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Home arrow Real Estate News arrow General News arrow Reasons why Real Estate does not smash into

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Reasons why Real Estate does not smash into
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Sunday, 27 August 2006

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A basic understanding of real estate and finance would put off fantasy headlines on pessimistic view on real estate. 

Much of the value of the stock market and other financial markets is “good will.” The only solid asset of some companies is the real estate they own. One good scandal, lawsuit, or moronic manager and that “non-real estate” value can go up in a puff of smoke. 

A total crash in the general market will not happen. You will never see a $500,000 house become a $5,000 house. Not unless everything else is devalued, and then it makes no difference. If real estate were to sell for “pennies on the dollar” then the days of penny candy will be back, and you’ll get change from a buck back from MacDonalds again.   You will never have a 5000 square foot house sell for $5,000 while a Mazda sells for $25,000. All other value in this world is basically tied to real estate. If real estate plunged, so would everything else. But it is not going to happen.

If values began to plunge, money would rush in so quick your head would spin. Local markets "correct" themselves.  Even in local markets this is the still true. When Boeing shut down, the market was hurt bad.

Canadian investors came in and bought up properties and made millions upon millions upon millions. In thirty years, I've seen some corrections around different states, but nothing resembling a crash. I have books on my shelf about the coming real estate crash of the 70s, crash of the 80s, etc. It never happens. It never will.

Authors that write those books have no greater insight to the future of the world than the heaven's gate people or Jonestown groupies. But like those organizations, there are always nuts willing to listen to financial fanatics. The definition of fanatic is “zeal without knowledge”.

Real estate doesn't crash.  The stock market, commodities etc. would have gone down the toilet long before. The same stock market writers predicting a real estate crash would be leaping from a ledge.

Now, local markets can correct. California does tend to get a little high priced. It corrects and money moves to other states like Utah. After the quakes some years back, there were 100,000 people a month leaving California. At the same time, 40,000 of them were coming to Utah. Then the values correct and people head back to the beach.

Now, I am talking the residential market and ONLY the residential market. Commercial real estate and other areas can have wider swings. Hotels can be overbuilt like Utah had twenty years ago or shopping centers can be overbuilt like in Denver a couple decades ago.

But, it corrects. Within five to ten years of hotels going up for auction in Utah there was a 100% occupancy rate (because people were leaving California). The plan and path for an investor should not be one of panic. There are things to do and not to do.

Here is what you should do . . .

1. Avoid or be extremely careful of areas that are highly dependent on one employer, industry or other factor. A large company like Boeing shutting down or having big layoffs can drastically affect a local market.

On the other hand, in the same area you can also have both stability and volatility. We had a steel plant shut down a few miles away from me and that local area was hurting. At the same time, I live near an extremely stable University that has to turn away students and the market is quite stable. So, in the same city or adjoining cities you can have both safe and risky areas.

2. Stick to bread and butter properties. The average property that Ward and June Cleaver would live in. Even condos or apartment complexes can have more volatility.

If you are following a buy and hold philosophy (which I do not advocate), than you need something very stable to hold on to--residential single family homes in the starter home range and just above. High priced homes can be volatile, too.

3. Be careful about “buy and hold.” The plan of buy all the real estate you can and hold on for dear life has flaws. I heard one guru say “buy all the real estate you can and hold on by your fingernails if you need to.” I know of many people who acquired the nicknames “nubby” or “stubby” throughout the years.

It is very high risk to be highly leveraged with no plan for a downside. The same guru also used to say “Negative cash flow is like bad breath; it’s better than no breath at all.”

Well, I’ve seen it squeeze the breath right out of many people leaving tragedies of everything from bankruptcy to divorce and even death and suicide. Even a small market correction in prices or rents and someone has to begin eating their portfolio and that rarely works.

4. Have some reserves. If the only way you have food for your family is if all the tenants pay, there’s a problem. If a property flooding or needing a new roof means you can’t make mortgage payments, you have a problem. If you clothe your kids from what tenants leave behind, you’ve got a cash flow problem and probably not the happiest kids.

This isn’t just a joke. I’ve known people that were that tightly stretched and that even ate the food tenants left behind. Anyone following a strategy where there is little or no cash flow and no ability to handle problems or a market correction is gambling with their finances, future and even family. Again, a buy and hold strategy must be very carefully planned out.

5. Make your profit going in. No other strategy makes sense. You don’t need to "buy and hold on for dear life.” The greatest thing about real estate is that you can profit from an “inefficient” market. The fact that there can be profit from the moment you own the property is wonderful and quite unique to real estate.

When a stock broker shows you how to buy IBM stock at less than the price your neighbor is paying right now, this very moment, then pay attention to what he has to say. Until then, learn all you can about real estate. There are many, many strategies and techniques to make money when you buy the property.

When you are good at it, you can buy and resell quickly and make a large profit. When that happens, you have little concern for what happens to the market ten years, one year, or even one month from now.

It’s about education. When a stock market analyst tells you that real estate is going to crash, he is only demonstrating his ignorance. When a real estate investor is worried about a crash or even a correction, that is also about lack of education.

6. Learn to forecast a market. That doesn’t have to be all that hard or ultra-technical. You can watch your local market for factors such as “housing starts” and new and existing home sales. Read the archives here or some of the posts or information from a frequent poster here, Robert Campbell, will help your understanding of how to read the trends.

Basically there are even some simpler predictors available from the Board of Realtors. I like the “average days on market” factor that is available in the sold information. That is the time between the listing of a property and the sale date. When that time begins to go up, a market is turning. If you want to apply a little calculus, you can even catch it sooner, but I won’t get into that here.

There is also a statistic available that shows the difference between sale price and listed price. When that begins to grow or shrink, a market is changing short or long term.

Typically a property lists for one price and sells for a lower one. Example. List price $100,000 and sale price $95,000. When the gap starts closing the market is heating up. If it starts growing, the market is softening.

This isn’t meant to be a course of market forecasting or market feasability studies. Take the CCIM (Certified Commercial Investment Member) courses for that. This is more of a small illustration that it is possible to forecast a market somewhat--as long as it is not too dependent on large factors like a large company closing or an earthquake, etc.

But, back to the original message. Real Estate Will NEVER Crash--no matter how many headlines or talking heads say so.


-jhd-

 

 
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