“Poor guy.”

TIPS & TRICKS

3 Things to Keep In Mind Before Getting into Real Estate Investing

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“Real estate is never worth nothing.”

“If you want to make some real money, buy real estate.”

“Being wealthy and successful means passive income, and passive income means real estate.”

If you’re like me, you’ve heard the above axioms your entire life. When time, money, and opportunity all converge, buying real estate is the obvious choice. In the Big Sort during COVID, in which millions of Americans moved across state lines, enterprising investors bought and flipped homes left and right, often at tremendous gains as home values went up and up (and as California and New York money flooded into Texas, Idaho, and Tennessee). Developers were building like crazy. Rent was rising. It was a party you didn’t want to miss, financially speaking.

With so much success, investors have been increasingly attracted to the prospect of getting in the game, but home values haven’t really gone back down, interest rates and inflation present a very real obstacle to home ownership, and the supply may not be meeting the needs of the demand.

All of that to say, it can feel odd to question the wisdom of buying property when you’d like to invest, but it may be a good time to do some very serious digging before buying real estate. As Larry McDonald recently said, the housing market is “a slow-moving train wreck” and predicted up to $700B in coming defaults.

Some will still do well with real estate, even now. But here are three things to consider before you buy:

Rates Are Climbing Again

After a few months of sharply falling 30-year fixed mortgage rates, from October of last year through mid-December, we have seen the trend line climbing again. As of Monday, rates are back above 7%.

This may represent a correction to some of the overly optimistic market outlooks of the past few months. Even just a 1% difference in mortgage rates can price out a lot of consumers, contributing to a stagnant demand. Home prices have fallen 0.2% overall since October, but the circumstance depends greatly on where you live or invest. Markets like San Diego are increasing sharply (8% year over year), while cities like Boise and Austin are experiencing falling prices (just under an 8% drop).

Boomers Are Not Downsizing
Part of the reason the US housing market has worked for so long is that people naturally sort themselves out according to their needs.

For example, a 19-year-old mechanic is not typically going to buy a large house. He’s likely going to rent or buy something small. When that mechanic gets married, however, and certainly by the time he’s got a few kids, his need for space has increased (as has his earning power), so he trades up, now willing and able to spend more on living space. Then, once the kids move out, and our mechanic and his wife are in their late 50s or early 60s, they might decide that the extra costs in time and money for maintaining a big empty nest just isn’t worth it. So, they downsize to a small home to save money and focus on traveling, hobbies, or spoiling the grandkids.

That’s the idea, anyway, and for a long time, it has worked sort of like that. With the “silver tsunami” coming as Baby Boomers are now firmly in the autumn and winter of their lives, and with so many people in this generation, you would expect a surplus of family homes to flood the market right about now, bringing prices down, and making space for young families and first time home buyers.

The only problem? Largely due to market conditions, Boomers aren’t selling. They aren’t downsizing. It’s easy to see why – homes have appreciated tremendously since the 80s and 90s when many in this generation bought their homes, and faced with the massive capital gains tax, high-interest rates on new loans, and a small available supply for sale, it just doesn’t make sense to sell right now.

This means the supply side is not well matched with the demand, further contributing to the awkward, halting nature of the current market. There are a few macroeconomic conditions that could shift this current trend, but for the moment, it’s what we have to plan around.

Trying to Flip or Develop Is a Risk

“Don’t count your chickens until they hatch” is a wise saying for that reason.

That flip that is “going to” earn you a quick $75,000 free and clear might do just that – but if it doesn’t sell, you’re left with a property that may or may not become financially burdensome, depending on maintenance costs, insurance, and if you are able to rent it out. A flip that doesn’t sell ties up a lot of capital, and in an inflationary environment that isn’t ideal. A flip can also end up requiring more money for rehabilitation than originally expected, and it’s no longer 2021 when home prices were basically guaranteed to go up.

Some people prefer to buy land, get a building loan, and add to the overall supply. This, too, can be lucrative, but in a strange home-buying market such as this, you have to be very sure that your home is going to be in a price range that is acceptable to the right demographic for the area. Carrying costs on building loans can be steep, and six months can mean the difference between a healthy profit and breaking even. Another six months after that can turn an asset into a liability.

TL;DR

All investing involves risk, and just because there are uncertainties in the current housing market does not necessarily mean you shouldn’t participate. It does mean that investors should be cautious, have a plan B in case things go south, and consider other options for their money.
(This information is for entertainment purposes only and does not constitute financial advice.)

Quick Hits

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