Sunday, November 27, 2022

Real Estate - Is A Yes, Even If Its Value Can Drop

The real estate market, by its nature, always seems to generate the narrative that over time prices will go higher. Partly because those putting together this message have an agenda and that is to make money. This tends to become a problem when prices slide into reverse. Real estate is no different in this regard from most other markets but being a somewhat illiquid market dependent on many factors, moves in real estate prices can last a while and be devastating to those trapped on the wrong side of the current trend.

Expect a tremendous number of opportunities in real estate during the next economic downturn. This sector of the economy is very sensitive to interest rates. Not only because of the barriers related to buying and selling real estate, but the large number of dollars involved, when losses develop, they can be a ball buster. This is why most investors shy away from owning property. Many of these transactions are highly leveraged and even if not, when maintaining a structure is involved the cost and burdens such as taxes and general upkeep can be staggering

Adding to the problem is the fact empty buildings, housing or commercial, spoil like a basket of fruit. When there is a chance a building may sit empty for years, financing dries up. Since most real estate is financed with a long-term mortgage, an inability to get financing drastically thins the number of buyers in any market. Another issue is that since real estate is generally illiquid, prices tend to be reflected by the last piece of similar property sold in your neighborhood or area. The phrase is, REAL ESTATE IS SOLD AT THE MARGIN. This is especially true in housing.

This is a market known for its excesses, historically, real estate has gone through many boom and bust cycles. Anytime we reach a situation where things are overbuilt, the bottom can fall out of the market and prices tumble. Real estate valuations are linked to borrowing costs and rental demand. With this in mind, when borrowing is easy and money is cheap, higher real estate valuations often soar. The market is currently a bit strange in that even with higher rates and monetary tightening, I'm still getting calls from people wanting me to sell them my properties. One person cursed me, and people like me, for not giving them the opportunity to get into this market, this makes me feel rather lucky.

With all its downside risk, why would anyone in their right mind choose to enter this sector of the economy? The answer is that it's real, it's basic, and when all is said and done people need it. People need a place to live, and businesses need a place to conduct their daily affairs, and this translates into it being valuable. Also, while values may ebb and flow, the overall direction is upward based on replacement cost and high entry barriers.  

When it comes to real estate the most common type the average person is likely to own is a residential unit, The collapse of home prices has a greater impact on the economy than lower stock prices because it affects more people and reaches deeper into the consumer's psyche. This can generate financial insecurity that causes owners of property to reduce spending and send the economy into a recession. It is the wealth effect in reverse. 

It seems, no matter how many times it happens, we still love pumping up real estate valuations only to watch them collapse again. Still, in my opinion, if you have the skills and temperament to handle such an investment, it is where you should stash the bulk of your wealth. To clarify, you should buy only when prices are super low and plan to hang on to the property for a long time. You should also purchase property that will generate revenue and has the potential to eventually rise in price.

As in all investments, real estate presents a challenging learning curve and is not for the faint of heart. When empty it drains away your wealth and  the competition from market insiders is not to be discounted. These insiders, agents, attorneys, bankers, REITs, and big money have several strong advantages over independent owners. The place they fall short is they often have to endure huge inefficiencies within their organizations and tend to get mired in red tape.  

Two great opportunities were squelched by my over cautious-attorney years ago, these guys can be deal killers. When all is said and done, I paid this fella to teach me this valuable lesson. The reason I like real estate and view it as a solid piece of an investment portfolio is that it will still be there after paper promises have been proven worthless and vanished. The reason they call it "real estate" is that it is"real."


 (Republishing of this article welcomed with reference to Bruce Wilds/AdvancingTime Blog)

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