Building Value vs. the Bubble Mentality

One of my favorite economics bloggers, Megan McArdle, wrote a post recently on the Washington, DC real estate market, extended to the state of the market overall.  It appears to her that the single-family residential market has bottomed out, while multifamily still has a way to go.

Megan also posed the question of when, and if, a boom will begin again.  Possibly, in her view, there won’t be a boom.  After all, the last nationwide (really, worldwide) boom was driven by a couple of unusual factors: historically low interest rates, and a big, competitive market for subprime loans.

Megan is one of the smartest economic bloggers, and a lot of what she wrote here makes sense.  Still, the post bugged me, because it focused on macro-economics, which is not the world in which most of us live.

We know that real estate investing success comes from a million factors, only one of which is the boom-bubble-bust cycle.  Outsiders don’t see a lot of difference between real estate investing and stock market investing, but there is a huge difference.  In stock market investing, there are really only three factors:

1. You decide which stock or mutual fund to buy
2. You decided when to buy it (what price)
3. You decided when to sell it (what price).

All those apply, in a sense, to real estate investing.  You have to decide what and where to buy, pick one or more properties at what seems to be an appropriate price, and figure out when to offer them for sale, at what price.  But there are also these factors:

Price Factors Exclusive to Real Estate

1. What can you do to cut ongoing costs?
2. How are you going to treat the tenants?
3. How can you renovate the property to make it worth more?
4. What can you add to the property to increase the income it generates?

You can probably think of a few more.  The point is that in between the buying and the selling, most stock market investing is essentially passive.  Once you own it, you’re waiting for the right time to sell it.  You really have no say over how the company is run. 

Consider an investor with 10,000 shares of General Electric (currently worth over $130,000).  His influence is very low because he owns just one-millionth of the company.  His only real power is the power to sell his shares.

For all practical purposes, as a real estate investor you own the whole company. 

You have a terrific influence over the value of the properties you own, relative to the market.

Timing is still important, and even a smart, knowledgeable, hard-working investor can be overwhelmed by a collapsing market, while a stupid, ignorant, lazy one can enjoy short-term success in a boom market.  However, the smart and hard-working investor will always do better in the long term.

A while back, I wrote a post that was extremely critical of Michigan’s state government and recommended that investors avoid the state.  I got an extremely angry comment from a Michigan real estate broker, who was understandably perturbed that I was essentially telling folks not to buy from him.

In retrospect, I should have acknowledged that it is possible to make money in the Michigan market.  It’s just harder to do it there than in other markets.  The trends are working against you.  It is beyond debate that people are leaving Michigan and that the folks that are coming in tend to have lower income than the people who are leaving.

Focus on Value

These mean that the average real estate investor in Michigan, putting in average effort, is going to lose money.  A smart investor, working hard to build the value of his properties, buying smart, selling with precision, is much less likely to lose money.  The best of the best Michigan investors will make money.

In almost any part of the country, you are more likely to make money now than you would if you had bought a couple of years ago at the height of the market.  Consider that a 5-unit property in my home market of Somersworth, NH might have sold for $300,000 in 2005.  Now it is probably going to sell for $200,000.  If you buy it now and sell it in 2015 for $300,000, you will have made some money, even without a real boom.  But, if you bought it in 2005 and sell it in 2015 for $300,000, you will have made nothing.

However: suppose you bought it in 2005 and worked extra hard to reduce costs, maintain good tenant relations, and increase the value of the property.  You might sell it for $350,000, instead of $300,000 – making a little money even despite the real estate bust.  Or if you did all that work, having bought in 2009 – you made a lot.

I’d like to think I’m writing for value builders, not bubble thinkers, here at BiggerPockets. 

Article Author: Brendan O'Brien

Brendan has written 60 articles for us.
Visit Brendan's Website: http://www.pcpropertymaster.com

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Tagged as: bubble, business, housing, real estate investing, real-estate-bubble, stock market