One of the questions I hear over and over is “when will the real estate market return to normal?” There were so many newcomers investing in real estate that have no historical perspective of the market. So many things occurred that had never been seen before. People lacking in experience did not realize that this wasn’t normal. They sit on the sidelines waiting for conditions to return to the way that they were before the bubble burst.

News Flash: It Ain’t Happening!

It seems that during the high-flying days of the real estate boom novice investors were a lot like Alice In Wonderland. They went through the looking glass into a bizarre world of an altered reality where the normal rules of economics didn’t apply. These neophytes jumped in with both feet and paid a heavy price when reality returned to bite them.

The Fallacy of Easy Money

A frequent question is “when will lenders start making $0 down payment loans again?”

The answer: hopefully never. Like many investors, lenders were caught up in the hype and loosened credit standards in ways that were previously unimaginable. It wasn’t that long ago when you actually had to have a down payment to buy a house. In their haste to originate loans, lenders allowed people to buy without putting in any of their own money. When the market slowed it was very easy for people to walk away from houses that they had invested nothing in.

“When can I get a no-income/no asset verification loan again?”

Answer: don’t hold your breath. Stated income loans were originally designed for the self-employed borrowers who had a difficult time verifying information. The paid the price for the convenience in the form of higher rates and fees. Somewhere along the way these loans became fairly routine and just about anyone could get them at rates that weren’t much worse than full documentation loans. These so called fog-a-mirror mortgages were a huge contributing factor in the meltdown of the real estate market. People who can’t afford to pay shouldn’t be allowed to have a loan, it seems that this logic was cast aside in the market euphoria.

Having been badly burned, the lenders have pulled back with a vengeance. We may never see such easy money again. Fannie Mae had relaxed standards to the point of allowing investors to have as many as 10 mortgages. Their new guidelines (as of August 1, 2008) allow for investors to have no more that four investment property mortgages.

Appreciation Is Not A Birthright

I wish I had a nickel for every time I heard “real estate only goes up” or “they aren’t making anymore land”, and my all-time favorite, “what could go wrong?” Real estate can, and does, go down in value. Rampant speculation had driven prices so far above any justifiable valuation level that they had nowhere to go but down. Over the long-term real estate has shown great appreciation and is a fantastic hedge against inflation. However, you still need to buy it right.

The cost of liquidating real estate may be as much as 10% when you factor in sales commissions, transfer taxes and other selling expenses. That means that a property has to appreciate about 10% just for you to break even on your investment. Let’s say you didn’t do your homework and paid 15% too mush when you purchased the investment. That means you will need a 25% gain just to get back to where you started. In this environment you could be waiting a very long time.

We Don’t Need No Stinkin’ Cash Flow

During the boom many real estate agents tried, and often succeeded, in convincing investors that cash flow was overrated. “So what if you are negative $500/month. That’s only $6,000/year. The house will appreciate by $100,000 in a year!” I wonder how often that line was repeated. When you have positive cash flow it doesn’t matter if the market is going up down or sideways. Your monthly profit allows you to ride out the market until conditions favor the seller. When your investment is hemorrhaging cash every market downturn is magnified. If you can’t afford to ride out the storm you become another statistic.

Reality

Investors need to accept the fact that a new reality is upon us. This new reality is very much like the reality of years ago. You need to make sound investment decisions and have a plan that isn’t a get-rich-quick scheme. Multitudes of people have become fabulously wealthy in real estate. They didn’t get-rich-quick, they did it the old fashioned way – hard work.

It’s true hard work never killed anybody, but I figure, why take the chance?

Ronald Reagan