by Filip Vercauteren
Well, the
Real Estate bubble is finally bursting… and how... Everywhere in the Western
world prices are falling, moreover, the price declines are becoming bigger month
after month with no end in sight as inventories keep rising. So, does this make
investing in Real Estate a bad thing to do? Not at all, but the rules of the
game have changed. In the following article I will give my take on investing in
real estate and how you can make profitable investments in real estate in
today’s market.
So while there are many
theories circulating explaining the real estate bubble, I prefer to keep it
simple. Real Estate prices depend only on interest rates and the availability of
credit. Put in another way, give people money and they will spend it; how much
they can spend, depends on the bank. Forget all other items like baby boomers
retiring, scarcity of land and inflation of building costs. It is all about
interest rates and credit.
Given that we are in a
period of recession, Real Estate prices will keep on going down… everywhere and
in all categories. Important to note is the fact that while the USA has begun to
tackle the issue (acceptance is step 1), a gigantic crisis still awaits us in
Spain, Ireland and the UK. But no single country in the Western world will
escape this havoc. Many middle class people will loose their homes in the two
years ahead.
But this situation
revolves around timing; without a doubt these problems will get solved and
prices will in the future start rising again. It is in the period that lies in
between that fortunes can be made. So how can this be done? Let’s formulate the
new rules:
-
All Real Estate is
local:
forget investing abroad in Spain, Brazil, Florida or Boston. Invest in your
area as investing abroad is very unlikely to give you a higher return for the
following reasons:
-
Laws are
different: the investor needs to study this or invest in a trustworthy lawyer.
Some countries have very high capital gains taxes and others make it very hard
for you to get your money back. Also a very good understanding is needed of the
annual recurring costs.
-
Distance:
The travelling costs need to be taken into consideration, including money spent
on hotels, food, hiring a car etc.
-
Real estate
agent: When you buy a property abroad you depend almost entirely on a single
agent as it is he who needs to take care of the property (extra cost), try to
rent it out (extra commission) and he is not so easy to replace since you have
no clue who to trust in another country.
-
Knowledge:
when you are not present in a certain market, it is extremely difficult to judge
the evolution of prices, whether you are renting out at the right price to the
right people, whether you have the right lawyer, agent, maintenance people etc.
Conclusion: do
not invest in any property that lies further than 1 hour from where you are
living.
-
First make sure you can
make a large down payment: the biggest mistake that is made is using
too much leverage to buy a property. If this means you cannot buy it, so be
it, just make sure that you never end up in a situation where the mortgage
debt becomes higher than the market value of the property.
Actually, a 50% equity
level is to be preferred. In this way, less interest costs need to be paid and
rent is creating more free cash flow which can be used towards the next
investment if that occasion arises. Many people ran into problems when the
property was not rented out for a few months because they needed every penny
(and more) of that rental money to pay the mortgage. Rent should always be
enough to pay for the mortgage. Herein lies a positive evolution: rents have not
been rising in line with property values, hence they will also not fall, so this
ratio is set to improve dramatically. Furthermore, inflationary politics will
lead to higher wages in the coming years, so there’s a potential for nice
increases here.
-
Timing:
Be fearful when others are greedy and be greedy when others are fearful
(Warren Buffet). This small bit of wisdom is very applicable to real estate.
As people become more fearful about real estate as the stories increase of
people who loose their money and house in this downturn, start preparing to
buy. The best moment to buy is when interest rates are peaking, which is of
course no exact science, but with all the problems we are facing they are
likely to peak somewhere next year as I do believe that the ECB will raise
interest rates to fend of inflation, but will be forced to reverse that move
as the economy will suffer extremely. So start getting your down payment ready
to buy in a year’s time, autumn 2009. I personally witnessed people buy faster
in spring and summer, hence it’s best to buy in autumn and winter.
-
Rental potential:
When buying a property, consider the rental potential; properties at the beach
are worth less due to their irregular rental income, stand alone houses are
not ideal for their maintenance requirements and always make sure you are
close to public transport as oil price increases will make the entry level for
owning a car more difficult to attain. Make sure that there is a lot of rental
potential in the area (students e.g.) as you want to maximize the months it is
rented out.
So after all this, the
conclusion:
Buy a small apartment in
a relatively new building in an area close to universities and with good links
to public transport. Preferably buy from an investor who is throwing in the
towel. Make sure the property is not far from your home and use a big down
payment so that rental income easily offsets the mortgage repayment.
Keep it simple people
and returns will be great!
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