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You’re going to learn how to analyze if real estate is a good investment right now.
One of the investing secrets of billionaires is that they don’t look in the rear view mirror, they look forward to the future to make investment decisions. Let me explain.
The investment industry can only legally evaluate an investment by looking at past performance. When they are proposing you buy an investment, like a mutual fund, they show you all kinds of calculations from the past and say it’s no guarantee of future performance. That’s true AND it’s not even likely to be future performance because investments move in cycles like pendulums. And the past is the past. It is where we have been and not where we are going.
Imagine investing in tech stocks in early 2000, right at the peak of the bubble. The past track record would look great, but now that we have moved ahead 15 years, you know exactly how the story turned out. After the peak in March 2000, the stock market declined for 3 years before it bottomed in 2002. Nasdaq didn’t reach 5000 again until March 2, 2015, 15 years later, and many stocks that were high fliers then are either out of business or haven’t made new highs. Think Yahoo & Microsoft. It’s been 15 YEARS.
Would looking at the rear view mirror been the correct way to make your investment decisions? No!
Could you have foreseen what might be ahead? Actually yes, if you understand that economic cycles peak in bubbles.
You could have seen that interest rates were rising and price/earning multiples were at the moon. People were paying $100 for $1 of earnings in the future! But more importantly, the anecdotal evidence was obvious.
People were quitting their jobs to become day traders.
Magazine covers asked, Are YOU Rich yet? They explained how the “New Economy” was here to stay and would never return to normal metrics. Whenever you see a “this will go on forever” kind of message, it usually won’t and it’s over soon.
People who were not investors were fixated on investing – my UPS delivery person told me he was excited to buy Cisco’s stock, my town car driver gave me bio-tech tips, and a 27 year-old millionaire refused to diversify his IPO stock because he was SURE it would continue to increase in price and value. Two years later it was worth $200,000.
Everybody was a buyer and there seemed to not be any sellers. Or fear. Or uncertainty. They were all looking in the rear view mirror too.
What cycles are telling us about real estate, is that it peaked in 2007 for the average market. Many houses are still selling below 2007 prices and some houses are still being held back by the bank. So there’s more inventory than it seems, which is temporarily limiting supply and propping prices up. When that inventory hits the market, like anything that increases in supply, we will likely see prices decline.
On BRAVO TV’s Million Dollar Listing NY, we are seeing high end homes sell for record prices – $10 million, $30 million, even $50 and $100 million price tags. What’s happening are foreign buyers are diversifying out of their currency and into real estate in the US. Cities like NY, Miami, L.A., Vancouver, Seattle, and San Francisco have reported a lot of foreign buyers. They want to get out of fiat (paper currency backed by nothing but a promise) and currencies suffering a loss of confidence and even devaluation, like the Russian Ruble.
What does that mean for you? It’s probably not the time to be overweight in real estate. If you’ve been flipping houses, this would be a great time to finish up and put them on the market – and don’t be buying new homes to flip. If you’re leveraged to the hilt, sell some houses and pay down the debt.
Why am I not a fan of real estate going forward?
1. The easy gains have been made. Trees don’t grow to the sky. Nothing keeps going up forever. Cycles change and this one is swinging in a different direction.
2. Interest rates are about to increase. The Fed is talking about raising rates. Higher rates mean the cost of owning a home will rise and fewer people will be able to borrow.
3. Rising interest rates may create another crisis like we saw in 2007-8, only worse this time. Rates have been kept artificially low for 8 years and that is the reason housing prices have been able to rebound. Without artificially low rates, we would not have seen prices rebound and buyers would not have had as much incentive to buy.
The Mortgage Bankers’ Association predicts that rates will rise to 5% by the end of 2015. This will curtail affordability for buyers.
4. Construction has been strong. More new homes on the market means an increasing the supply of homes, which usually means prices will decline.
It’s hard to talk about a national housing market because individual markets vary. Some markets have continued to set record prices while others have not seen the highs they had in 2007.
My point is that the easy money is behind us and it will become harder to see gains in real estate.
5. The anecdotal evidence is compelling. Remember I was just talking about how investors acted at the top of the tech bubble?
Is the real estate market much different from this today? Aren’t we seeing everyone talking about buying real estate, flipping, TV shows about buying and flipping (including my favorite show Million Dollar Listing NY), and seminars about flipping.
Here’s something else – corporations are making big bets that now is the bottom for interest rates.
Microsoft completed the largest U.S. corporate-bond sale this year, selling $10.75 billion in debt with maturities of five to 40 years. The sale surpasses a pair of megabonds like an $8 billion bond sale by drug maker Merck & Co. and a $6.5 billion bond from Apple.
Microsoft issued $2.25 billion of 4% bonds for 40 years. That means they only have to pay 4% interest for the life of the bonds – some for 40 years.
Besides corporations, the government of Mexico has issued $1.5 billion of 100 year bonds at 4.2%. Strategically, this may be a great decision for them to take in the cash and pay investors 4% for decades. If this is the lowest interest rates will be for approx a 30 year cycle, it could be a very savvy move.
Since interest rates move in a 30 year cycle, it’s likely we won’t see rates this low again for a very long time. You typically see massive debt offerings with long maturity dates when interest rates are about to rise.
These are signs to watch for to make your own investment decisions.
One thing to consider now before we see rates rise is to lock in a fixed interest rate mortgage. If you have a variable rate mortgage, now would likely be a good time to lock in a low fixed interest rate for 30 years. That way, no matter what rates do, even if they rise, you will have the same mortgage payment locked in.
You can check out HARP—the Home Affordable Refinance Program—created by the Federal Housing Finance Agency specifically to help homeowners who are current on their mortgage payments, but have little to no equity in their homes. If you owe as much or more than their homes are currently worth, you may be eligible for a HARP refinance.
If you got your mortgage loan at a bank, credit union or mortgage company, it may be owned by Fannie Mae or Freddie Mac. If so, you could qualify for HARP refinancing and you could save thousands with a lower rate or other more favorable terms. No minimum credit score is required and closing costs can be bundled into the new loan so you don’t need much cash up front.
What you learned today are the reasons why real estate may not perform as well going forward as it has in the past.
Your action step is to talk to your mortgage broker about locking in a fixed rate mortgage. See what rates you can get now. If applicable, check out the HARP program and see if you qualify.
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