With Markets Shifting, Should You Invest in Real Estate Now—Or Wait to Buy?

by | BiggerPockets.com

Remember the 2001-2006 years, when everyone was buying houses? Conventional wisdom at the time said you should buy before prices got much higher. Housing values skyrocketed and loans were given away like candy on Halloween.

Everyone was making money—until they weren’t.

By 2009, the music had stopped and the same people who were excited about buying were starting to get a little worried about holding. By 2010, those “smart” people were looking pretty stupid. Foreclosures dominated the marketplace, for sale signs sprung up everywhere, and the economy went from soaring on the wings of eagles to a pure nosedive into peril.

Now it’s 2018, and things are starting to look a little familiar in some markets. Where I live in the San Francisco Bay area, homes have been consistently selling over asking price for years—until now. An increase in interest rates caught buyers off guard, and many have checked out of the game until they can stomach the new normal of rates over 5%.

While the Bay Area market may have cooled, many markets across the country are still rising in price faster than rents can support. It’s so bad in some places that the local investors are left shaking their heads at how much an out-of-state investor is willing to pay for traditionally conservative value neighborhoods.

So, what should you do? Should you buy now before prices rise, or wait to see if there’s going to be another crash coming? Are we in 2012, when prices had just begun rising again—or is it more like 2005, when they were at their peak?

If you want to make the best decision, you have to consider all the facts. Before I make a black or white suggestion, let’s take a second to consider several market factors, strategies, and possibilities. There just may be a way to invest now and still be primed to take advantage if the market crashes later. I always recommend looking for ways to have our cake and eat it too when possible.

Are We at the Top of the Market?

When we say the word “bubble,” we are typically referring to an unrealistic, unsustainable value in an asset class we can’t reasonably expect to continue. In 2005, home values weren’t based on affordability; they were based on horrible loans that allowed people to borrow much more than they could afford. When those loans reset, nobody could pay them, and the market was flooded with foreclosures.

Today’s market is different. My day job is as a real estate agent, and so far, I haven’t seen any of these dangerous, adjustable loans that were prevalent during the last bubble. The majority of today’s loans have fixed rates, 30-year terms, and are based on a reasonable portion of the buyer’s income. Of course, home prices have risen since 2006, but so have wages! People often complain about how expensive housing is, but when is the last time you heard someone complain their job is paying them too much? Wages have increased right alongside home prices. If we are going to complain about real estate prices, we have to be fair and acknowledge wage increases as well.

So, are we in a bubble? In some areas, possibly. Does that mean we are headed for a crash like 2010? In order for a housing collapse, we’d need to see something more like overall recession.

What could cause this?

  • A hit to the job market (tech bubble collapsing)
  • A spike in interest rates to slow the economy (monitored and controlled by the Fed)
  • A national disaster like a war (beyond any of our predicting or control)

If this happens, many asset classes are going to take a hit, not just real estate values. It may feel “safe” to avoid the real estate market, but where are you putting your money instead? The stock market? Bitcoin?

Are those assets guaranteed to be protected if the economy recedes? Don’t be lazy and assume just because home prices seem high it automatically means we headed to a repeat of 2005. It’s not that simple.

What If I Invest Now and the Market Crashes Later?

This seems to be every investor’s worst fear, and let me tell you, it’s slightly annoying to hear all the time.

If you invest too early and the market crashes later, you’ll be kicking yourself when homes are cheaper. If you wait for the market to crash and it doesn’t, you could spend years not making any financial progress. I’ve heard people saying the market is about to collapse for five years now. Meanwhile, it’s just trucking forward and growing each year. There is really no value in using the market as your excuse not to buy unless there are clear, objective, and sensible signs the economy is unhealthy and heading towards a correction.

Related: How I Landed a Solid 4-Plex in Denver, One of the Hottest Markets in the Country

This question also assumes real estate markets are the same across the country. They’re not. A “crash” in one area doesn’t always mean there will be a crash in another. Some markets are driven by specific economic factors that aren’t affected by the rest of the country. Example? Texas. In 2009-2010, when much of the rest of the country (CA, AZ, NV, FL, to name a few locales) was losing value, Texas went by relatively unscathed. The same goes for parts of the Midwest and South that tend to operate independently of coastal markets.

So what’s the solution? Should you buy now or buy later? Wait for a market correction or focus on a great deal instead? The trick is understanding why it is you’re afraid to buy now and miss out later. If you’re asking me it can be summed up in two words…

Opportunity Cost

Opportunity cost is an economic term that refers to the price you pay when you miss out on one option in order to commit to another. In this case, buying house A can be a problem if you miss out on house B. If house B ends up being better (as in, you bought it after the market crashed and paid less), your opportunity cost would be the money you lost that you could have made if you’d waited for house B.

Think of it this way. Let’s say you have an opportunity to go work overtime at your job and make $200 or go to a concert that costs $100. Most people who go to the concert think it’s setting them back $100. That’s because they’re not factoring in opportunity cost. The reality is that concert is seeing you back $300—$100 for the ticket and $200 in lost wages you could have made while working. That $200 is your opportunity cost.

Many haven’t heard it called “opportunity cost” before, but they instinctively understand if they make one choice, they miss out on a better choice later. This creates the dreaded analysis paralysis that holds so many investors back. So how do you beat it? The BRRRR method.

What is the BRRRR Method?

BRRRR is an acronym that stands for “buy, rehab, rent, refinance, repeat.” It is the order by which you conduct the various stages in the “investment cycle” (my phrase) when you buy a rental property. When you BRRRR correctly, you can end up buying an investment property with zero money down. This often ends up resulting in a cash-flowing property that’s been fully rehabbed and sometimes puts more cash in your pocket than you put in.

How is this possible?

When you buy a house traditionally, you put a hefty down payment into it, then include money for closing costs and the rehab. The total of this money you’ve invested makes up your investment basis. This is used to calculate your ROI (return on investment). With the traditional model (non-BRRRR), there is always a heavy opportunity cost. If you put $35K down, pay $5K for closing costs, and have a $10K rehab, that’s $50K of your money you cannot invest anywhere else.

In this case, if the market crashes, you don’t have that $50K to invest in the down market, so your opportunity cost is high, as you miss out on the killer deal you could have got had you waited. This is the reasoning behind the “fear of missing out” that keeps investors from getting started investing in real estate. So, how do you overcome this? My solution is to remove the opportunity cost. If you can buy a property and recover the capital you used to buy it, what stops you from buying the next one too?

BRRRR-ing successfully is the way to accomplish this. In a hypothetical BRRRR deal, you would buy a fixer-upper property for $60K that needs $40K of rehab work. Throw in the same $5K for closing costs, and you end up with a total of $105K, all in.

At a loan-to-value (LTV) ratio of 75%, if the property appraises for $135K once it’s rehabbed and rented out, you can refinance and recover $101,250 of the money you put in. This means you only leave $3,750 in the property, significantly less than the $50K you would have invested in the traditional model.

It’s not too difficult to save another $3,750—and it’s definitely significantly easier than saving $50,000. This means you’ll have all that money to put into the next house when the market crashes. If you do this effectively, you can pull out even more money than you put in, growing your capital and the ability to invest in future properties.

Voila! No more opportunity cost.

How Do I Know Which Market to Invest in?

While no one has a crystal ball to tell you where the market will crash and when, there are some pretty standard metrics you can use to hedge your bet against a crash.

Diversified Economy

You want to avoid any area that is dependent on one employer or economic driver. Detroit is a great example. When the auto industry failed, so did all the home values. With no one able to find work, all the rentals went vacant (and so did everything else). Other examples would be North Dakota (oil dependent), an area known only for tourism, or a coastal village in Alaska that is completely dependent on fishing.

C-Class or Better Neighborhoods

Real estate investors tend to evaluate neighborhoods like school grades. A-class properties are the best spots in town, B-class is where the upper-middle class lives, C-class neighborhoods are your average areas with lots of renters, and D-class properties are problematic with high crime and high vacancy rates.

You want to avoid anything less than a C-class neighborhood. By investing in nicer neighborhoods in economically diverse markets, you avoid the worst of the negative factors when a market turns, and you’ll be able to ride out the storm. For more information on how a property is classified, ask a local top-producing real estate agent or property manager.

Cash-Flowing Properties 

If your property cash flows (brings in more income than it costs to own), it doesn’t really matter what happens to the value. If prices drop, that doesn’t impact you unless you sell. Experienced investors buy properties that produce income—and only experience price appreciation as icing on the cake.

Related: 6 Deal-Breakers that Disqualify a Market for Real Estate Investment

Look for properties in areas that meet the 1% rule. If a property will rent for 1% of the purchase price every month (a $100,000 that rents for around $1,000 a month), it is very likely to cash flow positively. If you focus on buying in areas like this and avoid bad neighborhoods and non-diversified economies, it won’t matter what the market does. Your investment will be safe.

If you’d like more information about these concepts, check out my book Long Distance Real Estate Investing: How to Buy, Rehab, and Manage out of State Rental Property. Don’t wait to buy real estate—buy real estate and wait!

In Long-Distance Real Estate Investing, real estate investor and police officer David Greene shows you exactly how he’s built a multi-million dollar portfolio on blue collar wages buying out of state rental property without ever even seeing it. Check out this read, available today!

How do you view current markets? Will you be buying up rentals in your locale?

Let’s chat below!

About Author

David Greene

David is a real estate investor/agent/author/entrepreneur/police officer in the CA SF Bay Area. David’s goal is to achieve total financial independence through real estate and to help as many others do so as possible. When not hunting bad guys, he hunts deals and loves talking real estate. To learn more about David, visit his website where you can also sign into his free investor’s newsletter and follow along as he walks you through his deals and shares his latest projects.

10 Comments

  1. Christopher Smith

    I’m a bay area investor (East Bay) and took the big plunge in early 2011 through 2013, then
    because of pricing shifted to the Midwest for a couple of additional acquisitions with my last coming in mid 2016 (when pricing became an issue in the midwest markets).

    My most recent acquisitions have been in publicly traded REITS, equity and mortgage REITS, but even those are now very rapidly becoming quite pricey. So I don’t anticipate much action there for the time being.

    I believe very much in the Buffett and Munger “margin of error” thesis, and for me any acceptable margin of error is long gone at current pricing levels given my limited ability to truly professionally evaluate real estate investments with great precision, notwithstanding my past aqusitions and current portfolio.

    I certainly recognize the risk of attempting to time the market by erroneously concluding that we are near a market top, but at the same time I already have significant holdings and cash is not the worst thing to have when (in my assessment) intrinsic values (factoring in a healthy margin of error) simply don’t support current FMVs.

    Others may conclude differently, and that is totally fair and ultimately what makes a market. But at this point, I personally can’t arrive confidently at decision to aquire more real estate related assets.

  2. Jerry W.

    Brian,
    I am a big fan, and agree with your analysis. Just to play devil’s advocate let me point out a few things about the BRRRR strategy. This is similar to the high leverage acquisition model used by many in the late 70’s and early 80’s before that crash. It can work, but remember value is only a number on a piece of paper until the property is sold and the money is in the bank. I have seen 3 fairly bad crashes now in my lifetime. When you BRRRR you also remove a safety margin. You can cash flow if you refinance everything out if the market holds up. When you pull all of your down payment out you increase your risk. The question is how much are you willing to risk. A 30% devalue in property prices puts the BRRRR in an upside down position on lots of properties, in fact all of his properties. A guy who pays 25% down and covers his rehab costs will grow a LOT slower than the BRRRR guy, but a 30% drop in value puts him still in the black. In my area even if I could BRRRR out all of my money I put in I am a little bit into the red for cash flow. Our market is not as healthy or robust as yours. The good news is there very little bubble left to burst, but there is some.
    So while I agree with your hypothesis, there is also a danger factor by using BRRRR that needs to be acknowledged. Is it an acceptable risk? Probably so, but is still a real risk.

  3. Mike McKinzie

    Very good blog, thank you. The most difficult thing to do in Real Estate Investing is to BUY YOUR FIRST RENTAL!! The next most difficult thing to do is to NOT treat it like it is some kind of hobby or job. If you drive by it your rental often, tell other’s that you own it or you become friends with your tenant, you are NOT a Real Estate Investor, you are a hobbyist. I can’t wait to read your book as I have been investing “out of area” since 1985. I am not a big fan of the BRRRR method as I like to have good financing in place when I BUY it and refinance costs can be a real profit drain. But others make it work and I congratulate them. I was talking to a lender earlier this week and he was telling me that all loans under $200,000 have a higher point cost and a higher interest rate as most banks/lenders don’t want to mess with that low of a loan (my last car loan was $60,000) Anyway, a couple of more things to keep in mind when starting out investing. The 1% rule can be tough in good appreciating markets, so give yourself a little leeway. In a good market, I will pay $120,000 for a house that rents for $1,000 a month. That lost $200 a month is usually more than made up for in appreciation. Next, try to NOT have your PI payment be any more than 50% of the rent, one month’s rent should equal two mortgage payments (not counting the taxes and insurance) For instance, a $500 month payment at 5% allows you to borrow about $93,000. The other 50% of your rent goes into RESERVES, DO NOT SPEND IT. Repairs, vacancies, Capital Expenditures are tough without reserves. My first 20 years in Real Estate Investing, I took NO MONEY to spend, it was all there for reinvesting and repairing. This is a LONG ROAD TRIP, not a day trip to Disneyland. By doing it this way, I fully retired at age 50. So follow the writer’s advice, don’t get locked up in Analysis Paralysis. Do Due Diligence, make that first purchase, and you are on your way to financial freedom.

  4. john prinz

    I would also recommend thinking about max leverage on some and zero on others. In case some bad markets hit, if all your properties are encumbered, Selling won’t produce much cash. It could take down the whole ship! If some houses are un-leveraged, you can sell one or two of them and have all the proceeds to assist in short term survival.

  5. Nathan G.

    David, thanks for the great article! My foundational belief is that there are good deals in every market and investors can make money in every market. We need to buy smart and avoid over-extending just to get another door under our belts.

    If we buy a property that cash-flows $200 a month, ensuring we’ve accounted for all expenses (taxes, insurance, capital expenditures, repairs, and property management) then we should be able to handle a down market. Our property could lose equity, but it won’t matter because we can continue holding the property until the market recovers and we get the equity back. If rents decrease, it won’t matter because we can handle a $200 monthly decrease before it impacts our ability to pay the mortgage. We can handle even more if we have a proper reserve and multiple properties that spread out the impact.

    The bottom line: buy smart in EVERY market and you should continue to prosper, even in a down market.

  6. Sam Shueh

    The SFBA market may have slowed downed a bit. Bargain hunters are abound. While the flippers are hesitating and have to turn down offers that do not provide a ~$300K profit. It is rare that homes are sold below listing price. Home sellers do not hesitate to ignore the low balls as before and will accept a solid offer at least asked or higher to get into an entry level. The reluctant home sellers take it off the market and put it back in the future for more. The economy is fine. No high tech layoffs.

  7. Tim Simmons

    If the stock market continues to decline, the SFBA market will continue to soften. Stock options are providing people the ability to pay $1.5M for 1400 Sq ft, 1960’s houses. When tech works decide to wait to cash in their options and move it into RE, sales will suffer. We are just seeing the beginning. If the stock market recovers, RE will be OK here.

  8. Dave Rav

    Decent article. It does make us think about the past. The market is certain cyclic, and one is smart to look back and learn from past occurrences and happenings.

    I want to point out a few things. You mention jobs basically keeping up with housing. I want to admit, I believe is select markets (not all) this is a fallacy. Lets take your market there in SF for instance. I read on Think Realty that the average list or sold price (can’t remember which one) was $1M. That is significantly higher than most markets in the US. Lets take $300k as a a national average for sold (likely high). Your market is >3x that. Are employees there paid >3x what they’d make elsewhere? I doubt it. If so, you’re telling me doctors (gen practitioners) who make $120k per year would make more than $360k per year in SF? Gen practitioners? Show me. And the customer service rep making $35k year elsewhere would make $105k in SF? Again please show me. The truth is, this is not the case. The jobs there do pay more, but probably 90% of the jobs are not paid 3x more. Thereabouts is what would be needed to keep up with those increased housing costs.

    New point – i do agree its annoying to hear “buy now” or “wait and invest”. Essentially, one needs to just jump in and get their feet wet (after doing some diligence). Do your best to “buy right” and you just may be ok in this changing market cycle.

    Thanks!

  9. David Greene

    Hey Dave,

    Thanks for your comment.

    We disagree on the premise if a house is 3x more expensive that the jobs would have to pay 3x as much. You built your argument on that assumption and I don’t think it was a solid foundation.

    A house can be 3x more money but that doesn’t mean the payment is 3x as much. Low interest rates make it easy for expensive homes to still be relatively affordable. Basically sales price isn’t the same as the monthly payment.

    This point is most accurately observed in the way lenders approve buyers for mortgages. Lenders don’t look at your income and related it to a specific housing price you can afford. They look at your debt-to-income ratio and tie it to a monthly payment you can afford. The price of the home isn’t the same as the monthly payment. Different factors like interest rates, property taxes, homeowners insurance rates, etc all affect that.

    The second point where we disagree is you are referring to primary residences in SF, whereas I’m focusing more on investment property throughout the entire country.

    My point is that with rising wages come rising home values and rising rents (unless the supply expands along with the rising wages in which case you could see the demand stay flat or even drop, which would not lead to rising prices-this just never really happens). I wasn’t saying that the relationship between rising home prices and rising wages is exactly 1:1 even.

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