Speculative Real Estate Investors: What Now?
A: With interest rates rising, inventory rising, and a longer time on the market before selling, speculators are facing some tough fundamentals that all signal red flags for this type of investment strategy. The days of buying, renovating, and flipping for a quick profit are over. So, what is a speculator to do?
This post really affects housing markets OUTSIDE of NYC more as New York City is made up mostly of Co-ops, which we all know from my past posts are not speculator-friendly investments because of their restrictive policies. NYC real estate is blanketed, so to speak, from the prospect of a rush of inventory coming to the market by speculative investors looking for a quick profit.
Back in March one Detroit developer offered a free car with the purchase of one of their properties. According to the detnews.com:
Last fall, Seville Homes in Clinton Township began tempting home shoppers with choices that include a 52-inch TV, a stove-refrigerator-microwave package, a $2,500 Art Van Furniture gift certificate and free hardwood floors and granite countertops."We're doing whatever we can to get them to buy," said Bob Mitchell, director of development for Seville Homes.
Now the builder is planning to offer a new buffet of incentives that would allow buyers to get into a new home without paying closing costs, a down payment or mortgage payments for the first six months if they finance through LaSalle Bank.
And I recall this Curbed.com post about a Free Vespa Scooter for purchasers & brokers who sell the remaining units at 154 Attorney Street.
While now is probably not the best time to be a speculative investor in real estate for some pretty obvious reasons, let's discuss what a speculator might want to do now to adapt or hedge their bet should the housing market remain slow. Here are some ideas:
1. Change Location - Buy Bulk Instead of Premium: Why not? Coastal reeal estate is still very expensive and doesn't seem to me to be the best place to make money in the short term. So why not buy more land/real estate for your money and take a more longer term approach to your investment strategy. Markets such as Philadelphia, Dallas, Houston, Indianapolis, Raleigh, and Pittsburgh are way undervalued compared to markets such as New York City, Boston, Miami, Los Angeles, & Naples and offer some great buying opportunities in times like these. In Philadelphia for example, you can probably buy 2 or 3 properties for the same price you could buy 1 in Los Angeles! Just seems like a lower risk, higher reward situation to me.
If you do want to stick with these higher quality markets, buy a few cheaper properties instead of 1 big one. Spread out your risk in a few neighborhoods and look to rent out your properties and hopefully get 80-85% of your total cost back in rental income until you decide to sell. Even with rents rising lately in NYC you shouldn't expect to buy a new property and make money renting it out immediately. If you do, you got a great deal!
2. Write Calls / Buy Puts in New Housing Futures: The quickest and easiest way for a speculator to hedge their bet should they lay a lot of money down in a high risk/high reward market such as Miami or Las Vegas, is to Write A Call Option or Buy A Put Option on the new Housing Futures traded at the Chicago Mercantile Exchange. Both of these trades would mean you are placing a bet that housing will fall and will MAKE MONEY if it does within the timeframe you bet on.
Buy A Put Option: In general, the buyer of a put option expects the price of stock to fall significantly, but does not want to sell the stock short because that could result in large losses if the stock does go up anyway. For housing futures, buying a Put option basically means you are betting the housing market will fall.
Write A Call Option: The purchaser of a Call buys the option contract from the Writer of the Call option, and is betting that the underlying security will RISE before expiration (time value against them). Therefore the WRITER of the Call contract is betting the underlying security will FALL and has time value working with them. For housing futures, writing a Call option basically means you are betting the housing market will fall.
*Options trading are very risky and should be investigated thoroughly before investing. Use of options as a hedge against another investment will cancel out potential losses should the market go against your initial investment. Always contact your financial advisor before buying any housing futures so that you fully understand what your risks are!
3. Create Separate LLC To Minimize Equity Risk: Many speculators already do this so I am really reaching out to the average investor here who may not know about this concept.
Put each individual property into its own separate entity, such as an LLC, and try to withdraw as much equity as you can from the property. Should the property fall below the face value of the mortgage, you can declare banktrupcy and walk away leaving the bank holding the asset. The bank will be left exercising the lien on the property as it takes control of the asset. Your loss is the only equity you put into the property. Your credit will be seriously affected for a period of time, but you won't suffer as much financial loss.
This is what speculators did in the 1980's & early 1990's which pre-empted the Savings & Loan Crisis and resulted in the formation of the RTC.
Resolution Trust Corporation (RTC): A corporation formed by Congress in 1989 to replace the Federal Savings and Loan Insurance Corporation and respond to the insolvencies of about 750 savings and loan associations. As receiver, it sold assets of failed S&Ls and paid insured depositors. In 1995 its duties, including insurance of deposits in thrift institutions, were transferred to the Savings Association Insurance Fund.
REMEMBER: Contrarian real estate investors pay MORE attention during housing slowdowns as deals start to pop up. You know what is out there and if something is a good deal or not; check out at least 10-12 properties in your target market to get a good idea of what is a deal and what isn't. Are you ready to jump on a property once the price gets reduced enough to reflect its current market value? Looking short term I think there will be a plethora of nice deals popping up!
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Comments (1)
Rural real estate is collapsing as energy prices soar, but eventually we are going to have to start using our prime agricultural land to start producing more local food. I would start buying land upstate...
Posted by peakguy | April 10, 2006 10:05 PM