Navigating Real Estate: Buying, Selling, and Investing Wisely

Introduction

When it comes to buying, selling, or investing in real estate, there are a few common issues that people will want to consider. These include when to buy or 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 the same as what is 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 in order 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 the risks of upfront expenditure. For anyone interested in real estate, this paper provides some assistance in addressing these common challenges by offering solutions that will make the process easier and more effective. It argues that instead of jumping onto a momentum train, one should proceed with caution and conduct due diligence in understanding the specifics of the market and where it is likely to be heading in the coming years.

The Problem with Ill-Informed Real Estate Decisions

Many first-time buyers, sellers, and investors make the mistake of assuming that any time is a good time to buy, sell, or invest. They see others getting into hot markets and want to take advantage of what seems, on the surface, to be a good opportunity. They may be told that interest rates are low, so now is the time to buy — or they may invest out of a fear of missing out. Alternatively, they may refrain from selling a property because its current market value is below what they originally paid. 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 better ways to proceed when it comes to making real estate decisions.

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 television, what they hear on the radio, or even what they hear from peers. As Bandura (2018) points out, most individuals' cognitive processes are informed primarily by peers, groups, and media. But this is a very superficial basis for making buying, selling, and investing decisions.

As Wheaton (1999) points out, most types of real estate have very unique cyclic properties. The office real estate boom of the 1980s was myopic in nature, caused by a surge in demand that was not sustainable. It did not take into consideration the coming of the technology revolution and the shift to e-commerce 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 existed. The point is that just because momentum is present 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 on the basis of 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 not mark a legitimate shift in supply and demand but rather 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 a small home in favor of a larger one because they owed more on their mortgage than their home was worth at market value between 2009 and 2012. Even years after the market bottomed, many were still underwater. If a buyer in 2006 had simply 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 in other countries can help. For instance, Chinese buyers were shown to be inflating housing prices in Canada and the United States, as wealthy Chinese nationals sought to evade capital controls on mainland China by placing 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 decline as a mass exodus unfolds, with people seeking to live outside big cities in response to restrictive governance and a lack of affordable housing.

It is therefore 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 Ontario 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 in response to COVID-19 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. However, the housing market may have already priced in this rise in inflation, and 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 late, or to those seeking to exit the market before the trend reverses?

That is why it is important to have a big-picture perspective on the real estate market before making a decision on buying, selling, or investing. Fortunately, there are good solutions to the problem of ill-informed investors, buyers, and sellers that can help people make smart decisions about what to do with their money, when to buy, when to sell, and when to invest.

Market Forces That Drive Real Estate

The best foundation for navigating real estate is to understand the underlying currents that drive the market. As Wheaton (1999) notes, local market conditions 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 decline for long during a market correction. Investors are always looking to buy in such areas, and residents are always looking for an opportunity to move into these neighborhoods. In short, demand persists because of the general perception people hold of the local market.

In cities, there are fluctuations based on demographics, investment, regulations, taxes, and other factors. A city where commercial real estate is being abandoned due to changes in how people shop and do business is unlikely to attract many investors. But if a local government focuses on renovation and gentrification occurs, investors may return and housing prices are likely to climb. Understanding what is happening at different levels of policy and looking ahead is therefore critical.

Data-Driven Solutions for Buyers, Sellers, and Investors

For individuals who are keen on examining the data, there are numerous alternatives to relying on peers, groups, and media for information. One key source is 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, and the extent to which the market is saturated with home flippers. One can also assess the gross yield of home flips based on the dollar amount of the investment prior to any deduction of costs or taxes. For instance, one could compare the rate of home flips in 2016 to the rate during 2004–2006 and observe 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. An investor could thereby 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 valuable data source is sales data. Sales data can reveal 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 genuinely softening and that the slowdown is not merely a problem of insufficient inventory. To make use of 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 market health. Foreclosure data is lagging — it can take anywhere from months to years for the foreclosure process to conclude. However, because it is a lagging dataset, buyers, sellers, and investors should monitor it closely, since any uptick in foreclosures could indicate that the market is set for a correction. The key to buying, selling, and investing effectively is to remember that markets have cycles.

Conclusion

Every market is different, and markets are always changing. One of the things that drives a market is interest rates. When rates are low, borrowers have more incentive to take out home loans, which means there is greater interest in buying a home — whether for living purposes or for investment purposes. Investors will add to a portfolio of real estate believing that they can satisfy the interest on their loan by renting the property or listing it on platforms like Airbnb. However, rates tend to rise and fall just like other markets. To navigate the world of real estate, it is imperative that buyers, sellers, and investors understand these cycles and use them to their advantage, rather than acting on the fear of missing out.

References

Bandura, A. (2018). Toward a psychology of human agency: Pathways and reflections. Perspectives on Psychological Science, 13(2), 130–136.

Choe, S., & Vega, A. (2021). Why rising rates are unsettling Wall Street. Retrieved from https://apnews.com/article/why-rising-rates-unsettling-wall-street-explained-4a672f914e9396a9e9bcda44eebf74d6

Greene, D. (2018). Buy, rehabilitate, rent, refinance, repeat. BiggerPockets Publishing.

Maher, A. (2018). 4 ways to use data and algorithms to inform your real estate investment decisions. Retrieved from https://www.buildium.com/blog/real-estate-data-sources/

McLean, B., & Nocera, J. (2010). All the devils are here: The hidden history of the financial crisis. Portfolio/Penguin.

Richter, W. (2018). Chinese investors are inflating housing markets in the US, Canada, and Australia. Retrieved from https://www.businessinsider.com/china-investors-inflating-housing-markets-in-us-canada-australia-2018-6

Wheaton, W. C. (1999). Real estate "cycles": Some fundamentals. Real Estate Economics, 27(2), 209–230.