When to Buy Sell and Invest in Real Estate

Real Estate

Introduction

When it comes to buying, selling or investing in real estate there a few common issues that people will want to consider: these can include when to buy/sell, what kind of rate to expect, whether to use an agent to assist in the process, how to obtain a loan, how to negotiate, and how to identify an opportunity for investment. As Maher (2018) points out, real estate is an imperfect market that is hyper-local in terms of how it must be approached. In other words what is happening in the real estate market in one part of the country is not necessarily going to be the same thing happening in another part of the country. There is a great deal of nuance when it comes to buying, selling and investing in real estate that must be understood so as to navigate the complexities of the market. In a seller’s market, for example, real estate tends to move quickly with many buyers competing with one another for the same properties. House flippers also tend to be more active in a seller’s market as the demand for real estate outstrips risks of upfront expenditure. For anyone interested in real estate, this paper will provide some assistance in showing how to address these common challenges by giving solutions that will make the process easier and most effective. It will show that instead of jumping onto a momentum train, one should proceed with caution and do due diligence in understanding the specifics of the market and where it is likely to be heading in the coming years.

Statement of Problem

Many first-time buyers, sellers and investors make the mistake of assuming that anytime is a good time to buy, sell or invest. They see others getting into hot markets and want to take advantage of what seems to be a good opportunity on the surface of things. They may be told that interest rates are low, so now is the time to buy—or they may invest on the fear of missing out. Or they may refrain from selling a property because its current market value is below what they paid for the house initially. In each case, the individual is acting on a limited supply of information and basing a major decision on a narrow set of data. There are actually better ways to proceed when it comes to making a decision on real estate.

The problem stems from the fact that most first-timers tend to rely on simple media-driven narratives about real estate. These can include articles that appear online, news reports on TV, what they hear on the radio, or even what they hear from peers. As Bandura (2018) points out, most individuals’ cognitive processes are informed by peers, groups and media primarily. But this is a very superficial way to go about making buying, selling and investing decisions.

First of all, as Wheaton (1999) points out, most different types of real estate have very unique cyclic properties. The office real estate boom of the 1980s was myopic in nature and caused by a surge in demand that was not sustainable. It did not take into consideration the coming of the tech revolution and the shift to ecommerce and virtual workplaces. Today, empty retail outlets and offices sit across the nation, and cities like New York feel like ghost towns with boarded up windows where a once thriving economic center once existed. The point is that just because momentum is there does not make acting on that momentum a wise decision. Yet if one had been looking to buy commercial real estate in the 1980s or 1990s one might have invested purely upon what peers or mainstream media outlets were saying.

What about the housing boom of the early 2000s? As McLean and Nocera (2010) showed, that boom was caused by transitory changes in regulation and rampant speculation. The boom was unsustainable and did mark a legitimate shift in terms of supply and demand but only an atypical move that corrected substantially when the crash arrived in 2007-2008. People who had purchased homes at the peak of the housing boom soon found themselves underwater on their mortgages, unable to sell out from a small home in favor of a larger one because they owed more on their mortgage than they could get were they to sell their home at market value in 2009-2012. Even years after the market bottomed, many were still underwater. If a buyer in 2006 had just had the foresight to hold off purchasing, he might have found a much better deal in 2009.

For that reason it is important to understand what causes the real estate market to move and what effect lending regulations, interest rates, and other factors have on the market. Even having a sense of what is going on with other countries can help. For instance, the Chinese buyers were shown to be inflating housing prices in Canada and the US due to wealthy Chinese seeking to evade capital controls on mainland China by putting funds into real estate in the West (Richter, 2018). Prices soared particularly in cities like Toronto, Vancouver and San Francisco—oftentimes far beyond what the average worker could afford. For sellers, it was a great time to unload property—but for buyers and new investors it was not a favorable environment. Today, San Francisco is seeing prices crash as a mass exodus unfolds with people seeking to dwell outside big cities in large response to restrictive governments and a lack of affordable homes in the area.

Therefore it is important to understand how and why markets move and when they might turn. Local governments took action to curb inflation: for example, the Canadian Province of Toronto placed a 15% tax on non-resident foreign investors buying real estate in the Province (Richter, 2018). The cooling effect on the real estate market was immediate.

Today, people see central banks creating trillions of new dollars out of thin air in response to COVID lockdowns, governments issuing trillions in new debt, and inflation rising across the board. They naturally want to put their money into an asset that will retain its value, but the housing market may have already priced in this rise in inflation, and now speculators and late-comers are driving prices up even further in hopes of capitalizing on the momentum trade. House flippers fall into this latter category—but once the market stabilizes what will happen to those who sought to get in or those seeking to get out of the market before the trend reverses?

That is why it is important to have a big picture perspective on the real estate market before one makes a decision on buying, selling or investing. Fortunately, there are some good solutions to the problem of ill-informed investors, buyers and sellers that can easily help people make a smart decision about what to do with their money, when to buy, when to sell, and when to invest. These solutions will now be discussed in the next section.

Solutions

The best solution to this problem is to understand the underlying currents that drive the real estate market. As Wheaton (1999) notes, local market and demographics are the main drivers: in residential real estate markets, the highest priced homes will be located in areas that have well-respected schools, a thriving economy, and well-maintained neighborhoods with little to no crime. These are the areas where housing is unlikely to dip for too long when there is a correction in the market. Investors are always looking to buy and residents are always looking for an opportunity to move into these neighborhoods. In short, demand persists because of the view that people have of the local market. In cities, there are fluctuations based on demographics, investment, regulations, taxes, and so on. A city where commercial real estate is being abandoned because of changes in the way people shop and do business is unlikely to attract many investors. But if a local government focuses on renovation and gentrification occurs, investors may come back and housing prices are likely to climb. Understanding what is going on at different levels of policy and looking ahead is critical.

Alternative Solutions

For individuals who are keen on examining the data there are numerous alternatives to looking to peers, groups and media for information. One key source of data that can be used are home flipping reports, which can be used to see how many homes are being flipped in an area, the rate as a percentage of all sales, the extent to which the market is saturated with home flippers, etc. One can even assess the gross yield of home flips based on the dollar amount of the investment prior to any deduction of cost or taxes. For instance, one could examine the rate of home flips in 2016 to the rate of flips in 2004-2006 to see that even though 2016 represented a decade high in home flipping, the rate was still well below the peak of the housing bubble that burst in 2007-2008. Thus, an investor could calculate risk by determining that the housing market had not yet peaked and make a decision based on an expected return on investment given current prices and costs (Maher, 2018).

Another data source to use is sales data. Sales data can show whether demand is decreasing in a local market. To evaluate sales data effectively, one should look at both volume and sales prices (Maher, 2018). If sales are declining followed by a decrease in prices a few months later it indicates that demand is indeed softening and that it is not merely a problem of too little inventory. To account for this type of data, however, one needs to be patient. The real estate market does not move as quickly as the equities market.

Foreclosure data can also be a good indicator of the market. Foreclosure data is lagging and it can take anywhere from months to years for the foreclosure process to conclude. However, because it is a lagging data set, buyers, sellers and investors should monitor it closely because any uptick in foreclosures could be an indication that the market is set for correction. The key to buying, selling and investing effectively is to remember that markets have cycles.

Refutation

The refutation here is that one may acquire all the data one wants, but at the end of the day one still has to interpret it and make a decision. The fact is that real estate values, like stocks, tend to go up over time because the value of the dollar tends to decrease over time. With this in mind, buying real estate is a simple way to protect one’s purchasing power. It is no different from buying an index that tracks the S&P 500 and holding it for 20 years. The real estate market may have cycles like any other market, but a long term view would show that prices trend upwards over time regardless. At least that is the argument.

But what happens if one suddenly needs to raise funds? It is a lot easier to sell something liquid than it is to sell something illiquid—and real estate is an extremely illiquid asset. On top of that is the fact that real estate requires upkeep. It is not the same as buying gold bullion and putting it in a safe. The bullion does not have to be maintained the way a home does. Homes require routine maintenance that includes lawn care, plumbing, roofing, windows, electric work, tending to wood rot, mold, and many other scenarios that can occur. Beachfront property may sound like a good investment based on the belief that one can rent it out year-round—but what about the maintenance costs? One has to factor these into one’s calculations if one is serious about the investment because maintenance will make a big difference on one’s expected return on investment.

Best Solution