One thing that makes real estate so interesting and profitable is its cyclical nature. There are boom times when everything in sight explodes as costs skyrocket into the stratosphere and everyone seems to be jumping in hoping to cash in on the good times as they go. Then there are times of price stagnation when there may be price declines as the markets adjust to the lack of demand. And then, once every few decades, there will be areas where the property seems almost useless.
We’ve heard a lot about a looming housing bust. Doomsayers are predicting a total collapse in real estate prices. They are right? Everything is possible, but probably not! Too much depends on real estate.
Our growing population will have to live somewhere and the power brokers in Washington DC have vested interests to help maintain a semblance of balance. Real estate investing can be a risky business. But if history is any measure, prices will go up and down, but mostly up.
Professional real estate investors do well regardless of what a given market does. They make adjustments when they identify the telltale signs of market changes that allow them to thrive even in a bad market. Here are four real estate investing secrets used by investors to help you stay ahead of the game.
Red-hot markets don’t last forever. There comes a time when all “good things” come to an end. Hot real estate markets are no exception. The true professional will buy properties with an exit strategy that takes into account the tightening market by buying in the best locations that will allow them to more easily offload the property when the downturn hits.
Most professionals see the signs of an unraveling market and start looking at emerging markets and begin the process of getting out of the hot market. This strategy, while not a guarantee, will make it possible for the investor to go back through the best areas so that he can exit quickly if necessary. No one has a crystal ball, they look at things like employment, employment opportunities, real estate demand, rental housing availability and demand, local government, commercial projects, and many other indicators.
As investment opportunities arise, they start buying properties elsewhere that promise appreciation or profit. Many of them buy in several areas in order to spread their exposure and get “safe” returns on their investments. One geographic area may be sluggish or decelerating, while another may be experiencing an annual appreciation of 35% or more.
The pro will try to enter an area before the location peaks and then sell before the market goes down. That allows them to start buying in an area where they can profit from the next uptrend. Then they can wait for the old hot market to experience a flood of foreclosures and buy properties at a discount and wait for the market to recover.
The balance of supply and demand
Here’s a fundamental fact I want you to remember: When supply is high, prices go down. When demand is high, prices go up. There were people in my investment club who believed that prices would maintain their breakneck speed. The reality is that if there is too much of any type of real estate, prices go down. For me too. I bought building lots for $135,000 that I would have a hard time selling for $99,000 today. Obviously, I lost the market and I will pay the price.
There comes a point in every market cycle when investors and new buyers run out. As demand falls, excess supply cascades down to a more natural price level. There is also a direct correlation between rental prices and house prices. If there’s too much disparity, house prices go down because investors won’t buy a property that they have to feed (add extra income each month) or they’ll have a terrible return on their cash investment.
Study the market and determine when supply exceeds demand. Then, when you see new buyers light up the home buying market, you’ll know when to start shopping in that area again.
Put a stop to speculation
Speculation is expecting a profit, just like when you go to a casino and expect to walk away with your money. You can do it? Sometimes maybe. But the odds are in favor of the house.
I teach my students to earn money when they shop. In other words, they know how much money they have earned on the day the loan closes. Also know how much money you made on your transaction on the day you closed. Buy it right, get your profit when you sell, and you might even get a nice appreciation bonus or zone change that increases value.
Don Loyd’s RICH System(TM) uses a very simple way to evaluate an investment property. If you can’t answer the following questions and get good, positive answers, you may not want to invest in a project. ask yourself:
R-Return? – How much wealth does this property create for me today?
This is not appreciation or how much you can sell it for next year.
I-Investment? – How much money will this investment take me out of pocket?
Normally, I want to put in as little money as necessary.
C- Refund? – If I put money in, when do I get it back?
The goal is to get your money back as soon as possible so you can invest more.
H – Holding income? – Is this property positive cash flow?
You want to avoid negative cash flow. It can put you out of business.
This simple formula can be used when considering any investment made by most investors. It is very revealing because it gets to the heart of the problem. Cash and cash flow are vital to the livelihood of investors.
Preservation of fairness
Don’t give up your wealth easily. Protect it the best you can. If you think you have to borrow from your equity fund, borrow from some of your investment properties. I have lines of credit on almost all of my houses. I’ve never tapped into my investment portfolio, but it’s there if I need it.
Take great care to protect your personal home. Don’t borrow against equity. It’s too valuable a resource to be harnessed for anything other than short-term money. If you’re disciplined enough to resist the urge to use your equity for a vacation, a new car, and the like, I recommend getting a home equity line of credit (also called a HELOC) for short-term loans. Your capital for any use other than short-term loans exposes your family to unnecessary risk.
History suggests that you will do well in real estate if you have an investment plan that includes allowances for the ups and downs of the markets and solid exit strategies. It can also do well in bad markets. In fact, you can get rich if you know what you’re doing. Spend the money it takes to get a good education, information, and training. It will be money well spent.
Finally, learn to think outside the box of conventional wisdom. Being creative will go a long way to success as a real estate investor.