Ahhhh, the good ole’ American Dream. A lovely wife, 2 kids, and to top it all off, a nice house in the suburbs with a white picket fence.
In today’s post, we’re going to focus on the “nice house” part of the American Dream. Since the 2006 real estate downturn, savvy investors have been snapping up dirt cheap properties all over the place here in the States. Unfortunately, many of the bargain deals are gone, and American real estate prices have already gone up a bit in general.
However, prices are still far below pre-2006 levels. Although bargain deals and undervalued investment property are becoming harder to find, they still do exist. Thus, the careful investor with a scrutinous eye will still be able to pick out good deals on real estate.
Note* In this post, I’ll mainly be looking at investment returns (capital gains) for real estate. I’m not discussing rental property.
Real Estate is a Leading Indicator for the Economy
What do I mean by “leading indicator”? Real estate is the leader, while the rest of the economy is the follower. If real estate booms, then the economy will boom. If real estate busts (as we saw in 2006-2009), the economy will bust.
This is not just true for America but for every single nation around the world. Here’s a more concrete example. More than 20 years, then Chinese President Deng Xiao Ping decided that the chief driver of Chinese growth (aside from manufacturing) would be a real estate boom. This is because if real estate goes up, many other industries will rise with it. Real estate heavily impacts the manufacturing, raw materials, and labor sectors of the economy (hence why it’s a leading indicator). Thus, a real estate boom will result in a manufacturing boom, more development for raw materials, and more jobs. Looking back, President Deng’s plan worked (the economy took off), but not without side effects (e.g. real estate bubble).
Back to the U.S. What you have to realize is that unless real estate starts to pick up, the entire economy cannot pick up. This becomes a self-reinforcing cycle. If real estate prices stay flat or fall, the economy will cease to grow. If the economy ceases to grow, real estate will stay flat (people can’t afford second homes or bigger homes).
Thus, when real estate prices start to pick up, that’s a sign that the upcoming real estate booms is just starting. The real fun (watching your net worth grow) has just started. Wait for the economy to start growing at a brisk pace, and the real estate boom will really take off.
Real Estate is an Illiquid Market
The worst thing about American real estate (and real estate in general) is that it’s an illiquid market.
Illiquidity means that you cannot sell or buy whenever you want. When the market freezes and there ceases to be any buyers, you can’t sell your property.
Real estate is unlike the stock market where you can buy or sell whatever stock you own within minutes. In order for a real estate deal to be concluded, months are wasted going back and forth between the lawyers and getting the deal all signed. Months! That’s why real estate is also a slower moving market.
In terms of liquidity, whenever the real estate market faces a significant downturn, there ceases to be any buyers left. This is because when prices start to fall, many investors will think “if I wait, I can probably buy XYZ at an even cheaper price in the future”. This becomes another self-fullfilling prophecy; a lack of buyers who think prices will fall equates to prices actually falling even more.
Similarly, homeowners (families waiting to trade up to a bigger house) will hold off real estate purchases when the economy turns south. This is understandable – who wants to make a major purchase when they don’t know if they’ll have a job next month?
This lack of liquidity was evidenced in 2008 when many homeowners foreclosed their homes. Because there were virtually no buyers, based on traditional accounting standards banks had to report the value of their foreclosed homes as $0 (until the government stepped in and changed account standards).
Thus, this illiquidity in real estate has several implications:
- Real estate bottoms are very long. Because real estate is a slow moving market, it’s bottoms tend to be U-shaped, whereas for bottoms for stock markets tend to be quick and sharp (V-shaped).
- As an investor in real estate, you absolutely MUST sell your properties before the market peaks. Even if the market runs for another 10% or 20%, don’t regret your decision to sell. There’s no way to get out of real estate when the market faces a downturn (thanks to a lack of liquidity).
- Just because the markets have bottomed, don’t expect the real estate market to make a quick rebound. Bottoms are long and often last for years. Thus, for the investor who buys at the bottom, it’s probably best to use the property as a rental.
Real Estate Drawdowns and Returns Depend on Which State
Real estate prices in certain states fall and rise faster, whereas prices in other states will hardly fall. This all has to do with the fundamentals of the state.
Florida’s real estate prices fall the fastest in a downturn but also rise the fastest when the economy booms. This is because Florida is a popular vacation hotspot where a lot of the real estate is owned by investors as opposed to families who live there. Whenever a state is mostly owned by investors hoping to make a quick buck, the state’s real estate bubble will inflate and deflate faster.
Prices in California have hardly budged in the Great Recession thanks to a ton of rich Chinese home buyers snapping up property all over the place. In addition, a lot of wealth created from Silicon Valley results in rich and young high tech millionaires purchasing jaw-dropping mansions.
Thanks for reading this guest post by Troy! He blogs at www.TheFinancialEconomist.com about finance, investing, and the economy. Hope to see you there!
How has the real estate market been where you live? Would you invest in another state?
This post was featured on the Common Cents Wealth, Cash Funny, 2 Copper Coins, thank you!
Thomas | Your Daily Finance says
The real estate market where I am is tough. We have a lot of foreign investors buying cash for listed properties. Unlike some areas getting a good deal is hard to be had for under 100k and thats still with work to be done. I have been looking at purchasing outside of my local market as that maybe the only way I can get my first deal done. I see a lot of investors here buying tearing down and building new. Most are just waiting until the market comes back.
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Troy @ The Financial Economist says
But you don’t have to put up cash upfront, do you? Why not just make a downpayment?
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Thomas | Your Daily Finance says
I just purchased a home a few months ago and with me starting my business I wont get the loans from the typical bank. That means hard money and high interest rates. Even if I put down 20% most homes that are 100k need a lot of rehab.
Thomas | Your Daily Finance recently posted…Selling a Blog for Millions: Interview with Jim Wang of Bargaineering
Troy @ The Financial Economist says
Ohhh true.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
Financial Independence says
One of my core rules is to only invest in things I understand and unfortunately I don’t know enough about overseas markets to take the plunge and invest in international real estate. I would happily invest interstate however I believe that the domestic market where I live isn’t going to see substantial growth for a number of years – we largely avoided a major downturn however consumer confidence isn’t anywhere near what it used to be.
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Troy @ The Financial Economist says
Yea real estate is such a location based market. If you don’t understand it, don’t touch it.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
Matt Becker says
I’m not sure I understand the advice here. When you say you must sell before the market peaks, are you suggesting that people treat their primary residence like a hot stock tip? I know most people would like to make money from their homes, but I don’t know many people that want to pick up and move every time they think the housing market is about to peak. That’s incredibly disruptive for someone’s lifestyle, especially once you bring kids into the equation.
Besides, long-term housing prices basically just track inflation. Owning a home can certainly save you money over renting over a long enough period, but it’s really not an investment, or at least not one that you should count on to really build wealth. It’s just a different way to consume shelter.
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Troy @ The Financial Economist says
Sorry for the misunderstanding – I’m talking about investment properties (additional pieces of real estate besides your residence), not where you live. Obviously you wouldn’t want to move around just to save a couple of thousand here and there.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
Matt Becker says
It was this quote in particular that confused me: “In this post, I’ll mainly be looking at investment returns (capital gains) for real estate. I’m not discussing rental property.”
So are you talking about flipping houses? If so, are you suggesting that you buy at the bottom, hold for the duration of the cycle without renting, and then sell near the market peak? If so, is that just to avoid the hassle of renting in the meantime? What kind of time period are you talking about holding onto the property for? It would seem like it would have to be several years to make any profit with the kind of slow movement you’re talking about.
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Troy @ The Financial Economist says
Yep I’m purely talking about capital gains.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
DC @ Young Adult Money says
Real estate has been picking up where I live, though I don’t have any high hopes of my house skyrocketing in value. You made a good point about the fact that real estate is not liquid. It’s not like a stock that you can sell today if you want. When it comes to real estate as an investment it’s important to be careful about who you listen to – in 2006 people who warned that homes were drastically overpriced were getting laughed at on TV left and right and almost every commentator said real estate prices would never drop.
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Troy @ The Financial Economist says
Real estate is a pretty slow market because of the nature of the market. Deals take a while to be inked and signed.
There’s another problem with real estate – it’s not a standard market. Every single piece of stock is the same as the other – every piece of Apple stock is equivalent to other pieces of Apple stock. That’s not true in real estate – no two properties are alike.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
Glen @ Monster Piggy Bank says
The real estate market in Australia is WAY overpriced when compared to most other countries, yet despite this, prices continue to rise.
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Troy @ The Financial Economist says
Is it? I’ve never been to Australia and I don’t know much about the country.
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Rita P says
Yes real estate and economy are interconnected. Real estate is slowly picking now in the area where I stay. Maybe in future I am planning to invest in real estate after gaining some knowledge in this
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Troy @ The Financial Economist says
I was looking at the Calculated Risk Blog (the guy does a great analysis for real estate). He says that although real estate is still growing here in the States, it’s growth is slowing down.
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DW @ Great Passive Income Ideas says
And this is why real estate tends to be one of the money making opportunities I shy away from personally. Though it can be great if you know what you’re doing, I know myself enough to know that I don’t. So I try to stick to other methods of making money instead.
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Troy @ The Financial Economist says
Always stick with what you’re comfortable and familiar with. That’s my motto.
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Holly@ClubThrifty says
The real estate market in Indiana has stayed fairly steady. But, I think it’s picking up now! There are a lot of houses for sale right now and they’re getting snatched up quick!
Troy @ The Financial Economist says
That’s also the beauty of real estate. I find that the “experts” can never pick the top and the bottom. It’s mostly the average guy who does so, I guess because he can see how the market is doing (just like you are).
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
John S @ Frugal Rules says
The market has picked up quite a bit here in Omaha. That said, we were sheltered quite a bit from the downturn and while we saw some downturn, it was nothing like the national “average”. My in-laws actually live in San Diego and they’ve seen some turnback over the past year or two…not like us, but they have seen some positive movement.
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Troy @ The Financial Economist says
Apparently the Bay Area is on a ridiculous bullish tear. A nice decent 3000 square feet house costs over a million bucks. I hear that a lot of the buying comes from those new internet millionaires and rich Chinese folks.
Troy @ The Financial Economist recently posted…How to Analyze the Market’s Daily Price Action
Mrs PoP @ Planting Our Pennies says
We live in one of the areas of the US that was hit the worst in the recession. We “fought” for the #1 spot on foreclosure rates in the country for a while but the area had largely recovered. We are about back to where we would have been had the boom years been omitted from price forecasting.
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Troy @ The Financial Economist says
Oh wow that’s pretty intense. Are you in Florida?
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Kim@Eyesonthedollar says
We never really have the high highs or low lows where we live. It is still very affordable to own real estate, but the great deals are getting harder to find without having to put a ton of work into them. As far as my primary residence, hopefully the market will be up when we decide to sell. If not, it should have been paid off long before, so we don’t have to worry about paying off the bank.
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Troy @ The Financial Economist says
Speaking of the bank, there was a really funny story I heard a while back. This lady went on vacation only to come home to find that her house was foreclosed and sold off. Trouble is, she had finished paying her mortgage! So she looked further into the incident, and discovered that the bank that sold her home wasn’t even her banks! Turns out the bank foreclosed the wrong home – they were supposed to get her neighbor’s house.
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Mr. Utopia @ Personal Finance Utopia says
I’m still a bit skeptical that the recent trend upward in overall prices is an indication that the “boom is just starting.” There been’s 2 reasons for the growth over the past year: all cash investors (including foreign) and the extremely low interest rates due to the Fed’s actions. The interest rates are going back up. We’ve already seen signs of that and over the next few years they’ll probably continue to go back up as QE is phased out. In any case, I don’t think a boom is coming and, if it does, I think that’s a bad sign. Why? Because despite an improving unemployment rate, real job growth isn’t there. Without decent paying jobs being added, then growth will be stifled (especially in the face of rising interest rates). A huge boom would be based on some artificial foundation and that’s bad.
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Troy @ The Financial Economist says
Oh I think I might have created a misconception. The economy is far from strong – in fact, I think it’s mostly because of the Fed’s QE. However, housing bases last a long time (think of a giant U shape). We’re going to see growth, but nothing close to insane levels of growth pre 2006.
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Tara @ Streets Ahead Living says
Yes, where I am I realize I can never afford to buy what I want in a house in a decent location. I am saving up now to eventually buy a house elsewhere with enough down that I can afford to take a paycut and still have plenty leftover after bills to save.
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Troy @ The Financial Economist says
GLad to see your own the right track! Homeownership is the American way!
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Brian @ Luke1428 says
I have heard the market in Atlanta is slowly beginning to pick up, especially on the north side. In general prices are still depressed and many who want to sell properties cannot get out of them what they need. It’s great for investors though looking to pick up potential rental properties on the cheap.
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Brett @ wstreetstocks says
You made some solid points in this article. I like how that you point out that real estate is illiquid.
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charles@gettingarichlife says
Is this a booming economy or a bad one? Real estate has been leading for two years. Subsequently real estate prices rise at 1% above the rate of inflation. In the 90s the US was booming but real estate just tracked inflation. What happened in 2006 was a nationwide bust, we hadn’t had that since the Great Depression.
Real estate is localized. Look at LA in the 90s with the defense cuts, and TX with the oil bust housing dropped while the rest of the country was fine.
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Laurie @thefrugalfarmer says
Great stuff as usual, Troy. I didn’t know that the CA real estate market hadn’t budged much with the recession. Housing prices are always so unbelievably high there.
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Mel Laurence says
As a property investor, I think that there are still bargains to be had
in Brisbane, Australia.
Halifax Lakefront Properties for Sale says
Nice topic! you have to take care of few things while you investing in American real estate like what the result of investment it’s beneficial or not.
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americanproperty partners says
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samro main says
Wonderful things as common, Troy. I didn’t be aware that the actual FLORIDA market hadn’t budged a lot with all the downturn. Houses prices are generally often and so unbelievably high there.
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Fort Myers Real Estate says
Real estate is one of the best business for getting profits, but there are many of fluctuations are there in this business. The thing is to be knowing the important issues regarding that business.