Real estate analysts are fond of breaking the market down into two essential sectors: smart money vs. dumb money. “Dumb money” consists largely of people who are ill-informed or are operating on last quarter’s news, or (increasingly these days) are automated systems whose rules aren’t in line with how sharp investors operate. “Smart money” — well, hopefully that’s you and the others like you who come to places like BiggerPockets to learn before you invest.
The smart money folks these days are investing carefully because many analysts are pointing to the formation of a new housing bubble as bad or worse than the one in 2006. This bubble is fueled not by American families buying a second home to rent out, but instead by the massive rush of foreign investors and massive conglomerates buying up hundreds of distressed properties at a time. This has led many analysts to conclude that housing prices are inflated not because actual demand is high, but because speculative demand is excessive — once the properties are purchased by investors, there simply won’t be anyone to rent it or buy it on the other side.
But bubbles are geographical in nature; not every market forms bubbles at the time or to the same degree. So how can you recognize a housing bubble and what can you do about it?
Signs of a Housing Bubble
The following list was harvested from a number of different expert articles. It’s nothing more a compilation of the items various experts look for when they define a “housing bubble”:
- When more subprime mortgages are being written by non-bank lenders than by banks.
- When there is a higher foreclosure rate on loans originating this year than last year.
- When home prices are rising significantly faster than average wages over several months.
- When the rent you could reasonably charge for a house is less than a reasonable standard mortgage payment on that house.
- When there are too many houses available to rent for the number of renters.
- When the housing market in the region is overvalued, especially when growth is below average.
Investing Into a Bubble
The standard advice, as you might expect, is that if you see bubble, you should find somewhere else to invest — or wait. That’s because the fate of a housing bubble is predictable — housing prices are going to plummet when the bubble bursts, making any investment you make a losing gamble as the value of your equity vanishes. But there are ways to avoid that failure if you’re canny.
One of the most successful strategies for investing into a bubble is to take a dramatically longer — or dramatically shorter — view of the market than the standard advice would give. For example, if you believe the bubble is going to continue to inflate for a few years, invest in a “fix and flip” strategy and sell before the pop for a quick profit.
Investing Outside a Bubble
Alternately, if you can find a market like Detroit that is significantly undervalued but showing signs of real growth, you can take the long-term strategy, counting on the fact that eventually the market will correct and your investment will pay off (and the rent will help cover costs in the meantime). This is especially true of areas that have a bubble forming nearby, as bubbles tend to have small ripple effects around them as they rise. So if you look around and find signs of a bubble in your usual area of comfort, spend a little time and effort looking for undervalued areas nearby — that way, you can turn the bubble into your friend rather than your foe. Don’t be the dumb money!
What do YOU think about the current housing market? Do you have strategies for investing when you fear a bubble is imminent?
Let me know with a comment!