How real estate financing occurs tells me a large part of the market “story” each month. (I am not an investment advisor. I am a real estate broker with a love for data, trends, and helping others with their story.)
In analyzing this months’ data, it appears that Real Estate has become a regular place for investors to put their cash. I think the draw is due to the decrease in opportunity costs (savings rates) and then depressed by pressure from rising prices. I think the reason MORE cash is NOT being moved into “dirt” is because the equity/commodity Newscasts are stealing investor attention (and rising prices = decreasing yield).
This chart shows me:
- The entrance and abundance of FHA financing erodes the use of down payments (“skin in the game”) and therefore equity in real estate, and
- The entrance and continued use of cash financing means there are successes which begets more cash (and mitigates the loss of equity from FHA and VA).
The question you are probably facing: Is the timing right to bet on rental income (and maybe appreciation) rather than the better uses of our cash?
The most important 3 words in Real Estate SHOULD BE DIFFERENT for investors than those building a family. For a family that is buying a home, Location Location Location have long been the most important 3 words. However, for an investor, Timing is fundamental and always present and takes precedence to Location. But, like any other investment, your tolerance for risk (and a licensed advisor) will help guide your decisions. And, like any other investment, Timing is important.
Making Money in RE
These are the ways to make a profit in a real estate commodity:
- Cash-flow – This is like having a Dividend-paying stock in your portfolio; you value the periodic payments. (You still want to be favored by Timing when you sell.)
- Appreciation – This is like selling a stock at a price higher than when you bought it. This is what the typical homeowner wants and makes the Cash-flow investor happy, too.
- Building – Acquiring the empty dirt, adding a residence, and selling for a profit.
- Flipping – Like being a builder, you are purchasing low, adding value to an asset, and selling high.
A Cash-flow investor has a longer-term strategy that includes holding the rental property. Whether the benefit is because of taxes or personal reasons, it remains true that “holding” real estate is how wealth is built, not “selling” real estate. “Holding” means you’re getting rent payments (unless you’re “banking”).
Appreciation is a longer term strategy unless you’re Flipping without adding value. That’s just arbitrage and doesn’t work very well when a bank, appraiser, government entity has some power over your eventual sales price. There have to be comps and reasons your price jumped so much in a short amount of time (arbitrage). Banks don’t appreciate other people making money; their money.
Building is a special art and requires a lot of capital. This is the birthplace of what we call “home”. It is also the birthplace of multi-family dwellings. Demographics affects profit and, therefore, builders want to match projected buyer desires to construction details. Timing is critical. Location is critical. Insurance and longevity are expensive.
Then there is the investment activity known as “Flipping”. Simply put, Flipping requires working backward with the profit-chain to determine whether an asset is a good candidate for purchase and re-sale. For example,
- you have $200,000 to invest
- your investment opportunities are limited to Flipping (determined by your Time and Money rules)
- you want to make at least 10% in the Flip of an asset
- a home is priced at $112,000 – the comps may support $212,000 with upgrades – kitchen, bath, roof, yard costs $25,000 – contractor and regulatory costs $25,000
- spending $112,000 and $50,000 in upgrades could yield 31%; you could spend $65,000 on upgrades and still make 20%, notwithstanding the time it takes to achieve that return.
Barriers exist for any investment activity. Specific to Flipping:
- Regulatory costs
- Market unknowns
- Construction skills and availability
Being a real estate investor without guidance and help is sure to cause you pain. Let me know if you have questions, needs, or if you have any feedback (or post it here).
I’m sure someone will have another way to make money in real estate. Share your ideas.