If you’re in the real estate investing business (or hope to be), you’ve seen a lot in the news and media forecasting the real estate market. Should you believe this data? All sorts of numbers and projections are tossed around, but are they real? Should you invest according to real estate market statistics?
You’ll probably be surprised with what you read here. But what you won’t find is information about a crystal ball that holds the future to your real estate investing success. There are numerous studies that have literally proven that the human race poorly forecasts the future, and frequently they are wrong when they do so. Think about the weather. It tells you it’s supposed to rain tomorrow, and then it’s pure sunshine outside. We are poor predictors. Knowing that, you should not make investing decisions based on market predictions. You’re going to need to make your own decisions that aren’t based on predicted market statistics.
Listen to the investing professionals, and rely on your own experience
So exactly who should you listen to when it comes to the real estate market? You should listen to the professionals. Would you go to a doctor to do your taxes? No. So don’t listen to the media when it comes to making huge financial decisions like real estate investing. Listen to mortgage brokers in the area that you want to purchase in, and the realtors. And your own experience. Base what you should do off of your experience.
Many investors look to articles or the news to figure out what they should, shouldn’t invest in, and when. Nobody can tell you what will or will not happen in the market. It’s ever-changing. Daily. And nobody can predict the future. This article will explain to you why it is a waste of your time to rely on using real estate forecasts to determine your portfolio choices.
Humans are poor forecasters
Forecasters love to talk about interest rates. Again, humans are horrible forecasters. Many investors take their data to heart. But, humans can’t predict the real estate market. Investing decisions should never be based on prediction statistics. When we want to know what to invest in, many usually turn to market forecasters. We all have our favorite websites, or news channels to do so. But let’s be entirely honest. Market forecasters cannot and do not accurately predict the real estate market.
When forming your investment strategy, you are going to be making decisions in a framework of uncertainty and unknowns. Humans don’t like uncertainty. So we turn to the media and listen to their “expert” predictions and their forecasting models. We believe the predictions of these experts because they’re professionals, and they know more than we do. That’s true, but it doesn’t mean that their predictions are any more accurate than random guesses about the future.
How do we make money in real estate?
Money is made in real estate by purchasing a property, fixing it, and then re-selling it; or, either buying it and selling it right away so that it can be traded, we transact it, or we purchase it with the intent to rent it out to make a monthly rental income. So, you can either flip a house, or make it into a rental. When it really comes down to it, that’s how you make the money; a rental, to a flip. If it is a flip, you would guess it would be short-term. Because short-term investing, basing your decision on what’s going to happen in the near future is a horrible idea, because it is going to be short-term anyway.
If you’re going to make your money right away on the deal, then you’d got to make your money on that flip when you buy it. It has to be purchased below retail value so that it can be sold for retail value. Otherwise, no profit was made, and you’ve wasted your time. Rentals are similar. If you’re going to rent the property, you’re going to want a positive cash flow immediately. Otherwise, you’re losing money. So, now you can see that looking to the long-term market predictions are simply a waste of time (and money). You need to base your investing decisions on today, not tomorrow.
Residential Property: When looking at residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds and so on, the value climbs. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays.
Home improvements can also spur appreciation, and this is something a property owner can directly control. Putting in a new bathroom, upgrading to a heated garage and remodeling to an open concept kitchen are just some of the ways a property owner may try to increase the value of a home. Many of these techniques have been refined to high-return fixes by property flippers who specialize in adding value to a home in a short time.
Commercial Property: Commercial property gains value for the same reasons as the previous two types: location, development, and improvements. The best commercial properties are in demand, and that drives the price up on them.
Generally referred to as rent, income – or regular payments – from real estate can come in many forms. Here the different forms that income generate from:
Raw Land Income
Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include pump jacks, pipelines, gravel pits, access roads, cell towers and so on. Raw land can also be rented for production, usually agricultural production.
Residential Property Income
The vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month — and this will go up with inflation and demand – and you take out your costs from it and claim the remaining portion as rental income. While it is true that you will get an insurance payout if your tenants burn down the place, the payout only covers the cost of replacing what is lost and is not income in a real sense.
Commercial Property Income
Commercial properties can produce income from the aforementioned sources – with basic rent again being the most common – but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. These are essentially options that tenants pay a premium to hold, whether they exercise them or not. Options income is sometimes used for raw land and even residential property, but they are far from common.
Let’s say you purchase a property with the intent to rent it long-term, but it goes down in value. Then what? If you’re positive cash flowing, that will be irrelevant because you are still bringing money in every single month. Actually, if you’re bringing in a positive cash flow, it would be hard for the property really drop in value significantly, because the value of the property could always be based on the profit flow. It makes more sense regarding multi-family homes and commercial real estate as opposed to single-family homes. It can’t go down in value too much, because you are still making money regardless. All the same, rentals don’t usually go too far down as well.
No matter what the real estate market forecast is, it doesn’t matter, because you’re still on top. If it’s a short-term flip, you aren’t going to own it long enough for a market disaster. You’re in and out quickly. If you own the property for a few months or 1 year and the market crashes, that is a different story. In this situation, you haven’t prepared for a margin of safety. This has nothing to do with the market forecast, and everything to do with you not preparing well enough. Perhaps the property needed more renovations. There are tons of reasons that this house didn’t move that have nothing to do with the market predictions.
If you’re buying the house for the short term, you’re making a fast profit on it or renting it out. Therefore, the market has no impact on whether or not you’ll profit. Forecasts are speculation, nothing more. Investing is really difficult, theres no arguing with that. The overwhelming majority of professionals, and amateurs, are bad at it. It’s natural to want to rely on so-called “experts.” It’s perfectly understandable. And, know this: there’s nothing wrong with relying on experts for opinions. The problem is, experts often make short-term predictions about things that aren’t that predictable.
Purchase correctly; know what a good deal is. You’ve got to buy property correctly. Every deal should be painfully calculated, and ultimately successful. There are so many things about the property you can figure out before you ever buy. Purchase a house that there is no way that you will lose money on it (i.e. below retail value).
Keep in mind that this piece of advice is not just good for a well-done flip. It is also for rentals. Perhaps you can structure the deal to where you have an interest-free owner financed loan. The principle decreases over a span of time, and you then build lots of equity from the equity pay down. Consider that each loan is one hundred percent principle payments. It isn’t just for the purchase price, it is also the terms. Do not focus on real estate market forecasts.
What is local forecasting, and why should you follow it?
So, that half of the article was all about forecasts on a national level. When it comes to a local level, you can use trends as a guide; note, this still doesn’t say forecasts, it says trends. There are trends that you can follow when you are dealing with properties locally that can certainly impact decisions you make regarding investing. Such as, perhaps you want to buy a certain property but you read in the paper that a huge strip mall is about to be built behind it. Oftentimes, they will announce it some number of years because they actually start the construction of it. Also, just because they say they’re going to doesn’t mean it will actually happen. You may find that there are local things happening that will work to your benefit.
You need to discover the trends on your own
Don’t follow the trends from the news reports. Instead, base them on your personal investing. When you’re out and about, that’s when you notice trends on your own. Real ones. You’ve got to base it on your own experience in the local market. Many trends you’ve got to pick up on yourself, they aren’t going to be on the news. This article may be disappointing to some people who thought they could use the media to aid in figuring out where and how to form or build their investing portfolio. However, this is the truth; you can’t. You’ve got to get out there and watch what’s going on yourself. No matter what, make sure the deal will make you money today, not tomorrow. Real estate forecasts are forecasts, which means at a later date. You’ve got to focus on the now.
We know for a fact, that experts aren’t very good at predicting the future. While we’re naturally inclined to lean on experts for opinions, be very cautious in believing that experts are any better about predicting the real estate market than anyone else is. Be wary when you read the headlines and think that you’re getting the whole story. The odds are high that you’re really only getting half of the story.
If someone is trying to sell you on a new way to make money in real estate other than buying low and selling high or collecting rent, they’re probably trying to sell you on the process of real estate investing, rather than a new mechanism for making profits. Whether the process is worth it or not is up to you, but know that it doesn’t change how the money will be made (or lost) in the end.