But Why You Should Anyway!
We were advised by a real estate broker when we started buying rental property, that the market was about to tank and that we shouldn’t invest at that time. That was ten years ago. We all know what has happened instead. Since then we’ve been told by others countless times that it’s not a good time to invest.
Residential real estate fluctuates along a continuum generally assessed as either a buyer’s market or a seller’s market. Equilibrium between these two is usually considered 6 months of inventory. Months of inventory means how long the current available listings would take to be snatched up if no more inventory came on the market. By these terms we’ve been in a seller’s market for as long as I can remember. This means demand is greater than supply and that sellers hold more negotiating power than buyers. We’ve been able to buy throughout the sellers market successfully by buying distressed property that is harder to sell and solving problems for our sellers. The upside to buying in this market has been that values continued to rise with the market so the equity in those properties rose too.
But price isn’t the only thing that cycles. Interest rates vary over time. When we started buying real estate we had already decided to use leverage in what we felt was a responsible amount. Rates were in the five percent range for investor loans when we started. 20 years ago I bought my first home with a rate of 5.25% and that was considered a great rate for an FHA owner occupied home loan at the time. Investor loan rates are usually about one percent higher than owner occupied loans so at that time a rental loan may have been 6.25% although they may have been even better back then, before the subprime meltdown of 2008.
When we started, I thought that rates were very good and that we should try to get as many loans as possible that would be financing good properties. I was only partly right. Rates would stay low and get even lower over the following ten years. We now hold many investor loans in the 4 percent range due to the recent, artificially low interest rates. So 6.5% seems very high to most of us due to recency bias. We have short memories. Many older (ahem, more experienced investors) recount times where rates had “teen” at the end of them! Now that is high interest. **Real estate owned outright is great but the use of leverage is what magnifies the rate of return and adds some level of risk. Although with the rate of inflation, it could be argued that owning outright adds more risk but that’s for another post.
Many people who have expressed interest in getting into real estate over these last several years have told me that prices were just too high. And the prices WERE high compared to what we were accustomed to. Car prices were too. We just want the prices we’re used to! We want 1980’s house prices…but not their interest rates!! What was overlooked by many was that interest rates were dirt cheap for the last few years. We now have interest rates rising and prices are still high. For long-term rental investors this means it’s harder to make cashflow a thing. So what do we do? Sit around and bemoan that we didn’t time the market right? NOPE!
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Those that look for reasons not to act will soon be saying that prices are falling so they don’t want to invest. Or that interest rates are too high. Quote me on this. They may try to time the bottom of the market but no one knows when they are in the bottom until after the fact. Think about the stock market. It was down 400 plus points one day last week and up 300 plus later in the week. So where are we? Top? Bottom? Middle? I’ll tell you in a year from today!
There is never a perfect time to invest. While rates are rising, so are rents. But so are taxes! Yikes. Why can’t we just buy when prices are low, rents are high, interest rates are low and taxes are low? Because that isn’t how the market works. If you are waiting for that (be honest with yourself) you’re never going to act.
We don’t flip houses very often but consider what flippers have had to deal with in a seller’s market. High prices and multiple offer situations make finding good deals tough for them but often rapid appreciation has increased their profits when they sell those deals. So is that a good market for them? How about the opposite when it’s easy to buy (buyers market) but you have to sell in a buyer’s market too? In other words, there is never a perfect time to be in that business either. We know many people who have been successful in that segment of the real estate business over the last several years. They’ll probably be successful in the market we see developing now too because they are wiling to learn and pivot.
So what is a buy and hold investor to do? We have to get in when and how we can. We still have to create value with each transaction, which isn’t too tough. It’s the cash flow that has gotten tougher. But there is good news: time makes us all look smarter. If you buy something today that cash flows at a 6.5% interest rate and rates drop in a year or two, you can refinance and the property will be even better. If rates rise then you secured a locked rate that you might look back on as a great rate in the future. If the market drops by 20 percent, you probably had that much equity anyway and as long as it cash flows, you should be good to ride out the storm. You also have the advantage of being really aware of the market cycle (because you are invested) which helps you see opportunity. What if you could buy the house next door at that time for a 20 percent discount and it needed work, so you got it at a 40 percent discount to your first house? Are you mad that you bought high? I would’t be. I’m just going to buy some more balloons (houses) with a little air in them and let inflation and appreciation inflate them!
My biggest fear is honestly a drop in rents. And while this is possible, it is unlikely. As interest rates increase and ownership becomes less and less affordable, more people will stay in the renter pool. While this isn’t what is best for many of them, it does increase demand for rentals. This means that while prices could drop, rents could actually increase. Your net worth could literally drop while your income increases. I would be okay with that. After talking to many investors with more experience than myself, very few recount times where rents dropped. Those who did experience rents decreasing reported it lasting for a short time and not by a large amount. These were all from my local market of San Antonio, Texas, which has solid fundamentals but we have readers from other markets so this could be different in your market. I know there were markets that were overbuilt prior to the mortgage meltdown of 2008 and there were empty houses in some areas. Past performance is no guarantee of future performance but look at the fundamentals of the market you are investing in. None will be without risk. Risk is why we get a better return than mutual funds. It’s also ultimately why we get great tax benefits.
I say we should all stay active and look for opportunity. It is discouraging to not find deals that will cash flow easily. But they still exist. The power is beginning to shift ever so slightly back toward the buyers in our continuum of sellers market versus buyers market. We should remember that we are problem solvers and listen for ways that we can solve sellers problems. I like to buy for the long-haul with the belief that there will be ups and downs and that we will be able to weather the storms that come. What we don’t do is try to time the market (in real estate or mutual funds) as the statistics are strongly against us being successful at it. We will continue to create equity with each deal and buy below market value. We will only buy property that cash flows from day one. During periods of softening values we aren’t hurt unless 1) rents drop or 2) we get ourselves in a position where we have to sell at a loss – or get emotional and panic sell. Otherwise, we’ll keep collecting cash flow, writing off depreciation, paying down debt with rental income, waiting and, most importantly, BUYING deals while they are on sale.
To be clear, I could be wrong about all of this but I’ll say that we would never have done anything if we had listened to the naysayers and fear mongers or if we had waited until the “right” time to get started. It is tougher today than it was ten years ago in some respects but it wasn’t easy then either. It was scary back then as we were in the aftermath of the mortgage meltdown and housing crash. It gets less scary the more you do it. It’s not for everyone and if it keeps you from sleeping at night, then I would stick with mutual funds or bonds. There is a lot to be said for those methods of investing. We both have found the most reward on the other side of “scare the S*&+ out of us” fear in most aspects of life. If there was a less scary way to get in, I’d share it. If there was a better asset class, I’d buy it. I just don’t know another vehicle that will get average W2 earners a shot at freedom the way that real estate has for us. We are passionate about it because it has helped us live the life we want. We write, talk and teach about it because we want others to achieve their dreams – whatever those are.
I welcome comments of agreement or disagreement because if we are afraid to talk about money we are likely never going to break the unhealthy habits of our culture in regards to it or to remove the taboo that exists around talking about it. My hope is that we can understand money so that we can get beyond it and focus on the things that are really important in life. So with that I hope that you continue to Keep the Main Thing the Main Thing!