investments need 9-12% but still there are ways to get there. The other caveat is leverage. If you got decent interest rates a 6% cap rate with 4X leverage and a 3% interest boosts the return substantially. Now a days with mortgages at 5% a 6 cap home leverage factor is much less. On my portfolio of cheap homes I have ranged between 10% to 30% with an average of about 18% on invested cash. That is worth some hassle. This is not including appreciation which as been 40-50% over the last 5 years. On my CA rentals its been all about the appreciation.

Absolutely. Rentals are probably better, all things considered, but everyone has a different threshold for what they consider hassle and I think a lot of people who are getting into rentals think the hassle is going to be quite a bit less than it actually is.

Appreciation is great too, but the way I look at it, that's when you get into the real skill work - finding stuff that will appreciate while maintaining an acceptable level of risk aversion. Obviously coastal markets have been on a run for the past 20-30 years but of course past performance doesn't guarantee future returns. I think we're going to see a shift in that dynamic in the near future. The economic principle of substitution is a universal rule, it's only because real estate moves so slowly in general that we haven't seen much of it there, at least not yet. I think we will, actually I personally am a good example of that (millennial, moved from DC to Indy in no small part due to cost of living).

People talk about the inherent qualities of real estate in certain locales, California for instance, but really, what they're talking about is more the snowball effect than anything inherent, and that's not guaranteed to last. Only exception I can think of is weather and scenery. Besides that, there's no reason all of those high paying tech jobs couldn't move elsewhere. They're not attached to the dirt.

Account Closed · Answer

Definitely. The SFH price is sustained by owner occupants.  But for the 2-4 units people are still buying at very low cap rates and negative cash flow. This I have a hard time understanding. Your exit will be to another investor and that sentiment can change depending on external factors like interest rates, risk free return rates etc. MY best friend just bought a quad whose numbers I would never purchase at. Add that to the Prop 10 risk and I dont think its a good idea to buy now.

Account Closed · Answer

Well, its impossible to really predict 20 years out for anything so Im not going to try and argue about that. But in the near term there are still very strong positive drivers for the market. And I disagree with you that the median price is not based on tech salaries. The demand is so much greater than supply that just a few tech employees are enough to float the market. There is no need for average income earners to buy and in fact they cannot and they do not. Now I personally think thats not good for the communities but thats a different topic. But the outliers do in fact justify the market. The fact that the market prices are as they are is proof enough of that. It may not fit your understanding of economics but the facts remain and are indisputable. All I know is my first home in 1998 at 340K seemed really expensive. My second home in 2007 at 620K seemed really expensive. My third home at $1.3M in 2014 seemed really expensive. All three look incredibly cheap in hindsight!

Account Closed · Answer

It depends on whats driving the trends and whether you believe drivers are sustainable. So if the prices are going up based on speculation like it was pre 2008, you are right to worry. If the price increases are driven by actual supply/demand of people wanting to actually LIVE somewhere, its different. I have a small 3/2 1500 Sq ft townhome that is now valued at say $1.1M. That's about the median price in the area.  In the rest of the country you may say that's insane. But when you look at what a dual income tech couple pulls in which is a minimum of $300K/year you can see why they can afford it. If the salaries drop substantially then yes, prices will fall. At the same time we have very limited land for new builds. And new builds are small and cramped and expensive. Also people are reluctant to sell because if they do they will forever be priced out of the market. So given all the above I can see why the market is doing what it is. There is of course an upper limit but I don't know exactly what it is. But maybe the median price exceeding 4X the average techie dual income may be a point. I know its hard for Midwest and other people to get their heads around but some markets will always have demand far outstripping supply. Manhattan and SF Bay are two of them.

How should I invest my money?

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