In this article, I am sharing insights into the cyclical nature of the market and from my close personal experience, to highlight real estate investor mistakes to avoid. This is building on my previous blog Big Mistake Real Estate Investors Should Avoid. I will share how this experience shaped my understanding of real estate investing and has built success for me and my clients. Learning from these experiences will make investors much better able to withstand the inevitable real estate market shifts and cycles.
Real Estate Market Then and Now
If we look at the current conditions for real estate investing in the US and Canada, there are some striking similarities to the conditions that existed in the late 70’s to early 80’s. This was a period of rapidly increasing real estate values, increased inflation, loose government monetary policy and comparatively rapid increase in interest rates. From 1975 to 1981 real estate prices in Vancouver rose 240% and subsequently declined 35% over 18 months.
A comparatively rapidly increasing and excessively high interest rate was the norm. (In the US, the 1970s, mortgage rates were high, with the average rate for a 30-year fixed-rate mortgage hovering around 8%. In the 1980s, mortgage rates continued to rise, with the average rate for a 30-year fixed-rate mortgage reaching a peak of 18.63% in 1981. This was the result of the Federal Reserve’s decision to raise interest rates to combat inflation. Canada’s Interest climb was similar. As a result, Real Estate became THE hot investment, leading to increased demand and a frothy market.
- Real estate became the investment to get into leading to increased demand for real estate by new investors in addition to experienced
- Regular real estate headlines and commentary by the media
- Non-real estate industry “experts”
- e. Hot real estate tips being shared by taxi drivers
- Many inexperienced Real Estate Investors felt they couldn’t go wrong,
Fast forward to today! Does what I just shared not sound (and appear in the image below) a whole lot alike our current conditions?
A Real Example of Real Estate Investing to Learn From
In the late 70’s, someone very close to me was looking at options to improve his financial situation, considering he was the sole income earner in the household. Although he was in a management position and paid well, there was very little excess after paying all the bills for the household, tuition for his kids, etc. He was not a risk taker and invested in conservative financial investment instruments like mutual funds and bonds. He never invested directly in the stock market which was very volatile in the early 70’s. He was looking for a way to make his money work harder for him. Sound familiar?
His only experience in real estate was buying a couple of family homes over the years and he had done very well with the value of each home appreciating from his original purchase price.
He was constantly being bombarded by the news media headlines (almost daily in the late 70’s) and by others that he associated with, about how good and strong real estate has been in terms of growth in value and as an investment for them.
He researched the property and felt he negotiated a fair price for that time, but he also was dealing with constantly increasing property prices and was feeling the FOMO if he didn’t get into the market.
He decided that he better jump into the market to buy an investment property close to home and in a good location in North Vancouver.
He purchased a house for around $150, 000, which was reasonable price then.
He was confident that he could rent it out and manage it as he was handy and was not afraid of a little work. If everything went well, he could cover all his expenses and make a little profit each month. I don’t have the exact details of the rental rate, mortgage rate or taxes for that period but for a while everything worked.
Then interest rates spiked up to around 20+% in 1981 and he found himself in a terrible position of not being able to afford the mortgage payments that were almost triple of when he started.
That massive and rapid interest increase basically killed the demand for housing and the values dropped significantly somewhere between 35% and 50%.
Not only were his monthly mortgage payments now unaffordable, but if he wanted to sell the investment property, the market value of the investment property had significantly dropped. He had not accounted for any of this to happen when he purchased the property.
He was between a rock and a hard place as he could not financially cover the financing and operating costs of both his home and hold on the investment property, even with the rental income.
He was left with no choice in his mind, and he had no one experienced enough to turn to for advice, so he did what he felt was best for his family and peace of mind which was to stop the financial bleeding and cut his losses.
He sold the property as quickly as possible at the best price he could at that time based upon the time constraint, market conditions, and dropping values. He ultimately took a $50,000 loss. At that time (and any time actually!) that was very a significant hit.
In the end he bought high and sold low which is the exact opposite to what we always hear when it comes to investing. So, what are the mistakes and subsequent lessons learned from this unfortunate situation?
Lessons Learned from this Real Estate Investment
|Mistake||Lesson Learned – Possible Solution|
|He overleveraged his financial situation||Purchase something less expensive or purchase a house that had multiple suites. Rent out the home on a per room basis.|
|He didn’t have a contingency plan if something didn’t go according to plan||What was the plan for the property? How long was the intended holding period? Always have a contingency as nothing always goes according to plan. Always have cash for investment emergencies in addition to life emergency contingencies. He could have spoken to the bank to see what possibilities exist such as potentially extending the amortization period.|
|He did not have any exit strategies ahead of time and thus was forced to sell||Before he purchased, speak to someone who was experienced so that he could get advice on possible exit strategies not just selling. Could he have purchased a lower priced property, could he have done a joint venture, could he have employed a rent to own strategy?|
|He ignored the market trend, otherwise he would have known that the market was at a peak of the cycle||When the #1 story in the news is the real estate market, “everyone” is an expert and the investment “fishing hole is crowded” i.e. the market conditions are frothy those are signs that the market has peaked and most likely experience a correction. Take the necessary time to understand the macro and micro market fundamentals.|
|He didn’t do his research to understand real estate cycles and that timing is actually more significant than location||It is not Location, location, location. That is a REALTOR® terminology to sell houses. Location is important for sure, but timing is even more important as a real estate investor. Research the market so that you understand what you are actually doing. Get educated as it is a business. Read books on the subject like Look Before You Leap, BUT Leap.|
As I stated, this particular situation hit very close to home for me, because I wanted to know why this all happened so that I could avoid this very situation in my life.
It started my understanding of the many facets of real estate investing that can affect an investor’s success. If you are interested to learn more, click here for a free 30 minute consultation on real estate investing.