Proceed with Caution: Low Prices Doesn’t Necessarily Equal Quality Investment

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The great real estate boom reached its apex in 2006—and then the bubble burst. More specifically, the single family home bubble burst. Now, for the first time in years, condos and townhomes are suddenly affordable for a lot of people in places like California, Arizona and Florida. Combine this with Obama’s tax incentives and you’re looking at a buyer’s market. While this is great for able and willing prospective homeowners, it could prove to be a trap for real estate investors.

“I’m buying homes for 50 cents on the dollar!”

The question on most investors’ minds is “has the market reached the bottom?” The definitive answer is that nobody knows. On the BiggerPockets.com bulletin, Joshua Dorkin posted a link that addresses this very issue. In the article, the author argues that there will not be a quick recovery to home prices. That may or may not be a true statement (although I’d bet he’s right), but home prices are definitely selling at prices half of what they were three years ago.

And therein lies the trap

Some real estate investors like to think that they are purchasing single family residences at steep discounts—“50 cents on the dollar!” But this begs the question: to what dollar are they referring? If they are comparing their purchases to 2006 prices, they would be correct. However, if every other “investor” in the market is picking up homes at “50 cents on the dollar”, then 50 cents IS the new dollar. They’re buying homes at the new market value, and nobody knows when that market value is going back up. In fact, the market may still be searching for the ever-elusive bottom.

Every real estate investor must have a plan. If their plan is to buy up multiple single family residences at “steep discounts” only to flip them in a year or two, I urge you to proceed with caution. If you plan to rent out these properties, be sure to be conservative in your cash flow analysis. After all, remember you have two possible vacancy rates with single family homes: 100% and 0%. This is one example of how investing in single family homes is inherently more risky than multi-families.

I can’t stress enough how your conservative cash flow analysis must make sense before choosing to invest in single family homes. The cash flow has to make sense because betting on appreciation (in the short term) is like betting Michael Vick will be the NFL’s MVP next year.

I’m not trying to be a Negative Nancy

Many multi-family markets have sunny outlooks for the next few years. Those markets have strong economic bases, desirable locations, low vacancy rates, and the potential for rental rate increases. Remember, a residential income property’s value is directly correlated to its net operating income—if it goes up, so does the value of the property.

There are still deals to be had, but don’t be fooled into thinking it’s an investor’s paradise. There are still deals out there and they will always be there if you know how to look for them and you utilize careful analysis and effective planning. Happy investing!

Image by Getty Images via Daylife

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.