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“Defensive” Investing… Know Your Market Before You Proceed
By Attorney William Bronchick
The most common myth in real estate in that you can only make profits when the real estate market is rising. While it is true that more people make money in rising markets than falling markets, the reason is often luck, not good market timing. Armed with the right knowledge, you can profit in any real estate market, but first, you must know your market so you can plan your investing strategy to fit that market. By the way, the following is a short excerpt from my book “Defensive Real Estate Investing”.
What is “The Market”?
Most people think of the real estate market as something that is measured like the stock market – bearish or bullish. There are facts and figures that the media reports on the housing market on a daily basis, most of which are confusing to the average investor. Let’s discuss each of those numbers and discuss how they affect the market, and, more importantly, your investing strategies.
New Home Sales
Sales of new construction homes is an indicator used by many market economists to measure the strength or weakness of the housing market. This data comes from home builders in terms of scheduled permits for new home builds and orders for new homes from consumers. This data is somewhat relevant because it can show how strong demand is for new homes. However, keep in mind that in some places like inner cities where there is no available land, new homes are not being built in mass quantities. Likewise, in suburban areas where land is plentiful, there is endless room to build, resulting in oversupply.
Home Re-sales
The resale of existing homes is a more accurate indicator of the market, particularly in areas where there is not an abundance of new homes. This data comes from the Realtors® associations, such as the National Association of Realtors (www.realtor.com).
Rental Vacancy Rates
Rental vacancies are very relevant to the values for multifamily housing but can be a good sign of what is happening in the single-family home buying arena. When interest rates are low, home buying goes up on the low-end of the scale, simply because it is cheaper to make mortgage payments than rent payments.
Compare Apples to Apples.
When analyzing home building and sales data it is important to compare single-family homes with single-family homes. Condominiums and multifamily homes have different buyers, so it is possible to have strong demand for one and not the other.
Mortgage Applications
Applications for new mortgage loans shows data that is ancillary to the sale of new and existing homes. Of course, some of this is refinancing, which is driven by the rising efficiency and falling cost of loan processing, and in large part driven bylow interestt rates. Another part of the equation is the number of defaults on loans and the resulting number of foreclosures. Some of the defaults are because of sloppy lending practices, but if the market is rising, a person can always refinance one more time. Once prices stop rising and highly-leverage borrowers cannot sell or refinance, the market may be softening up.
Go Local
It is worth noting that most often these stats are based on nationwide facts and figures. The nationwide statistics are not as important to the investor who buys in local markets, which in most cases is his own backyard or some particular “emerging” market. The stock market uses indexes to determine the market as a whole, but is this really important if you only own two stocks? Likewise, does it really matter how many homes sold nationwide when you are buying homes in Cleveland? In short, you need to focus primarily on local trends rather than national, with two exceptions:
1. Interest rates. Interest rates on mortgage loans are controlled by nationwide and even worldwide factors, such as the Federal Reserve rate, worldwide markets and competing investments such as stocks and bonds. When interest rates fall, housing becomes cheaper nationwide because the monthly payments are lower. However, the flip side of the equation is that when rates rise, particularly for borrowers who are getting adjustable-rate loans, the default rate will increase, causing an increase in foreclosures.
2. Income Taxes. Federal income tax rates, particularly on investment properties can have sweeping changes on the real estate market nationwide. A prime example was the Tax Reform Act of 1987 that changed depreciation rules on investment properties and was a major catalyst for the downfall of real estate in many parts of the Country. Recently, however, there have been some changes that favor the investor, especially with a C-Corp.
The bottom line is to educate yourself in all facets of the national and local markets before you act. As Abraham Lincoln once said, “Give me six hours to chop down a tree and I will spend the first four sharpening the ax.”
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