The question on everyone’s mind: Is now a good time to invest in real estate? This question is hard to answer because it’s always personal, market (mine is Eastern Kansas) & deal specific. However, below are my high-level thoughts as I think through this challenge for my own business.
*None of the following is financial advice, just my opinion. Do your own research and seek professional help.
Thoughts:
- Free call option on lower interest rates:
If you can find a deal that cashflows and hits your return criteria when you borrow at today’s market rates, you essentially own a “call option” if rates go lower. For those unfamiliar, an “option” allows the owner to benefit if the market moves in their favor but doesn’t hurt them if it doesn’t. For example, say you find a deal that hits your return criteria at current interest rates. If rates stay the same or move higher, all else constant, you’re not impacted. However, if rates move lower and you capitalize with a refinance, you will benefit from both increased cashflow & equity build-up. This could be powerful if market interest rates move back to the 4% - 4.5% range in the future.
- Always think relative to your capacity to purchase: The decision to invest in anything should always be weighed against both the risk & return profile of the investment & the size of the investment relative to your total capacity to invest (position size). In real-estate, your capacity to invest in residential property is often governed by your personal net worth, debt-to-income ratio & banking relationships. If you only have the capacity to buy one property, the deal needs to be a great one for you to continue your investment journey. This should lower your risk tolerance and raise your return criteria. However, if you have the capacity to buy 10 deals at anytime, the risk of buying a deal in any market is greatly reduced. If you get a lemon or the market goes against you, your still in the game for the next peach!
- I’m going to wait until the recession sets in mindset:
If you’ve been in the real estate investment community, you’ve heard this 1,000 times minimum over the last five years. While this argument seems intuitive at first, it lacks practicality & doesn’t consider the risk of not
investing. Many people think of recession as homogenous (i.e. every recession is the same). The reality is starkly different. For example, in the dot-com recession in 2001 housing prices barely budged in stable markets, on average. However, in 2008 where the recession was centered on housing & banking, prices fell across the board. Following the 2008 recession banking regulations were strengthened significantly, while not impossible, these regulations make it unlikely for US housing to be the epicenter of any recession over the near future. To be clear, this certainly doesn’t mean average real estate prices can’t fall. However, it does mean there is a higher probability they fall by less than expected if you’re falling victim to recently bias in expecting 2008 to happen again.
- Impacts of inflation on rent: The recent impacts from the government stimulus & supply chain breakdowns following covid have caused inflation to rise across industries and geographies. I’m sure you’re noticing this in your own life, I certainly am! The impacts of inflation are true for rent as well. In my markets, rent has increased ~10% year-over-year. Historically, rent has been extremely “sticky,” where once they increase they very rarely fall significantly. There are deals in most markets where older landlords have long-term tenants where rent hasn’t been increased in years. Most of the time, this amounts to only a modest opportunity. However, in the current market this could be a much bigger opportunity for return.
My Conclusion: The question of “should I invest in this market” needs to be reframed to “what is a strategy that allows me to win
in all markets”. Think about the implications of following the “waiting for a recession” strategy in 2017? You lost. A strategy that wins in all markets must:
- - Ensure action on growing your portfolio in any market.
- - Have appropriate risk mandates that ensure you are never a forced seller in any market condition.
- - Ensure you always have excess capacity to add a material amount of property to your portfolio if we enter a market environment where prices fall.
Utilizing these principles, every market condition is an opportunity. If housing prices & rents rise (like they usually do), you’re in the game and profiting. If housing prices fall, you’re prepared to capitalize by significantly adding to your portfolio. If housing markets are flat, you’re enjoying the cashflow, equity build-up & tax benefits of your investments. You win.
It is my belief that these principles, if followed, give you a high probability of being successful over the long-term. The problem: like most intelligent investment strategies it takes patience and self-confidence to execute. With this, I hit send. Hopefully this helps. Cheers guys, here’s to an abundant future!
