Super Smart?..or Super Sucker?..Riding a Great Market Cycle?: 1-Cycle Investors, Leveraging RE, & Feeling (Too?) Good?

17 Replies

“You can only tell who is swimming naked after the tide goes out.”

Are newer investors as smart we think we are? Or are we just riding an amazing market off a bottom?

This post is to get:
1) The honest truth from investors who have lasted – OR MORE IMPORTANTLY – HAVE GONE BUST -in prior cycles- Tips? Are we stupid? Lucky? Both? How to avoid tragedies we haven’t seen with our own two eyeballs?.. (don't just tell me to stop borrowing! lol)
2) Investors who started investing in the last market cycle, during the downturn, like myself –
Share how much you think your success is attributable to the market vs. your own skills and cunning…

When the real estate market is doing well, it’s hard to lose. And it feels GREAT! :)But are us “first cycle” investors not quite as smart as we think we are?

This is a counter to my last post on how great the last few years has been...

AND HERE’S THE STORY…

I started investing during the last downturn, biding my time for a couple years, until the real estate market started reverting in 2012, buying my first property on New Years’ Eve of 2012. *Confetti trickles across the blissful New Years’ sky, backlit by *sparkling fireworks* *A passionate kiss* at the stroke of midnight, etc, etc.. I’m now an INVESTED real estate investor. My entire life “savings” of $12K that I slowly built while I increased credit card balances almost equally (forced savings? Lol).. bought me my first 4plex for under $400K, in the good ‘ol US of Bay! (Thanks FHA, Bernanke, etc..)

I had conviction. I’d seen so many get wiped out by the market in my day job, but a lot of signs pointed to this being an historic opportunity. There was blood in the streets. So after I saw the market bottom out, I decided to get more aggressive and truly bid to buy. The $3,500 in rents I got after rehab on the 3 other units, while I was living for free, was a bit better than I had budgeted! (even for one of the most marginal locations in the core Bay Area, like Richmond).

Many told me I was an idiot for investing in the worst real estate market in living history. For investing in a low-income area with a bad reputation (..that it turns out most have never visited). For MOVING THERE with my (then) girlfriend [different, unrelated story..]. For borrowing on a credit card to buy real estate. For buying a 4 unit vacant REO. For leveraging at 96.5%+ LTV. For buying a property that looked so ugly, and kinda smelled like piss.

For me, THOSE WERE ALL GREAT REASONS TO BUY (for this deal at this part of the cycle ;)

I’m an investor that believes in the long-term appreciation of land-constrained, job-filled, commuter-friendly, good weather, NIMBY building-hater areas. So I went back and bought another 2 houses with a partner, another 4plex with a partner, and another duplex with a different partner. All with high leverage, but even better cash flow…

But when the real estate market is doing well here, it’s hard to lose. In the Bay Area, the longer your flip project gets delayed, the more money you make from the market’s escalation for the last nearly half decade. I have seen even big mistakes recently be rewarded by the rising tide of the market. And those who are more conservative sitting on the sidelines watching others making a killing on what looked like unprofitable deals, as the market rises. You can see the same “impossible to lose” philosophy in the Banking Sector. For example..

NOT A SINGLE BANK IN THE UNITED STATES OF AMERICA FAILED/CLOSED IN 2005 OR 2006 - $0 Loss to FDIC. Regardless of amazingly risky loans, fraud (later found out), or just pure costly mistakes, lax internal controls & theft, etc, not a single bank could lose in this market. There was always another bank willing to buy them for a premium. Aka – sell to the next exuberant buyer.. It didn’t matter how low your trunks were, or whether you were swimming naked. No one really cared to know or look, because they were looking at the multiple and volume they planned to sell to THE NEXT GUY.

IN 2009, A SHORT 3 YEARS LATER, 157 BANKS FAILED - ~$40B Net loss to FDIC. (I personally helped close one bank my first year on the job – a $10 Billion Institution w/ ~$2B in govt/FDIC losses by public estimates). Talk about finding out who was swimming with their shorts off! (And who was playing lifeguard? :-/ )

In 2015, there have only been 4 closures, for a total of under $1B in estimated loss. Hard to lose in this market. Except for the very few that were still unwinding from a slow death from the last crisis, where it still hasn’t recovered..

Like banks, we are leveraged investors, exposed to the vagaries of the real estate market and consumer and investor sentiment. (But investors take first loss in equity position when banking is normal). And the wind is at our backs right now. @Minh Le  , @Brian Burke , @Aaron Mazzrillo , @Jay Hinrichs , @Gene Hacker , @Kathryn M...

How much of our success is purely due to which way the winds are blowing? (the young “1-cycle investors” who have only read about prior cycles in books.)
 Are we really that smart? Or just lucky? (with luck favoring the prepared? ;)
Without the benefit of another huge upswing, how many of us will continue to be successful in the future? (including myself?!..)
Advice to weather the storm?

J. M.

  there were over 400 banks that failed in Georgia alone.. not sure were you getting the 157 :)

this is my 3rd roller coaster ride.. but 08 09 was the big dipper... I had way more than I ever had before but I also lost way more than I ever had.

For me personally this time around its not only assets but cash accumulation.

I believe that success comes from the preparation, planning and positioning of oneself for luck... More to the point of your post, we are ALL lucky to be in this market. The difference between those who last and fail is based upon what we individually do with that luck.

Originally posted by @Jay Hinrichs :

@J. Martin

  there were over 400 banks that failed in Georgia alone.. not sure were you getting the 157 :)

this is my 3rd roller coaster ride.. but 08 09 was the big dipper... I had way more than I ever had before but I also lost way more than I ever had.

For me personally this time around its not only assets but cash accumulation.

 Cash is king! Do you have any sort of way of estimating how much you should have on hand.. The more the better? What has you sleeping well at night? Do you break off some assets in a retirement vehicle or maybe even a BK-remote entity also?...

I got those bank failure numbers from a summary chart, but I did actually go the FDIC website here, and downloaded the data set, since you made me doubt myself ;) It looks like there were 91 banks that failed in Georgia over this crisis. (actually 90, since 1 of them failed in 2002.) 157 total failures in the peak of 2009 - about 3 per week - sounds about right just from my recollection of getting about two emails each Friday afternoon, and the occasional mid-week liquidity crisis shutdown.. But if I'm wrong, please confirm.

Georgia for sure had the most number of closures per capita, and probably the most total count. CRE and development slaughtered them (residential didn't help I'm sure.) But a lot of them were little baby banks. A few hundred mil apiece. Didn't do much to hurt the fund. Just time-consuming closing so many..

You can download the data set of failed banks from the FDIC here:

https://www.fdic.gov/bank/individual/failed/banklist.html

I can't comment in whether you and others getting into the game are smart or not.  But, smart or not smart the key to survival is discipline.  Start pushing your limits too hard, go outside of the box too far, or abandon your core competency...this is the start of trouble.

Having survived at least a couple of cycles I can say that chances are you'll feel pain when it happens but if you were disciplined when you bought your properties and stuck to what you are good at you can survive.

In 2005 I regularly attended REIA meetings where people were bragging about the rental they just bought with $500/mo negative cash flow despite a neg am loan and nothing down. All I could do was shake my head and think to myself "you just wait". I knew it was coming. What I didn't know was how deep it would be but that is beside the point. The climate now is nothing like the climate then.

If you can buy with positive cash flow and you have reserves, you are more likely to be fine than not fine.  If there is a devaluation of real estate you may experience paper losses but if you hang on to the other side of the cycle you'll recoup them.  Your risk is if there is a deep recession and people start losing jobs and can't afford to pay rent, causing you to experience vacancies and rent declines.  Can it happen?  Yes.  Will it?  I tend to doubt it, at least in the foreseeable future in most areas.

Being on the right side of the trend is a wonderful place to be.  But trends can change. 

My advise is to follow the data and try to consistently evaluate your holding with as little emotion as possible. 

Keep up on the basic data: sales, prices, inventory levels, interest rates, etc. 

Audit your personal holdings and ask yourself...is my current holding ideal based on all the current data and trends. If the answer is yes, then ride on. But if the answer is no or maybe not...then I would seriously consider moving some things around.  

I shook my crystal ball and when the white particles settled, it said "Merry Christmas!" 

I have a few rehabs going as I think people are paying too much for houses these days, but I'll get out of that business before end of summer. If I do any more they will need to have large equity cushions so I'll have room to be the market maker in that neighborhood if need be. Some of my investor friends think the market is hot and about to go full wild fire. Others are saying foreclosures are going to start ticking up in 2016-2017 so they are accumulating cash and getting their offices ready. Like the Dire Straits song Industrial Disease - Two men say their Jesus, one of them must be wrong. I have no opinion either way.

I reduced my yearly rental acquisitions to a goal of just 4 this year and that is only if they come with seller financing. My goals this year are heavily focused on eliminating unfavorable debt and replacing it with long term, lower interest rate financing. I cleaned up a few messes last year and luckily only created 1 new one. I'm more focused on the sustainability of my business and nothing creates lasting power like well leveraged rental houses and a pile of cash... or Viagra. Guess it just depends on what you're into.

I watched the last disaster unfold. I know lots of people that lost everything. This time is different. Sure, there will be market cycles, but the days of no income and only a pulse required to qualify mortgages are gone. There is still lots of money to be made in this market. Will some people lose in this market? Yes. Money will be made in escalating market and declining markets.

J. M.

  stand corrected the 400 number in my mind was the total amount of banks in the state (which I recall at the time thinking was a heck of a lot) not the amount that failed.. but 157 nationwide seems low to me.. if one state had 90 as you say..

But I never actually check stats  just going on recall.

Originally posted by @Gene Hacker :

Keep up on the basic data: sales, prices, inventory levels, interest rates, etc. 

I have been spending the majority of my time trying to learn as much as I can about REI. I currently own and rent out one SFR and intend on growing that number over the next couple of year. What are some of the resources you consider to be reliable and or invaluable for basic data collection and monitoring?

I like to look at any and all data that I can get my hands on. 

For my area, the best source of data is generally the MLS. I have realtor friends that let me use the MLS, and in exchange, I package my findings and report back to them regularly.

I track...

Sales

Median Price changes (YOY and MOM), Mean Price changes (YOY and MOM).

Inventory levels

Average DOM

Difference between asking and closing price.

Interest rates

NOD filings

Then I also follow non real estate specific variables as well.

It takes time and effort but in a boom/bust state like California is worth the effort.

I am happy to say that I survived the last correction. I got bruised a bit, but nothing of lasting consequence. But I gotta tell you, during 2005-07 I was a lot like you guys now- J. M..  It's good that you're thinking of a potential downturn and how to prepare for it (as I was back then too) but that is nothing like actually going through it!  Circumstances are always different, your particular situation at that time matters significantly, and all you can do is deal with things and make decisions as the sh!t comes your way and pray that you'll make it through!  BUT once you survive it, you almost systemically make better choices going forwards. 

"Do you have any sort of way of estimating how much you should have on hand.. The more the better? What has you sleeping well at night? Do you break off some assets in a retirement vehicle or maybe even a BK-remote entity also?..."

I can sense your anxiety, but as far as offering advice that suits your specific situation, all I can honestly offer is (sing it....)  the answer my friend is blowing in the wind, the answer's blowing in the wind :)

@Brian Burke

Cash Flow & Fixed Rates w/ few Bullets

"If you can buy with positive cash flow and you have reserves, you are more likely to be fine than not fine. If there is a devaluation of real estate you may experience paper losses but if you hang on to the other side of the cycle you'll recoup them. Your risk is if there is a deep recession and people start losing jobs and can't afford to pay rent, causing you to experience vacancies and rent declines. Can it happen? Yes. Will it? I tend to doubt it, at least in the foreseeable future in most areas."

I do buy with positive cash flow (~8 GRM average total purchase + rehab on total gross rents), and have the vast majority of my debt on 30yr fixed and one 15yr fixed. So yes, I can sustain the paper loss as long as we don't take the "BIG DIP" in rents. The odds? I'm with you. But I saw the startling (and I'm sure true) statistic that rents on average in the Bay Area are about 50% above the lowest of post-bubble rents. I think they are "stickier" on the way down – but if they reverted all the way back there, that would be painful for me.. I also still have some rolling short-term debt, and a series of bullet payments totaling just under $100K, starting in 2020. Like Aaron Maz, I'd like to roll these into some long-term, RE-secured, cheap debt – and keep my cash for the rainy days… ;)

Back to the Basics Data & HAI

@Gene Hacker  , thanks for sharing with us. I need to keep a closer look on the basics, like you said.. I’ve been looking at all kinds of other stuff lately.. But I really like HAI for a lot of reasons. I think @Minh Le got me hooked on digging into the HAI data more deeply, and now I’m drinking more of the kool-aid than he is! I used to think the market was basically efficient, and too hard to time tops and bottoms, w/ transaction costs, taxes etc. I'm not quite as much a "timer" as you I don't think. But I will seriously consider unloading some or changing them up if things get really crazy again..

Long Debt Good; Pay off Debt Bad

Account Closed,

“My goals this year are heavily focused on eliminating unfavorable debt and replacing it with long term, lower interest rate financing… I'm more focused on the sustainability of my business and nothing creates lasting power like well leveraged rental houses and a pile of cash... or Viagra. Guess it just depends on what you're into.”

I think I’m with you on improving debt terms, rather than paying off.. All I hear is “pay off debt to lower risk” “pay off debt, “pay off debt.” Because my properties cash flow well, I’d rather have the low, fixed, 30yr-am payments and cash in hand for the downturn, than a bit less leverage and far less cash on hand for future risk or deals.. The amount of cash I would need to significantly reduce my debt is very large, compared to the safety and buying power of that cash if/when the sh*t hits the fan again..

You scare the SH*T out of me @John Thedford !!!!!!!!!!!!!!!!!!!!!
 
“I watched the last disaster unfold. I know lots of people that lost everything. This time is different. Sure, there will be market cycles, but the days of no income and only a pulse required to qualify mortgages are gone.”

“This time is different” are the words scrawled on the wall of every financial bubble - from the South Sea to the DotCom Bust (1.0) to RE Financial Crisis - before it comes crumbling to the ground. The new era of international trade; The new era of a super-productive online world; The new era of RE where prices cannot go down; The human mind is a funny thing!

The only thing that is different, is that financial asset bubbles and busts are always a bit different. The money might be coming from a different place. The asset might be in a different form. But some common themes are a “can’t lose” attitude, leverage, and amazingly enough, thinking that we’ll be OK because it’s different this time! It’s usually coupled with a lot of late-comers piling into the asset after years of sitting on the sidelines missing out, driving it ever higher above its intrinsic value, further increasing the odds and magnitude of a correction when everyone sees how naked the king is..

It doesn't matter if the "funny money" is coming from loose loans (see Great Recession), an overheated sector (See Tech Bust 1.0), an overheated country (Japan in 90's; see 2-3 lost decades..).  Their will always be another bubble filled with risk; but it will likely be in a different form.  PS.  *I also had a front-row seat to the extreme losses, watching RE borrowers and developers go from 8 & 9-digit net worth to negative in the matter of a couple years*

“An asset bubble is like an orgasm; It feels the best right before it’s over.”

@Jay Hinrichs ,

Bank Failures

My original figures were correct, except that 157 failures in 2010 instead of 2009 – just for that 1 year. 515 banks have failed so far during the crisis from 2007-2015. The 400 figure you said for all Georgia banks sounds about right, since I believe about 1/4 of Georgia banks (by count) failed during the crisis. So that’s consistent with my data.. Just over half of total failed in 2009 and 2010. Maybe after banks stop failing in record numbers, it’s a good time to start buying! And if no banks can fail, then time to run! Lol

Us youngsters don’t know much, but I do know a thing or two about bank failures ;) I was there living and breathing this stuff at failing or failed banks during the crisis, unfortunately having to assist in the closure of several Bay Area banks myself, as you may know..

20152014201320122011201020092008200720062005Total09-'10
51824519215714025300515297

 "A Lot Like You Guys"

@Amit M,

“But I gotta tell you, during 2005-07 I was a lot like you guys now- @J. Martin and @Arlen Chou.”

Can you elaborate some more? In being insatiably hungry for good deals, regardless of market cycle? In thinking about the next bust..? Or are we all mad men?! Lol I think the background of the cycle is a little different, but we’re getting closer to that point each day.. PS. I don’t have anxiety. Just want to make sure I’m realistic and not patting myself on the back too much for jumping in at the right time.. I will feel better when I refi some shorter-term debt and bullets into 30yr money though ;) Come on cycle!!

The RE market is a bit frothy.  Yields of 6% cash flow investors are buying up, and it is too little for the risk or RE.   

Housing prices, and rents, are a function of wages.   They cannot go up without wages going up.  Wages have been stagnant for a while.

J. Martin,

Timing the market is not an exact science but with real estate it is much more possible than more liquid sectors.  Stock are traded in nano seconds where real estate transactions take many months from handshake to reported data.  The existing home market is a giant ship out in the ocean that takes a long time to turn.  At first glance its so big that its hard to tell if its turning or going strait, but if you get up in a helicopter, you could see the prop wash behind it and easily tell. Someone running the data just once per month can keep pretty good tabs on what is happening.  

I do think the Bay area could be different as it is so tied to tech that if tech stocks correct everything could change quickly.  It may more like a single industry town compared to most large more diverse cities.  

The other important lesson we should learn from history is that markets can push boundaries a lot longer than one would think.  AG gave his "irrational exuberance" speech years before the tech bubble popped in 2001.  Many thing in the real estate market were unreal and screaming "unsustainable" in 2004 to 2006. Greed and fear are amazingly powerful forces. I think its fascinating to watch.  

Everyone is a genius in a bull market.

I appreciate this post a ton J. M..  I've been through a few cycles now and I admit I sometimes feel a little critical of the first cycle people who think they have it all figured out. I always wait and see who's around after the market shifts.  Not as many people live to play in the next cycle.

It seems like these bubbles go on until everyone starts thinking "Well, maybe it is different this time" and even the skeptical one get in for fear that they will be priced out forever.  Saw that with the dot com bubble in 2000 and the real estate bubble in 2006.  I don't think we are there yet but it kind of feels like 2003-2004 right now, depending on where you are. 

The bubbles are all a bit different though.

I just found myself almost into a triplex deal in Florida on well water in a commercial area with septic tanks with marginal tenants and deferred maintenance.  I thought of Bruce Norris and a story he has about if you find yourself buying a manufactured home on a dirt road, think about how you plan to get out of that if the market changes.

Anyhow, I backed out of that deal.

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here