Saturday, February 20, 2016
Investing in a “Stale” Market: How to come out on top. Planning for cycles.
This is an important topic to cover because real estate is a cyclical business it moves in cycles and the better you understand the cycles and how they relate the economy the better you can survive different market swings. Once you learn how to look for certain market indicators you can start to predict when a market may slow down to get stale. Why is this important? Well, let’s look at a very short term market cycle a seasonal one. If you are purchasing a home to renovate and resell in the summer to late fall when buyer activity is at its highest and you spent a month or two renovating the property and put in on the market in the winter months when buyer activity slows down, prices may become stagnant, or drop and this investment no longer has the same initial net spread as it did when you purchased. Let me give you a visual example. Now keep in mind every market is different however what stays consistent is markets move in cycles both on a micro and macro scale no matter what state you live in. The example I am providing is based on a typically “Seasonal” market cycle in Michigan.
· Let’s say you buy a home October 15th for $92k that would resell for $150k and you are putting $25k into the home. You are just coming off of a hot summer market and now it’s the fall, prices are still high, comps go back six months back to April. Now let’s say its takes you 60 days to renovate this home (yes that slow but let’s plan worst case). That puts you in a position to get this home on the market December 15th. Now the market starts to slow down because of the holidays, most people are focused on taking time off and gift giving, spending time with the family etc. Let say it takes you 30-45 days to get the home under contract sometime around Jan 15-30th. However now the market has slowed down dramatically and become “Stale” and prices have become flat, time on market has increased and or prices have dropped. Let’s say you re-check your comps and now that same house you planned to sell for $150k is now selling for $138k. If everything else goes right this is a reduction in your net profit right out of the gate of $12,000! So if you planned to make $20k on this home you are now at just 8k! And again that is a perfect scenario. All goes well with the closing, no concessions are given, no city occupancy issues and there is a quick closing.
The scenario I presented above gives you a good example of how some investors get into trouble by not timing the markets. I have been there myself and learned the hard way. This is also just a seasonal example, we also should look at this on a large economic model and one should be watching the big picture as real estate prices continue to rise and trying to predict when the next downfall will be. It’s only natural prices rise and fall.
How to prevent being burned?
So how you prevent being burned and possibly losing in a stale market? You first start by knowing your market cycles and what is happening with the economy. If you are moving into a seasonal cycle you need to forecast ahead and plan to sell in a much slower market where prices may drop. To protect yourself you purchase the property at an, even more, conservative number.
· Let’s use the same example listed above. If I knew that this property was going to sell in a slow market in January, February and I were buying in October. If the current prices said I should buy at $92k I would want to purchase this home at a price of around $80-85k. So if the market shifts I am safe and still make a steady profit.
The examples I am giving you are very basic but they illustrate the idea. Yes, you may ultimately do fewer deals during this time because it will be harder to get much more conservative prices, however, fewer deals that are more profitable is better than many deals that break even or you loose on.
This is also illustrated on a large scale if you follow the trends of real estate the market seems to rise and crash every 10-12 years. You will want to keep an eye on inventory, days on market and price in relation to peak market value.
3 signs your market is changing
· Days on market, longer or shorter?
· Number of new listings. As inventory increases, price flattens out
· Are the prices flattening?
To be a smart investor and survive different cycles always be forecasting out and conscious of the market you are buying in. I am a firm believer you can make money in any market, people always need to sell at discounted prices in relation to the current market, but don’t get trapped.
As always feel free to leave any questions, comments in the section below and if there are any topics you want covered we would love you hear from you.
Happy and profitable investing.