Real estate markets are generally cyclical—they go up and they go down over time. If you are near the bottom of a downward-trending buyers’ market, when real estate prices are heading into the abyss, you may be able to get a much better deal than during an upward-trending sellers’ market, when real estate prices are shooting to the moon.
When a real estate investor enters and exits a real estate market, it is critical to overall investment returns. A real estate investor cannot change market timing, however it is possible to spend a considerable amount of time and resources measuring it to determine the best time to maximize profits over the long-term or within each real estate bubble.
Many years ago, real estate markets were somewhat slow and steady giving real estate investors plenty of time to gauge their directions and make prudent investment decisions based on long-term market trends. Today, real estate market have been upended by short-term real estate bubbles caused by mortgage-backed and rent-backed securities originating from Wall Street, as well as capital flight out of the stock markets and into tangible assets. For this reason, it is critical for a real estate investor to move quickly, read each artificially-fabricated short-term bubble, and invest accordingly.
Buying a poorly-maintained distressed house in a lower socio-economic neighborhood directly violates the rule of location. However, that is exactly what a large number of real estate investors have done in response to the Federal Reserve Bank's (FED) quantitative easing programs. Real estate investors feared inflationary pressures caused by the increase in the FED's balance sheet from $800 billion a few short years ago to $4 trillion today.
Real estate rules tend to be effective during long, slow upward-trending sellers’ markets where economic growth is the backbone of real estate price appreciation. However, when central banks (i.e., FED) introduce new and untested stimulus techniques into the market trying to jump start a sluggish economy, the rules tend to go out the window.
If appreciation in value seems to be many years down the road, cash flow may be the main objective for investors to invest in real estate—along with wealth preservation strategies. Rental houses located in lower socio-economic neighborhoods may have the potential for huge cash flows—if purchased near the bottom of a downward-trending buyers’ market. Although, some investors may decide to keep their money in the bank, especially if inflationary pressures are low and they believe they can obtain higher returns in the stock markets or other investment entities.
As the real estate market moves from a downward-trending buyers' market to an upward-trending sellers' market, real estate investors tend to move their real estate assets from cash flow generating properties into more expensive single-family homes that are leveraged and will have a better chance of significant price appreciation. In other words, real estate investors may find themselves moving their equity into other property locations that are more suitable to capturing anticipated price appreciation in the real estate markets.
Overall, during a downward-trending buyers’ market when the economy may be heading into a deep recession, less expensive single-family homes may be less risky than more expensive single-family homes. As the market turns upward, more expensive single-family homes usually have a greater percentage return, and less perceived risk, than homes located in lower socio-economic neighborhoods.
California and U.S. Economies
As the California and U.S. economies fall into a recession, many people will begin to look at food and shelter as their primary concerns. Single-family homes located in lower socio-economic areas tend to rent well during these types of downward-trending real estate buyers' markets. There are usually more people who can afford to pay $1,000 per month in rent, than those who can pay $2,500. Of course, the location of the property in California can have a huge impact on prevailing market rents. For example, a home located in California's central valley may rent for $1,000 per month, while the same house located in the San Francisco Bay Area will rent for three or four times that amount. Location, location, and location.
There are usually considerably more lower socio-economic tenants available to rent homes in the lower rental price range. Many tenants who have lived in higher socio-economic neighborhoods in the past may find themselves moving into lower socio-economic neighborhoods because of economic factors. In fact, during a tough economy there may be a general lowering of the standard of living for many people around the country.
As the California and U.S. economies continue to decline, home values may decrease to a point where home loans are greater than home values. This is what is known as being “underwater.” People start losing their jobs and may eventually lose their homes to a short sale or foreclosure. Former homeowners will be forced to become renters. This drives up the demand for rental housing, which usually bodes well for landlords, because rents usually increase and decrease as a function of supply and demand of suitable housing in a local geographical real estate market. Greater demand along with the same supply, usually equals increased rents-as long as tenants continue to have the purchasing power to pay the higher rents.
If you did not sell your property at the top-of-the-market, you have probably ridden the downward-trending buyers’ market downward over the last several years. You have been collecting rents and waiting for the market to come back around. Historically, time has healed downturns in the real estate market. If you can wait out the market, you will usually have a good chance of recouping your equity over time.
If you are facing an upward-trending sellers’ market, prices will generally rise because of intense competition for homes, especially if they are located in the higher socio-economic neighborhoods. There may be a “frenzy” of owner-occupied buyers making emotional, and often bad, purchase decisions because of pressure coming from other owner-occupied buyers—who are making emotional and often bad purchasing decisions. New listing information is critical during this type of market. As a real estate investor, you want to be a seller and not a buyer during this type of market.
During an upward-trending sellers’ market, the best single-family homes are usually sold long before they reach the multiple listing service (MLS) and good deals are few and far between. It’s tough to get a good deal when there are multiple offers on each property—driving prices upward and creating a sense of urgency that is not in an investor’s favor.
As a real estate investor, you need to have made your purchases near the bottom of the downwa