Monday, 27 Sep, 2021

There is No Bubble in the Real Estate Market

There is nothing wrong with the real estate market! In fact, it's doing better than ever. Not only are housing prices up, but mortgage rates have also

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There is nothing wrong with the real estate market! In fact, it's doing better than ever. Not only are housing prices up, but mortgage rates have also declined to their lowest levels in decades. It's not a bubble that will if burst any time soon!

 

The recent decline of interest rates has not only benefited homeowners looking for mortgages, but also those who are renting property. With more people able to afford houses and apartments because they can get loans at lower rates; demand for living space is up which has caused rental prices to increase as well. The drop in interest rates have created a prosperity that benefits everyone from home buyers to renters alike!


That’s right – there is no bubble in the real estate market. In fact, there is no real estate market.

Many recent articles and stories on whether there is a bubble in the real estate market show a lack of understanding of real estate, real estate investing and real estate markets.

 

There is no one real estate market. Unlike the stock market, real estate is by definition geographically based and the markets are local. Also, there are various types of real estate that are differently affected by changes in the economy including interest rates. To make any blanket statement about the impact on the real estate market of interest rates or any other single economic factor is absurd. Finally, how any factor affects real estate investment decisions versus primary residence purchase decisions is very different.

 

The decision, for example, on whether to buy a primary residence in New Burn, North Carolina versus a pre-construction investment condominium in Miami or a multi-family residential building in Oklahoma City or a commercial office building in Manhattan or a strip mall in York, Pennsylvania is, always has been and always will be, affected by different market factors and right now by very different stages in the market cycle for those particular types of properties in those particular geographic locations.



 

Let us distinguish between purchasing a primary residence and an investment property. There are so many factors unrelated to value that should be more important to the decision to purchase a primary residence – such as do you and your family love the house, does it work for your lifestyle, is it conveniently located and are the schools good.

 

Of course, value should also be a factor but high current values could be due to the market being overheated or due to fundamental factors supporting the increase in value. For example, in the mid ’90s there were some experts who were warning that the Las Vegas market was overheated, yet values continued to increase for another 10 years due to continued growth of the city and its surrounding areas.

 

Also, if you are selling a house in the same market in which you are buying, the market value is less relevant as you either sell high and buy high or sell low and buy low. If you will be in the house for a long period of time, current market conditions are less important as well as it is hard to predict what conditions will be like in 10+ years.

In terms of investment properties, on the other hand, the economics are all that should matter. No matter what is happening in the overall economy, there are always submarkets in which there are opportunities and those that are less favourable.

 

Determining which is which takes extensive research and fundamental analysis – not uninformed or emotional investing. For example, it does concern me that over the last year I have seen people who have no real estate investment experience investing in, for example, pre-construction condominiums in Miami. If there is any submarket that might be in a “bubble,” it’s that one. In fact, people who have made a lot of money investing in that submarket over the last 5 years stopped investing in it more than a year ago. That tells me something. Those investors, however, have not stopped investing in real estate – they have just shifted their investments to other types of real estate or other submarkets.

 

The real estate investment fund that I manage is currently focusing its investments on multi-family residential rental properties. Why? We believe that interest rates will likely continue to rise. This, combined with the increasing percentage of people who have loans with high loan to value ratios and adjustable rate, interest only and negative amortization loans, will increase the cost of owning and over the next few years shift the rent/buy decision in favour of renting.

This will increase the demand for rental units and, correspondingly, the rents. Increased rents mean increased cash-flow and building values. Will we be right? There is no guarantee. However, even if we are wrong, like my clients who have been successful real estate investors over years and through several economic cycles, it is unlikely we will get hurt because the properties we are purchasing are cash-flow positive (the income exceeds the expenses each month) even at current rents. We do not invest betting on appreciation. This allows us to wait out a market cycle and not be forced to sell due to inability to carry a cash-flow negative property.

 

Successfully investing in real estate over time is not easy. It takes work and discipline. We often have to review over 100 properties to find just a couple that meet our criteria. I heard someone say recently that they ran into financial trouble in the stock market some years ago when they confused a bull market for brilliance on their part. In the shell game of betting on appreciation over the last 5+ years in many markets, some have made a lot of money and many will get caught and realize that it was just a bull market and not their brilliance that made them paper profits that were quickly lost.

 

Many experts and the press will blame this on the real estate bubble bursting. In reality, however, it is just the market catching up to inexperienced or greedy real estate investors who did not apply the fundamentals while the experienced real estate investors moved on to investments in other segments of real estate or sat waiting to pick up the pieces of those appreciation gamblers on the cheap.