How to Invest in a Changing Real Estate Market

I get a lot of questions from people asking, “Will real estate investing work in my market?” The truth is, real estate investing works in every market. But you need to learn your market and adapt the techniques that it requires.

There are many ways to describe real estate markets, including “hot” versus “flat” or “rising” versus “falling” or “buyer’s” versus “seller’s.” All real estate markets are subject to fluctuations; but these fluctuations typically do not greatly influence the ability for the informed investor to make a profit.

In fact, some strategies, such as flipping real estate, can be the least risky way for a beginning investor to make a profit in an uncertain market simply because of the relatively short amount of time the flipper will own the property.

Unlike the stock and commodities markets, real estate markets don’t rise and fall rapidly. For long-term investing, additional market factors are important to your buying decision. Investors who plan for short-term real estate market appreciation are speculating, which is outside of the basic model of low-risk investing.

What is the ideal market for investing?

Let’s be clear: There is no such thing as an ideal real estate market for investing. It tends to be more difficult to find bargains in rising markets, however, because if the market keeps rising, the probability of selling the property quickly for a large profit increases. In contrast, when property values are falling, more “bargains” become available.

Yet you need to assess the true value of these properties based on when you expect to sell the property. Thus, your purchase must be made at a steep discount to allow for a profitable sale later.

What are some basic strategies to limit risk?

Some basic strategies can be used successfully in virtually all market conditions. Become educated in your local market first by understanding the large-scale trends–from global down to national, regional, and specific neighborhoods. Learn about target neighborhoods, enlisting the aid of successful real estate professionals along the way.

These professionals will help interpret market indicators, such as the average length of time houses are sitting on the market this month versus last month or last year. Armed with this type of information, you will be able to make good decisions.

Inventory trends

Inventory, defined as the number of properties offered for sale, is a good indicator of current market trends. If inventory is low because of building restrictions or geography, then high demand will lead to rising prices. In rising markets, sellers often capitalize on the excitement of new listings to get properties under contract quickly, at premium asking prices.

There are also seasonal fluctuations in inventory, such as fewer listed properties in the winter months than in summer and a surge of listings in the spring. Some areas, such as resort destinations, follow seasonal trends.

Generally, seasonal drops in inventory reflect the trend to market properties more aggressively in spring and summer months when real estate markets are more active. Properties sell year-round, though investors should plan to reduce the price for winter listings or at least know that properties take longer to sell during those months.

Falling markets

While most markets have risen over the last five years, some are flattening out, and some may have already dropped. This type of market offers great opportunity to the savvy investor. When property values are falling, inventory often rises, and many sellers become highly motivated when their properties fail to sell quickly.

Motivated sellers will do whatever it takes to sell their property. Whether sellers need to move from the area, are struggling financially, or have other pressing reasons to sell, they may well accept a below-market offer.

Investors know that a weak market can offer extraordinary deals, though flippers need to proceed with caution. In a falling market, even a few months’ delay can turn a sound deal into a headache. It always pays to know the market and purchase the property at a price low enough to net an eventual profit, even if the market continues to fall.

The common myth is that you cannot make money by in a bad real estate market. In a bad real estate market, you can often buy “junker” properties for 50 cents on the dollar and sell them for 60 cents. It’s all in how you do the math.

It is worth noting that markets can and will change. If the market rebounds after a purchase, then all is well for the investor. However, if the market takes a downturn after a purchase, there can be trouble ahead. Markets commonly show signs of slowing or turning over several months.

Sometimes the early signs come from national economic trends, such as rapidly rising interest rates or sweeping changes in tax policies that affect home ownership or investment (e.g., the rapid change in depreciation rules for real estate investors in the late 1980s).

More likely, clues come from local market conditions, such as unemployment, oversupply, or a change in demand because of living conditions.

Exit strategies

More important than guessing the future of a local market, you need to have a clear plan in mind when purchasing property. A smart investor knows exactly how he will exit the property before he buys. An even smarter investor will have a backup plan or two, in case the first course of action doesn’t work.

In short, know your market and your plan before you begin to invest in real estate.

[For more information on the Housing Bubble, read Bill’s previous article, Real Estate Bubble Theory is Full of Hot Air.]

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