Lessons Learned from Real Estate Market Frenzy

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Lessons Learned from Real Estate Market Frenzy

Tom Goans
Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes

Lessons Learned from Real Estate Market Frenzy

This is an observation of real estate market frenzies and lessons learned from the viewpoint of a third generation real estate investor, developer, property manager, and financier with almost 50 years of personal experience. It is not scientific, nor are the observations and expressed viewpoints 100 percent correct.

Today, the real estate business has once again become a frenzy. Prices have become unrealistically high and the number of sales is fueled by market manipulation with a big heaping of denial. Once again, the reliance on too much credit is a dominate factor in the market. Too many people are over extended and justifying this attitude.

What is being ignored? The true entire economic picture. The continued reduction in individual buying power and the reduction of the workforce to 1990s levels are extremely alarming. Future support of the current real estate market frenzy is unreliable. The majority of the future population cannot financially afford the required payment demands of today’s investment strategies.

I am reminded of a Colorado real estate development company in the 1970s. The real estate market was extremely hot. Colorado had become very popular with the entire U.S. and people around the world. How could you miss? The development company bought tens of thousands of acres of very prime real estate in four separate locations in hot markets around Colorado, including one large chunk near 4 major Colorado ski resorts. The company was very debt heavy. The profit potential was off the charts. Suddenly there was the oil embargo, lines at gas stations, a depressed economy, and no buyers. The Colorado development company quickly went bankrupt. The debt ate them up. These old experienced pros went bust.

I recall what my father stated: “They were land rich and cash poor.”

Yea, but it this cannot happen to me ... right? How much more thorough was their research, studies, and numbers than yours?

During the first half of the 2000s, the real estate market was extremely hot. Then the recession hit. In about 3 months, many markets went from scorching hot to completely dead. The recession took down EXPERIENCED developers, builders, “real estate investors”, and a record number of banks. All had files filled with comps, appraisals, and good numbers.

One of the points being made is investing in hot markets or hot local areas can be a major mistake. By the time a market or area is considered hot by many, it is too late for the wise investment money.

This is just an observation and viewpoint. It is not scientific, but may be worth considering.

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Eric TaitPro Member
Investor · Houston, TX · Member since 2013 · 314 posts · 146 votes
12y

I look towards the durability of the payment stream as the metric for long term rentals.

I am lucky to be in a resource and healthcare based economy (Houston) and my focus is workforce housing.

Median income is around 42K in the city, but I target the historical 35K, two earner household and then keep my rents around 1/3 of their monthly take home pay. ($900 - $1350)

This I think gives some downside wiggle room, and since we purchase for cash flow, I do not really care about the nominal price of the assets, just my basis in that asset based upon the long term cash flow prospects.

I think that as long as we as investors keep an eye on median incomes of our respective markets, and make sure we are buying at a deep enough discount, we will alright and see the signs of the next bubble.

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Tom, have you looked at the historical tends on prices? Colorado saw declining or stagnant prices for almost ten years prior to the recent rise in prices. Our prices never shot up like they did in other styles like California and our building has been stagnant for years as well.

    As a realtor and investor my observation is the lack of building and previous reliance on Reo inventory has caused a serious shortage of properties in the low and middle end. Builders can't build homes cheap enough to meet low end demand. Where will the low end inventory come from to meet buyer demand?

    The reason I ask about historical trends is many experts say most areas of the country have not recovered to the historical trend of where house values should be.

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  • Tom Goans
    OP
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    Mark Ferguson,

    I have considered prices in Colorado and have been directly involved in the Colorado real estate business since the 1960s.

    I pay very little attention to comparables. I am not saying this is correct, it is only a very small factor in my personal considerations. Most of my focus is on the target market and employment.

    You cannot continue to sell Caddies to those who can only afford Chevys. It matters little what is taking place in another area. The other area may be so underwater the surface is unobtainable.

    With respect, I completely dismiss a recovery to historic levels. Most historic levels are false and unsupported. But, primarily, the economic landscape has changed - somewhat permanently.

    I do have very strong interests in developing affordable communities with a primary target market focus on seniors and the retiring - especially military.

    It can be done with the methods I have that are based upon my historical experience.

    Just my thoughts.

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  • Michael Spindler
    Aspiring MFR Investor - Kansas City, MO · Member since 2013 · 79 posts · 7 votes
    13y

    Tom Goans

    Originally posted by Tom Goans:
    Lessons Learned from Real Estate Market Frenzy

    ... The majority of the future population cannot financially afford the required payment demands of today’s investment strategies.

    ...........................................................................................................

    ...strong interests in developing affordable communities with a primary target market focus on seniors and the retiring - especially military.

    Hi Tom,

    Thank you for sharing your insight and experience. I really appreciate it.

    Two points you brought up have me a little concerned... Currency manipulation/bubble aside.

    I guess what I mean is that if a future population will have trouble making a mortgage payment, how can they be expected to pay a higher rent?

    I also suspect the second point you brought up will be further subsidized by the govt., in growing numbers. Eventually, this way of life will come to an end for those citizens that did not or could not prepare for retirement.

    As investors leasing or renting out properties, how do we protect ourselves? How can we move forward and meet our Customers needs while still making a profit. Where is the balance between being of service in the community, providing a quality home versus the bottom line and growing our business?

    When you mention a strong interest in developing affordable communities... would you be willing to shed a little light on what you have in mind?

    Thanks again for sharing.

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    I hear you saying buyers can't afford the houses they are purchasing now, however lender guidelines are much stricter now. What are you basing this on? Most lenders and industry experts in the REO field have said the default rate on loans since the new guidelines were implemented is extremely low.

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  • Tom Goans
    OP
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    Mark Ferguson,

    "Most lenders and industry experts in the REO field have said the default rate on loans since the new guidelines were implemented is extremely low."

    The word Most may be too broad of an assumption. This also applies to Expert. A month or so ago, there were reports released showing foreclosures and defaults were on the increase in two of the hardest hit states during the recent recession. Yet, this has been completely ignored and dismissed. The frenzy continues in these states.

    When it is announced the national consumer confidence is improving, the study is conducted by asking around 1,000 people.

    People seek and follow only what they want to perceive.

    Depending upon which TV station you watch or which political analyst you follow, Kerry should be president right now.

    The same exact “Most Experts” statement could be stated during the first half of the 2000s and numerous other times since the 1960s. How many experts are on staff at Citi Group? How many incorrectly predicted the recession of the second half of the 2000s? I cannot begin to count the number of real estate agents who told me how the up real estate market of the 2000s would never drop. Even the top economist at the University of Colorado Colorado Springs stated numerous times from 2006 to 2008 that the recession would not be significant or even experienced in Colorado.

    During the up market times, all is perceived as good and the red flags are ignored. It is during the declining markets when mistakes are revealed. Many times, the resulting mistakes are turned into finger pointing and denial of self-responsibility.

    It is not an assumption the population buying power has been on the decline for more than a decade. A government study released in April 2013 revealed the workforce is at 1990s levels. The number of full-time workers has been declining. Businesses are doing more with less workers - a trend that has been developing for decades. The population is aging rapidly. There are fewer workers feeding the retirement plans than retirement demand. It is not an assumption that the U.S. lenders are cutting back because of their own country financial challenges.

    There is very little sustainable evidence these trends will improve much, if any. I am intentionally leaving out a huge debatable assumption. What will happen to all that government debt and the unfunded retirement plans?

    This is the basis of my viewpoint the future population will not be able to afford the current levels of loan and rent payments.

    It is nothing new that “real estate investors” and real estate agents become caught up in frenzies any more than Wall Street day traders becoming caught up in frenzies.

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Tom, you mention two states have increasing defaults, what about the other 48 states?

    If you are so concerned with retirement savings and developers getting into trouble. Why are you gearing development towards those retiring? It seems you are going against everything you are warning us about.

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  • Bill B.Pro Member
    Camarillo, CA · Member since 2013 · 217 posts · 86 votes
    13y

    Mark Ferguson I think that Tom Goans is saying that the entire northern hemisphere is unstable. China is cooking their books big time, the Eurozone is still in crisis (it has just dropped out of our headlines for a while) the whole middle east thing can precipitate something very nasty in hours, and we have NO coverage in this country about 100 TRILLION in unfunded mandates at the federal level alone. Add several trillions more for federal state and local "promises" to retirees, the poor, the aged, etc.

    To state it most succinctly, the United States is bankrupt by any objective evaluation. Just as families who are bankrupt keep pushing off the inevitable, the US is also. When will it all collapse? THAT is the question.

    Tom (and I) believe it is soon; well under ten years, probably five or less....but that is NOT certain....we've become experts in kicking the can down the road. QE by the FED has prolonged the agony and seems poised to continue. But, end it must. There are ways to mitigate this: cutting benefits, ending programs, and MASSIVE increases in taxes. (not an either or, it will be some amalgam of the above) When the proverbial poop hits the fan there will be turmoil and riots just as we've seen in the Eurozone.

    Tom, please correct me if I'm wrong, but Mark, Tom is NOT saying to stop investing. He is NOT saying to eschew ALL debt. Tom is merely cautioning that debt must be used with EXTREME caution and prudence in this environment.

    We're talking about an adjustment to the entire economy that will make the mid 2000s look like nap time in kindergarten. That is why Tom mentioned the two states where the RE bubble is re-inflating. Those two states CAN pull the rest down if the general economy has a severe recession.

    So, KNOW your market and evaluate it with a very critical eye. Is the area's major employer supplying a market with inelastic demand (healthcare, to a large degree) or goods that will be unaffordable after the fall? (RV construction comes to mind) AND, after that type of analysis is complete, buy VERY right. BP has thread after thread about buying at discounts. I believe that Tom is merely suggesting that newbies hold out for even deeper discounts to market as that added cushion may be what stands between them and losing the property after the downturn.

    And, finally, debt. If you are fortunate enough to purchase at a 40% discount, maybe 50% down is a bit more prudent in this environment. Those numbers provide some leverage, but also provide 70% equity. I'm a newbie, I'm NOT advocating those percentages. I'm merely providing an example. Is 70% too much equity? Not enough? Everyone must evaluate those questions in light of their personal circumstances, tolerance for risk, available capital, etc.

    Personally, I wish Bernanke would stop QE in full very quickly, up the FED Funds rate by fifty basis points and let the market clear. There will be howling and unrest. Then it will pass. The dust will clear. The truth will be out. And we can all carry on with a clear picture of what things (in RE and outside of RE) are worth.

    Again, Tom, please understand that I am not trying to speak for you. I hope that I've presented your position fairly. Please forgive me and school me if I am out of bounds. Mark, I think Tom would encourage you to continue, with caution, prudence and a profound respect to the other edge of that double edge sword called "debt".

    With utmost respect to ALL on this post and throughout BP, a great, GREAT community.

    Bill

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  • Tom Goans
    OP
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    I do concur with what Bill B. has stated.

    With a special emphasis on “Tom is NOT saying to stop investing. He is NOT saying to eschew ALL debt. Tom is merely cautioning that debt must be used with EXTREME caution and prudence in this environment.”

    To expand on the debt issue, look to the lessons learned by some just a few years ago. A property with a stack of documents - including an appraisal, real estate comparables, and proven cash flow - claiming a Market Value in 2006 was worth less than 1/2 a year or so later in some markets.

    I do feel there is a need for new attitudes towards debt and entitlements, including debt is an entitlement. Too little was learned and embraced from the recent recession.

    As Bill stated, consider the primary employers in the community when assessing an investment opportunity or raising rents or predicting values. When I was a youngster, no one would have dreamed the auto industry would fail. And, yet ...

    This leads me to Mark’s questioning of my thoughts regarding the retiring market. I must not have articulated my point correctly. I believe the growing retiring market is a fact that presents numerous problems as well as opportunities for those who can provide affordable housing options. By the way, I am a baby boomer.

    I lived through the late 1970s with double-digit inflation and interest rates at 21 percent. Even if you qualified, there was no money to borrow. Is the same possible in our near future? It is your decision. I do know I, like many others, survived. I do not know one real estate investor/developer that survived entering the period with a large debt commitment.

    It is less about trying to prove a philosophy and more about learning from history.

    One of my favorite personal mottos is:

    Be the Best Informed and Prepared Person in the Room

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Bill B.,
    thank you for your post, that was full of information.

    Tom Goans,
    My concern is I see your posts telling us how evil debt is and how the markets are going to crash. You tell investors to be extremely cautious with debt, but give no details.

    Most people on Bigger Pockets are new investors looking to get started and have no other choice, but to use debt. They can't buy with cash, because they don't have it. In your other post you talked about how horrible debt was, but gave no ideas or specifics on how new investors should proceed. Should they not invest at all and just wait until the market crashes and then buy? Should they never buy Real Estate until they can avoid debt?

    There is example after example of investors on BP who have become very successful by using debt to buy Real Estate. Many have been able to quit their jobs and become full time investors. Is there risk involved? Yes, but the most successful people in the world take on risk all the time. They educate themselves, make plans and go for it.

    My question to you Tom, What is your advice for beginning investors who don't have the money to buy properties with cash?

    0Reply
  • Bill B.Pro Member
    Camarillo, CA · Member since 2013 · 217 posts · 86 votes
    13y

    Mark Ferguson with all respect, did you read Tom's last post? TOM said,

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  • Tom Goans
    OP
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    Mark,

    The bee in your bonnet is nonproductive and needlessly argumentative.

    The number of ways to invest in real estate without debt is limited only by the mind. I have already provided numerous examples.

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Tom Goans
    My goal here is to help newbies who may be scared off from investing because of the doom and gloom tone of the post. If I was a newbie reading this, my thoughts would be investing in Real Estate is a sure way to go broke. I'm trying to provide a counter argument that things may not be as bad as you portray them.

    I have read many of your posts, but not everything. I must have missed your examples on how to invest in Real Estate without debt when people don't have the money to pay cash. Please list one for me or send me a link to your previous discussion so I can put my mind at ease.

    I would also add I was around when the last market frenzy took place and most people including myself saw the writing on the wall. Most notably banks giving seconds for 110% to 125% of value. I am a Realtor and see the lending practices first hand. Things are 180 degrees different now than they were back then as far as lending practices.

    0Reply
  • Tom Sommers
    Houston, TX · Member since 2013 · 6 posts · 0 votes
    12y

    Bill B's observation about the importance of taking a critical view of your market's fundamentals -- major employers' outlook, salary trends, etc -- as the foundations of supply and demand can't be understated. In the Houston area, we're looking at an in-migration of 3 million people in the coming years which, plus continuing strength in oil and gas, could be something of an insulator from the downward pressures everyone has mentioned in this thread.

    0Reply
  • Kyle Hipp
    Investor · Appleton, WI · Member since 2012 · 1k+ posts · 464 votes
    12y

    Bill, I can guarantee that the economy would be irreparably changed if monetary policy that you advised was implemented. We are working our way out of a balance sheet recession centralized in the household sector of the private sector. Households overleaveraged and when the recession began to unfold the party stopped. The assets where worth less and thus borrowing stopped. When borrowing stopped that lead to a decreased in spending which invaribly leads to a decrease in incomes. QE operations are simply asset swaps that provided liquidity to a seizing market, this averted a depression. As the economy now slowly regains health the household sector continues to repair its balance sheet and pay down debt. The private sector needs this continued support in order to regain stability. To pull out that floor would lead to decreased asset prices, further spending and income drops and deflation. Also as a main goal of yours, I believe being a lowering of our debt to GDP ratio would actually have the opposite effect considering the operational realities of our monetary system.

    As for the overall thesis. All people must constantly be aware of the risks that we are taking. These include the leverage or even lack of leverage that we use. We must be aware of future forecasts and the likelihood of economic events taking place. Our risks are constantly in flux and we must always remain vigilent in understanding any changes occuring and respond accordingly. I for one have made bets that a relatively low rate environment will endure in the medium term. Economic growth will remain low especially with the current climate in Washington with this idea that all debt and deficits are inherently bad at the national level. Monetary policy will remain prudent as we transition to Janet Yellen as Chair. A lot of events are up in the air and I must pay attention to be aware of any events derails this path.

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  • Eric TaitPro Member
    Investor · Houston, TX · Member since 2013 · 314 posts · 146 votes
    12y

    I look towards the durability of the payment stream as the metric for long term rentals.

    I am lucky to be in a resource and healthcare based economy (Houston) and my focus is workforce housing.

    Median income is around 42K in the city, but I target the historical 35K, two earner household and then keep my rents around 1/3 of their monthly take home pay. ($900 - $1350)

    This I think gives some downside wiggle room, and since we purchase for cash flow, I do not really care about the nominal price of the assets, just my basis in that asset based upon the long term cash flow prospects.

    I think that as long as we as investors keep an eye on median incomes of our respective markets, and make sure we are buying at a deep enough discount, we will alright and see the signs of the next bubble.

    1Reply
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