Five Variables that Affect the Value of Real Estate
Along with the previous post's four reasons to invest in real estate, real estate investors usually consider five variables that will affect their real estate investment:
A. Price B. Terms C. Condition D. Location E. Market Timing
Price, terms, and condition of a parcel of real property can usually be changed; however, location will almost always remain unchanged. In fact, many real estate
A-C. Price, Terms, and Condition Price, terms, and condition of a property can usually be changed. This is where a real estate investor can use his experience and expertise to increase the value of a real estate investment. "Value-added" real estate investment properties allow the real estate investor to negotiate price and terms with the seller to obtain the lowest out-of-pocket costs to acquire the investment. Value added properties allow a real estate investor to change the physical characteristics of an investment property to increase its value and/or derive greater rental income.
D. Location Location, on the other hand, cannot be changed. There is an old saying, "Location, location, and location," meaning that location is the most important variable to consider when acquiring a real estate investment property. This is why many real estate investors consider location to be the most important long-term factor affecting price appreciation of an investment property and are very careful where they purchase real estate investment properties.
E. Real Estate Market Timing Alongside location in importance is real estate market timing. When a real estate investor enters a real estate market and when she exists is critical to overall investment returns. A real estate investor cannot change market timing, but she can spend a considerable amount of time and resources measuring it 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 real estate markets and make prudent investment decisions based on long-term market trends. Today, however, real estate market have been upended by short-term real estate bubbles caused by mortgage-backed and rent-backed securities originating from Wall Street. 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 in approximately 2001 to $4 trillion in 2014.
The real estate rules tend to work fairly well 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.
Rental houses located in a lower socio-economic neighborhoods may have the potential for huge cash flows--if purchased near the bottom of a downward-trending buyers’ market. If appreciation in value seems to be many years down the road, cash flow may be the main reason to invest in real estate—along with wealth preservation strategies. Some investors may decide to keep their money in the bank, especially if inflationary pressures are low and they are not obtaining enough cash flow and/or price appreciation in light of the perceived risk of the investment.