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Some real estate investors make the mistake of not continuing to research the economics of their real estate markets after they've made their investments. Even if you plan to buy and hold, you need to pay attention to the market conditions. The criteria to consider in making decisions about which markets are the best for investing are dynamic and fluctuate.
Savvy real estate investors monitor their markets and look for the telltale signs of real estate cycles. These cycles present opportunities for expansion of your real estate portfolio or repositioning from weaker markets to stronger markets because not all areas experience peaks and troughs at the same time. That is why you need to know and track the timing of seller's and buyer's markets.
Real estate cycles
Real estate is cyclical and that successful real estate investors always remain aware of the real estate cycles in their areas. First, here are some defining differences between a seller's and buyer's market:
- A buyer's market occurs when the current owners of property are unable to sell their properties quickly and they must be more flexible on the price and terms. This is a great opportunity to seek seller financing.
- A seller's market is almost like the classic definition of inflation — "too much money chasing too few goods." In this case, the "goods" are real estate properties, which are in high demand with buyers lining up for the chance to purchase them. When sellers are receiving multiple offers within 24 to 48 hours of a listing or you see properties selling for more than the asking price, then you're in a strong seller's market.
Real estate traditionally experiences cycles as the demand for real estate leads to a shortage of supply and higher rents and appreciation. That leads to the building of additional properties, which, along with changes in demand due to economic cycles, usually results in overbuilding and a decline in rents and property valuation.
However, not everyone agrees that real estate cycles are relevant to residential real estate investors. Some of the real estate infomercial gurus claim that real estate investing in homes and apartments is recession-proof because people always need a place to live. Although that is partly true, we think that the economic base of the community where you invest does have a direct impact on all aspects of your operations — occupancy, turnover, rental rates, and even quality of tenant.
For example, when times are tough, residential tenants are the first to improvise with some finding that "doubling up" or even taking in roommates is palatable if it results in lower costs for housing. Some renters are even willing to move back in with Mom and Dad or another relative when their personal budgets don't allow them to have their own rental unit.
Can real estate investors who track these real estate cycles make investment decisions based on this information? Absolutely. That is where most successful and knowledgeable real estate investors see potential for increasing their real estate investment returns by timing the real estate market.
Timing the real estate market
Although the length and depth of the real estate cycles vary, there are clear highs and lows that real estate investors need to consider.
In some real estate markets, the double-digit appreciation over the last 5 to 10 years has brought record prices for homes and income properties. Deciding whether to buy high-priced income properties calls for a hard look at the investment horizon or planned holding period for a particular investor and that specific investment. If the holding period is long enough, even purchasing income properties in today's overpriced markets will probably look good 15 to 20 year from now.
The alternatives are to identify those markets with excellent economic fundamentals where prices have remained low and invest there. The concept is similar to the "Buy low, sell high" truism for stocks except you sell in overpriced markets and reinvest in the lower priced markets. Such markets do exist but the question is whether the properties in the lower priced markets are going to provide the same or better investment returns in the long run versus alternative markets.
 | Unlike the stock market, real estate transactions entail significant transaction costs (as a percentage of the market value of the property). That's why selling and buying property too frequently undermines your returns. |
Even in the few markets where such "bargains" exist, they aren't really great opportunities. In the long run, you usually get what you pay for!
Risk and return are generally related. That is, the lower the risk you take, the lower your expected return. (That is why short-term government-backed bonds and federally insured money market accounts offer nominal rates of interest or return on investment, and investments with higher risk, such as real estate, demand higher rates of return.)
So, what are the risk-adjusted returns like for investing in these areas of the country with record high prices versus the risk-adjusted returns available in other lower priced real estate markets? At the end of the day, you may find that your lower priced market with all of those "bargains" provided you with minimal cash flow and marginal appreciation.
Knowing when to sell and when to buy real estate is easier said than done. But if you follow the fundamentals of economic analysis, and remember that "location, location, value" is the key to successful real estate investing, you can do well.
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