A homeowner may consider selling a home at the top of an upward-trending sellers’ market and becoming a renter during the entire downward-trending buyers’ market. The homeowner could then buy at the bottom of the next upward-trending sellers’ market and leverage the purchase (with a loan) to increase the return through price appreciation—while riding the real estate market back up again. Many homeowners have a difficult time becoming a tenant after having been a homeowner for a long period of time.
If the real estate market is a downward-trending buyers’ market and possibly heading into the abyss, homeowners may be able to protect themselves by buying the smallest size home located in the highest socio-economic neighborhood within their price range. The smallest home will generally have the least relative price depreciation (loss of value) as opposed to larger homes located in the same geographic area. During a downward-trending buyers’ market, homes located in higher socio-economic neighborhoods tend to have slower price depreciation rates than those located in lower socio-economic neighborhoods.
A homeowner is usually elated when their home increases in value, and quite depressed when it loses value. The equity in the property, which includes the down payment and any price appreciation, is not earning interest while it sits in a person’s home. This is called opportunity cost because the homeowner is losing the opportunity to receive income on that money. Although, homeowners will experience the emotional security of owning their own home, they may continue to be vulnerable to market and property risks.
Real Estate Investors
Real estate investors generally have different alternatives than owner-occupied homeowners. They can buy and sell, not based upon their own home and where they live, but strictly by market timing. When the real estate market nears the top of an upward-trending sellers’ market, many investors perform a 1031 tax-deferred exchange and move their equity into another real estate market that has not yet peaked.
One of the decisions real estate investors must make is where to move their money? If all the real estate markets are at or near their peak, where do they place their money to experience the least amount of loss in value? The answer may be to cash out completely, pay the capital gains taxes, put the money in the bank, and wait for the bottom of the next downward-trending buyers’ market.
If it is advantageous, some real estate investors play the stock market during the period between real estate market cycles. Otherwise, they may keep their money in liquid bank deposits waiting for the proper time to invest back into the real estate market. They may also look at buying businesses that derive good cash flows. It really depends upon the investor’s experience, tolerance for risk, and comfort levels.
One word of caution to your real estate clients: Advise them not to tell anyone what they are doing. As soon as their relatives hear that the real estate investor has cashed out and is sitting on a pile of money, every distant cousin will show up with some very creative hard luck stories. A good thing to remember is that money chases good deals and bad deals chase the money. The relatives may have any multitude of investment schemes trying to separate your clients from their hard-earned money. Silence and patience are two virtues of the successful real estate investor.