Is a real estate correction imminent?

Real estate markets are uncertain, which means one thing: unwritten “rules” that govern their “behavior” are everywhere. One of the most popular is the prevailing opinion that a market correction occurs every seven years. Because it’s been 11 years since 2008, we’re long overdue, right? If only it were that simple.

The recession of 2008 saw the biggest housing correction ever, in which prices fell by as much as 30-40%. With such a major drop, it makes sense that it would take much longer to return to normal and then take even longer before it’s time for another correction. As one of my wisest builders likes to say, “We might be in the eighth inning, but it’s a 16-inning game.”

When you read about impending corrections, it’s also important to consider the source. I would hazard a guess that many of these doom-and-gloom writers have chosen to call San Francisco or New York home and that they’re on hands and knees praying for a correction to cool their absurdly overheated markets (where millionaires are being priced out of two-bedroom homes).

They might believe fervently in the perspective they hold, but the fact remains that they’re describing a different reality from the one experienced by the rest of us in the Southeast, the Midwest, and all over the middle of the country: Attractive homes are available in lovely areas at affordable prices.

Bring on the bulls

A few key factors drive my bullish real estate investing perspective, and the first is the sentiment of builders themselves. A real estate correction can squeeze builders the hardest, but sentiment in October 2019 reached its highest level in 10 months — an increase that represented the biggest change in six years.

At 15% of GDP, real estate is the single biggest contributor to the U.S. economy, and strategic interest rate cuts by the Federal Reserve are also bolstering the outlook in the sector.

Rates are currently hovering around 3.5%. To give you an idea of what that means in terms of cold, hard cash, a 2% reduction on a $300,000 loan is $6,000 saved per year (or $500 per month).

That means people can either afford about $80,000 more when it’s time to buy, or they’ll buy as they had previously planned and inevitably inject some of that $500 per month back into the economy.

Finally, credit programs have emerged that help buyers make purchases. FHA loans, VA loans, and rural development loans all now offer as much as 100% financing, meaning people can purchase a home with average credit and no money down.

Unlike the subprime mortgage disaster that is largely credited with setting off the recession, the financing options aren’t necessarily good or bad, but they do broaden the market for real estate to include more participants.

Delving into the data

When I take the pulse of a local housing market, I look for a ratio of 3:1. That means that the average home price in an area should be about three times the median income. If the ratio is lower, homes are particularly affordable in a market, such as the 2:1 you might find in Birmingham, Alabama.

On the other hand, California has a ratio that’s 5:1 or higher. While my focus is on real estate in the U.S., international data points can offer an additional perspective.

Head on up to Toronto and you’ll see a ratio approaching 12:1. Venture down to Australia and you’ll see 8:1.

What does this approach indicate for our country as a whole? According to the U.S. Census, median household income increased to just shy of $62,000 in 2018, while the median home price in the same year dropped to just over $240,000. 

That’s not an exact match of the “magic” 3:1 ratio, but it means that the average homebuyer can afford the average home. To dive a little deeper, we can look at another metric called the capitalization rate.

The cap rate is the cash return you get on your real estate investment. If you paid cash for a $100,000 home and got a net profit of $10,000 after a year of renting it out, you have a 10% cap rate.

You can get into good markets and get a cap rate between 7-11% on single-family homes, which in my opinion constitutes a good investment. It’s even better if you’re buying a home below replacement cost.

If you’re buying a home for $70,000 that would cost $150,000 to build new, you’ve got a relatively safe real estate investment.

Regional real estate

When investing in real estate on a smaller scale, it’s crucial to look at the tertiary markets. Everyone knows that prices in the Midwest are generally low, but if you’re looking for the untapped opportunity you might specifically look at Grand Rapids, Michigan, over metro Detroit or Fort Wayne, Indiana, over Chicago. 

Take the same approach to the Southeast and you’ll end up in Augusta, Georgia, instead of Atlanta or Jacksonville, Florida, instead of Miami every time.

That doesn’t mean that Atlanta is a bad investment. It’s a great market, and it’s one that my company regularly buys in, but you have to know what you’re getting into.

Cities such as Atlanta, Phoenix, and Las Vegas have experienced tremendous growth over the past five years, which means the biggest investors are already there. 

If you go to Atlanta ready to write real estate checks, you need to know that you’re competing with Invitation Homes (NYSE: INVH), which owns more than 100,000 properties. Not all of those properties are in Atlanta, but many are.

For these massive companies, capital is cheap, and they can borrow money at a rate of just a couple percent. Instead of competing in these high-growth areas that likely already experienced faster appreciation, you should at least consider giving up some appreciation in return for a better yield. 

In Atlanta, for example, you might pay $150,000 for a home that rents for $1,200. In Augusta, you can get the same rent each month for a $100,000 home, offering a stronger return.

Practice makes perfect

How do we know these things? Practice. Some people think about investing in real estate for decades but never work up the courage to start. To chase down that dream of your own, follow these steps:

1. Start today

Nine times out of 10, action will be better than inaction. Whether you visit some of the places you’re thinking about investing or decide to focus on a single local market where you see potential, you need to start now. Walk the streets and get a feel for the neighborhood. 

When you find something you like, put in an offer. The worst thing the sellers can possibly say is no. On the other hand, you could find yourself under contract for a lot less than you were expecting.

2. Avoid seminars

So many people pay lots of money to attend seminars where they’re told someone will help them buy homes. Those people aren’t real estate investors — they’re speakers who make a living off those entry fees, not sharing valuable knowledge.

Everything you need to know is available to you online for free. If someone is promising you insider secrets that come at a cost, just turn the other way.

3. Conduct research (for free)

Adopt the mentality that you are your own teacher. Consumer as much information as you can on real estate investing, whether it’s a local property owner’s blog or a prominent real estate investor’s YouTube channel.

You can absolutely do this on your own, so don’t wait for a teacher, a mentor, or a Jedi master. Start with Google and an open mind and you’ll learn more than you thought possible without paying a dime.

They say that timing is everything, but trying to time the market can get you into trouble. Instead of waiting until the next big crash to scoop up an investment property at rock-bottom prices, you’re better off starting now.

That correction might not come for another five years. Investing now means you’ll have that much more experience when it does eventually take place.

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(Featured Image by ArtisticOperations via pixabay)

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