Investing in real estate can be a very lucrative endeavor, but only if you make smart decisions. Many people have been asking me lately what’s happening in the world of real estate investing and whether they should be investing now or sitting on the sidelines.
The truth is, I don’t have a crystal ball — I don’t know what the future holds — but I look at data to determine where things may be headed.
Mark Twain said, “History doesn’t repeat itself, but it often rhymes”. We can look to the past for clues as to what might be in store for us going forward. Looking at historical data can give us an idea of how the market has moved in the past and using this information we may be able to predict where it is going.
Investors should also look at current market conditions, such as interest rates, unemployment figures, and housing supply & demand factors. These are all important indicators and real estate investors need to be aware of potential changes and trends so they can adjust their strategies accordingly. Here are three things that investors should keep in mind as we look ahead.
Mindset
When it comes to investing, our decisions are often heavily influenced by recency bias. This phenomenon is when we give more weight to recent events than those that occurred further back in time and can be a big factor in the way we interpret data. For example, a real estate investor may focus on short-term market trends instead of looking at the bigger picture of what has happened over the past several years. While short-term market trends may be important, they should not be the sole factor when making investment decisions.
It’s important to evaluate all relevant data when deciding to invest in real estate rather than just focusing on what has happened recently. Looking at longer-term trends can help investors better assess whether or not an opportunity is worth pursuing and provide insight into future opportunities that may arise from changes in the market.
The most recent recession in many investors’ memory is the 2008 recession. Due to recency bias, many investors are weighing what happened then more heavily than long-term, historical data. 2008 was one of the worst economic downturns in history, with US home prices dropping by 15-20% in some places. However, this isn’t the usual pattern for recessions. Typically, we see home prices decrease by 2-4%. In fact, experts have predicted that the next recession will be milder and result in only a 2-4% drop in home prices.
Recessions aren’t something to fear, even if they can be disruptive. They are normal parts of the business cycle. For nearly 14 decades, the United States has been in recession nearly 30% of the time — we’ve just been lucky not to have them happen recently! Since 1945 the average recession lasted about 10 months.
Investors would be wise not to let recency bias lead them to think that every recession will be just like the one that has happened most recently.
Interest Rates
When it comes to real estate investing, mortgage rates often have a huge impact on your investment strategy.
Don’t let recency bias cloud your thinking on interest rates either. When investors look at current mortgage rates, they might compare them with the past two years and assume that current rates are abnormally high because they have seen such low rates. Even when looking at the past decade, our current interest rates are much higher.
In reality, mortgage rates are actually relatively low compared to historical averages. According to Freddie Mac’s Primary Mortgage Market Survey (PMMS), the average 30-year fixed-rate mortgage was 8.12% in 1991. Rates were even higher in the 70s and 80s, reaching a peak above 20% in 1980.
That’s why it’s important to understand both historical context and how recency bias can shape our perceptions of where interest rates should be today.
When discussing interest rates, one of the things that I look at is SOFR. For those who do not know, SOFR stands for “Secured Overnight Financing Rate” and is the new benchmark that replaces LIBOR as the standard that financial institutions and instruments use. It’s basically the overnight lending rate that is used to determine the cost of borrowing money. Many commercial real estate mortgages are based on a spread over SOFR – meaning that if SOFR rises or falls, so too will mortgage rates.
If you’re a real estate investor, you’ve likely heard of the SOFR forward curve. This is an important tool for businesses and investors alike in helping to estimate future pricing and interest rates.
The SOFR forward curve works by taking into account the current state of financial markets, along with expectations about how those markets will move in the future. It does this by looking at a variety of different factors, such as market conditions, economic indicators, and other data points that can help predict how interest rates may change. This information then helps to create an expected range for where interest rates may be in upcoming months or years.
The curve isn’t always correct when it comes to predicting where things will go in the future. No person or tool can accurately predict these things. But we can take a look at it and use it as one of our data points when we are trying to understand where the market may be heading.
At the time I am writing this (January 3, 2023), the SOFR forward curve shows rates reaching their top in May of 2023 and then going down for the next 2.5 years. Going from 4.96% to 3.13% by November 2025. So it appears as if we are near the peak and the market is expecting a gradual decline from there.
Demand
One of the most important things to remember when investing in real estate is that it is all about supply and demand. The NAA (National Apartment Association) in conjunction with the NMHC (National Multifamily Housing Council) conducted a study to understand the future of US Apartment demand. They found that up to 4.8 million new units will be needed in the next 13 years to keep up with demand. There is clear evidence that demand will continue to drive real estate prices up.
Playing The Long Game
With the news of rising interest rates and a volatile market, it can be easy to feel overwhelmed and unsure of what steps to take. However, there is still an opportunity to make smart real estate investments, even during these challenging times. The key is to look at things from a longer-term perspective. No matter what fluctuations may happen in the market, there are always opportunities if you know where to look.
In my book, Backstage Guide to Real Estate, I talk about my journey from knowing nothing about real estate all the way to where I am now. I share the 18 Keystone Concepts that I learned along the way, and I think now is a great time to focus on Keystone Concept #5 – Cash Flow Is King.
In order to understand why cash flow is so important for investors, one must understand the cyclical nature of the economy. The US economy has been in recession 30% of the time since 1908, and it stands to reason that another recession is just around the corner. When this happens, having positive cash flow gives you resiliency and allows you to easily ride out these inevitable dips in the market. When assessing potential investments, make sure you only buy properties that generate positive cash flow.
Are we in a recession? I do not know. Possibly. There is going to be another one at some point. If we have that cash flow and a little bit more of a longer-term outlook, we can ride out the inevitable dips in the market and hopefully end up in a really good place.
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