I started investing when I was 30 years old and I have probably bored more than enough readers with my recitation of my history plenty of times in the past. But I think it bears repeating that I was attracted by the “shiny object syndrome” that so often gets attached to real estate investing. In the end, I was one of the lucky ones who knew how to work hard, how to kick a little dust off when I got beat up and how to eventually learn enough through experience to no longer be a danger to myself. Unfortunately, there are still many out there who gravitate to real estate for the wrong reasons and find there way to the table only to get carved up by a reality that is not nice to those that do not understand the rules. How is that for a first paragraph!
I have been noticing recently a lot of posts on real estate forums, including those on BiggerPockets, where posters are asking questions about creative financing and how to buy properties with no money down or refinacing with cash out. This surprised me and I was wondering why the sudden uptick in interest. Then the responses surprised me as well as many readers were commenting on either how they were accomplishing these creative strategies or were just as interested in what the answers may be. I wondered to myself about history repeating itself.
As if that were not enough, I received a piece of mail that bothered me even more. It was from a bank in another state and they were encouraging me to refinance my home to a cheaper rate. And the best part was…no appraisal needed! Just tell them what the value is, they will do a desk top appraisal and we are off and running with a super low rate of 3.99% (for the first year of course) and then a nice adjustment each year there after of no more than 1% for 5 years.
I am a student of history. I love reading anything and everything that I can get my hands on and, if the book grabs my attention, I will keep reading. Last night I had no idea what this weeks’ article was going to be about. Lately I have been in kind of a creative funk because I want to put articles out that are going to make a difference and I just have not been sure lately what subjects to tackle. I performed a Google search on some different phrases including a question I tackled last week on my own blog about public works projects and there effects on real estate investing. And that is when my journey of research began.
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What History Can Teach Us About Real Estate
“Nearly every one of us has been made directly aware, in one way or another, of that much talked about bugaboo, The Housing Problem.”
Some of us have found the house we were building cost far in excess of estimates. Some of us have had our savings sacrificed through a foreclosed mortgage because we were unable to pay a large amount on the due date. Some of us have seen the neighborhood go to pieces around us in spite of our efforts to keep up our own property. Some of us have had to relinquish a cherished holding because of mounting taxes. Many of us, for all our searching, have been unable to obtain a decent house within our ability to pay.
It is a rare family indeed which has not discovered that hte housing problem is a thing which not only concerns social workers campaigning against slums, or bankers seeking safe outlets for their funds, but a matter which affects almost every phase of day-to-day living.”
I am not sure what you think when first reading that, but my first thoughts were that this came from a report from some government agency or real estate researcher, possibly a think-tank, and they were lamenting the state of the current housing crisis. Maybe it was from a research paper trying to tackle housing issues and searching for a solution. Knowing the topic, some readers may have guessed this was written in the early 90’s during the last housing crisis. Maybe it was from the early 80’s when 15% interest rates priced many home buyers out of the market.
I will tell you that, if like me, you thought this was from a recent report on U.S. housing problems within the last 30 years you would be wrong too! It was written by Miles Lanier Colean in 1942. The title of the text was “Can America Build Houses” and it was intended to challenge the American psyche and inspire change from the thinking that existed at the time. Read this next passage and tell me if it sounds anything like challenges facing our cities today.
“If we take the evidence presented by the survey of housing conditions made in sixty-four cities in 1934 by the Department of Commerce, we find further misgivings. The Survey shows that, after a period during which we built more houses than ever before, only 37 percent of the dwelling units in these cities could be considered in good condition, that over 15 per cent needed major repairs, and between 2 and 3 percent were, by any standard, unfit for use. It shows that the surprising figure of 23 percent of the dwellings did not have what we long considered the normal sanitary conditions.”
If this was the state of housing in 1942, why then are we still dealing with some of the same problems today?
Not to get off on too much of a side note here, but if this is the description of housing at this time, why are so many investors attracted to housing built during this time period and directly after? I am amazed at the number of investors I talk to and they tell me how excited they are to be buying a “cute little bungalow” in some far away city built in the 1930’s and how excited they are to start earning cash flow. My question now is going to be…if it was a piece of junk then is it a piece of junk now? That conversation can be for another day, but it does lend itself to a problem of today.
Who Called The Housing Crisis…And When Is the Next One?
I had two opportunities to learn from others back in the early 2000’s but chose to beat my head against a wall and take the road less traveled. That would be the dark, windy road full of potholes and broken bridges! Twice I had people close to me tell me to study up and be careful. I was taking risks that I should not be taking and that danger was directly ahead. I had a good friend in Florida who was investing in single-family rentals and he suddenly backed off the market and contacted me to advise me to do the same. He had been reading a blog kept by an economists in Florida who was publishing and writing about data from Peter Schiff. The premise at the time was that defaults on sub-prime mortgages were ripe for exploding and that housing prices were growing faster than at any point in history. Housing starts were outpacing population growth, banks were lending to anyone who could fog a mirror and creative financing would cause massive foreclosures. I still remember my response…
After I got done chuckling at him I told him to relax…I had been investing in real estate for 3 years, if anyone knew the market it was me! This was in 2005 and, after all, I had Ben Bernanke on my side:
(July, 2005) “We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.” -Ben Bernanke
(October 20, 2005) “House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals.” -Ben Bernanke
(November 15, 2005) “With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.” -Ben Bernanke
No need to play politics here because, for this article anyway, I don’t really care which way the Fed Reserve leans. As dumb as I am, there were a lot of people who are supposed to be really smart telling me and every other investor at the time that the economy and the housing market were safe. If I had simply studied history and expanded my mind a little, I would be a much happier (maybe), have a better performing portfolio (maybe), have experienced more restful sleep nights (for sure), and possibly not had to go through the painful lessons of a real estate investor who over-extended and bought properties simply because he could instead of because he should.
Outside Forces that Affect Your Investing
The second piece of advice I received is what shaped my future buying decisions and really helped me build a stronger portfolio once I dealt with the aftermath of my original crazy purchases. I had a home builder here in Memphis who had lived here all his life (over 50 years) sit me down and educate me on what I was doing. It was in the fall of 2007 and I was knee deep in worry, bills, paperwork and desperately trying to keep my sanity. Luckily, I was able to offset any losses I was experiencing in my real estate portfolio with the other companies I had started. That being said, I believed like many did at the time that the U.S. economy as a whole was going to be o.k. and I was looking at continuing to expand my portfolio as a way to hedge against the losses I was taking. I wanted to mix better properties with the losses in hopes of mitigating the damage and even Ben Bernanke was giving me hope:
(May 17, 2007) “All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.” -Ben Bernanke.
Ahhh – ignorance is bliss!
So my builder friend sat me down and asked me to pull up several of my properties online so we could research them. He pointed out to me that as an investor, I would only have success when I recognized that there were many outside forces at work in the market and most of them conspired against my success. He really educated me that there is so much more to picking and choosing the right investments, especially in property, than simple numbers on a spreadsheet. He pointed out that I really had to dig into social and economic factors and conditions not only in the cities I wanted to invest, but also in the neighborhoods and the streets themselves.
He showed me that most investors come in and get out quickly and they secure their profits and move on. For investors like myself who were looking to build a generational portfolio that cold be passed to my heirs, there was a lot more danger.
In looking at my portfolio he showed me where houses that I was purchasing built in the 1940’s through the 1960’s were originally sold. In researching the records we could see all of the activity on the homes. He showed me where the house sold when it was built for a price of mid $20,000’s. At some point in the next decade it may have been foreclosed or lost by the owner. It was then sold to another person for somewhere in the mid $20,000’s. Then again the next decade and again the next and so on. And then I walk into the picture. I was buying this house for the mid $20,000’s and receiving a bill for $20,000 to fix it up into a great rental property. Anyone familiar with investing at that time can probably relate to being told that they property was actually worth closer to $70,000 because sub prime lenders were lending all over the neighborhood to anyone who would buy at those prices. I was paying the same price that the property has sold for every decade since it was built. My investment was going nowhere but down.
There are a lot more details to all of those stories but his point was that throughout the history of that property in that area and in that neighborhood, it has been sold multiple times through the foreclosure process and always at that same low price. Regardless of what any independent appraiser or banker or city tax man tells you – history will always paint a full picture of the housing market. I needed to be buying where people wanted to live and fixing the homes to a condition that people wanted to live in. Plain and simple. No more buying because some spreadsheet showed me I would be making money. I had to dig deeper and learn from what history shows us.
There has been lots of blame throughout the housing crisis tossed around by everyone as well as plenty of solutions. My biggest worry is that any solution that we come up with has to take history into account. If you take any time to read some of Mile Lanier Colean’s works, you’ll find that he laid some blame at the feet the federal government for creating unintended consequences with taxes, fees and monetary policy. When you look at the most recent crisis, it is not too far of a stretch to say Colean called the current crisis 70 years ago. As I read the forum posts and receive more solicitations to do business, I can not help but wonder if he has already called the next housing crisis as well.
Image: Tony Fischer