Buying Real Estate as an Investment

To listen to any newspaper, TV show or magazine from a few years ago, you could be forgiven for thinking that buying real estate as an investment was an absolute guaranteed return. One thing the financial crisis has taught us is that real estate is like any other commodity - it can go up or down in value in the short term.

Many people failed to take into consideration the underlying fundamentals and found themselves over paying for a property they could not afford, anticipating that the market could go in only one direction – up, and that they would be able to either refinance or offload the property at a profit when the time came.

The simple fact is that the housing market, like any other market sees highs and lows, and historically, never really wavers from average home prices being around three times average incomes. Any time the market diverges from this fundamental we are seeing either a boom or a bust situation, and the market invariably overshoots on both occasions.

At the time of writing this (23rd March 2009) we are going through a correction phase after one of the biggest asset bubbles in the history of asset bubbles. The housing boom of the late 1990s to early 2000s was fueled by easy access to cheap financing and government interference in the free market economy. This asset bubble then fueled several other bubbles which are also deflating.

My feeling is that real estate markets all over the world will overshoot and fall well below the three times average salary range. With anything in life, timing is everything. If you are considering buying property as an investment, bear in mind that the correction is nowhere near over yet. That is not to say one should discount the idea of buying property – just that there is likely to be short term loss on any property purchased during the down swing.

Realistically, real estate is a good long-term investment rather than a quick in and out profit. A lot of investors got caught with their pants down when the financial crisis took hold and saw years of past “profits” wiped out in one fell swoop after over extending themselves on that “one last deal.” As did the banks and insurance companies that got caught up in leveraging the mortgage-backed “assets,” that are now discovered to be worthless investment vehicles.

The financial crisis is exactly that – a crisis. The fact is, most of the world’s banks are insolvent, and most of the world’s governments are putting themselves into insolvency trying to prevent the banking system from collapsing. Both the British and American governments are printing money in an effort to induce an inflationary cycle that will reduce the real value of outstanding loans. Whether they will be successful or not is anyone’s guess, but I predict another two years of deflation followed by massive inflation.

Which means that some time in the next two years will be a good opportunity to invest in real estate. As a long-term investment. Even the luxury property market is not immune to the current downturn, and prices in certain markets have fallen drastically in a matter of months. Dubai for instance has seen falls of up to 60% in just six months. I would consider very carefully before buying property in Dubai, as there is a good chance this market will not recover for many years. London, Hong Kong, Manhattan and Long Island saw falls of around 25% in the last quarter of 2008 and are continuing to decline.

Timing is everything. Using the three times salary average price point is a good starting point when looking at a local market. Obviously averages are just that – average. Some areas in some towns are above average, and vice versa, but to give an idea of when the bottom of the downturn will be reached, this metric is almost perfect. For example - In the UK, average salaries are around £25,000. Average home prices – even after falling through 2008 – are still around £155,000. 6.2 times average salary. Which gives an idea of how far prices are likely to fall in the UK. The time to start buying property as an investment in the UK is when average prices reach three times average salary.

Do some research

Markets vary wildly, and some markets were extremely over-built during the boom years. A few that come to mind are Las Vegas, Miami, Dubai and Spain. There are certain parts of Miami that may never recover. So maybe that 50% off luxury condominium in Miami is not such a good deal when you discover the amount of empty units and the amount of still unfinished units coming on the market. Spain has an estimated 1.5 million newly built properties sat empty – on top of the thousands that are for sale by owners. Dubai is facing serious social issues as well as coming to terms with the crisis. Do some research in whichever market you are considering investing in. Caveat Emptor.

Get your financing in place in advance

Even when the bottom of the current downswing is reached, financing is still going to be hard to come by for those wishing to get into real estate investment. Do not expect a swift return to the halcyon days of 125%, no deposit mortgages. I suspect (and hope) that some sanity will prevail in the lending markets, and it is likely that a 25% deposit will be required to obtain a mortgage in the future. Cash is king – if you have cash, look for some good buys over the next 18-24 months – but – do not be pushed into an investment by an over-eager real estate agent.

This was written in response to the hubmob weekly request, but I have written a number of other hubs on real estate including these: