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!