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“Significant downward adjustments” expected in the Real Estate market

 

by Phyllis Espinoza

 

If Warren Buffett says so… we better listen. After all, the “Oracle of Omaha” didn’t become one the greatest value investors of all time, by making loose predictions.

A $10,000 investment in Buffett’s Berkshire Hathaway in 1965, would grow to be worth nearly 30 Millions by 2005. By comparison, $10,000 in the S&P 500 Index would have grown only to about $500,000 during the same period. I don’t know about you, but I like to listen to people that outperform the markets consistently.

This is what Warren Buffett said at the Berkshire Hathaway’s annual meeting (May 2006):

"What we see in our residential brokerage business [HomeServices of America, the nation's second-largest realtor] is a slowdown everyplace, most dramatically in the formerly hottest markets. [Buffett singled out Dade and Broward counties in Florida as an area that has experienced a rise in unsold inventory and a stagnation in price.] The day traders of the Internet moved into trading condos, and that kind a speculation can produce a market that can move in a big way. You can get real discontinuities. We've had a real bubble to some degree. I would be surprised if there aren't some significant downward adjustments, especially in the higher end of the housing market."

This is not news to Real Estate investors in some previously ‘hot’ markets that are starting to feel the overheating effect. What nobody can predict is the size and duration of this adjustment.

Let’s look at the Dow Jones U.S. Real Estate Index :                           

 

 

Since October 2002, the Real Estate Index has climbed from 136.59 to 293.72, producing a total return of 115% in less than 4 years.

Now, let’s look at what the Dow Jones Index did during the same period: 

 

 

It climbed from 7197.49 to 11670.19, for a total return of 62.1%, about half the return of the Real Estate Index.

How much higher could the Real Estate market go, before an adjustment? According to Warren Buffett, an adjustment may be just around the corner.

The ‘smart money’ has already milked the real estate index in the last 4 years and may be ready for a switch. Where to? We don’t know, but what matters to us is that it’s going to be out of the real estate market.

This is just our opinion and it doesn’t mean that there is no money to be made in this market. What it means is that investors need to be much more careful and do something other than sitting on their properties to make money.

As Warren Buffett said, the higher end of the housing market has the higher risk for a downward adjustment.

And he had something to say about the current state of mortgage financing also:

"Dumb lending always has its consequences. It's like a disease that doesn't manifest itself for a few weeks, like an epidemic that doesn't show up until it's too late to stop it. Any developer will build anything he can borrow against. If you look at the 10Ks that are getting filed [by banks] and compare them just against last year's 10Ks, and look at their balances of 'interest accrued but not paid,' you'll see some very interesting statistics [implying that many homeowners are no longer able to service their current debt]."

 

He is referring to the credit boom that we’ve experienced over the last few years, and how quickly it can turn into a credit crunch, where money will be more difficult to borrow.

A few things to keep in mind during the times ahead:

- Continuous interest rates increases may accelerate a possible real estate adjustment.

- Higher interest rates will qualify fewer people for conventional mortgages, increasing the need to offer ‘seller financing’ to sell a property quicker.

- Offering ‘seller financing’ on a declining Real Estate market is not for the faint of heart. 

- Holders of private mortgage notes may see their note market values decrease.

- Foreclosures may increase specially in the high end of the market.

These are some of the things you can do to reduce your risk in this area :

- Selling high end properties before the adjustment is well under way, especially if your area has appreciated in value considerably in the last few years. Some areas in New York, California and Florida may fall under this category.

- Unless you are planning to receive monthly payments for your note for the duration of the term, this would be a good time to consider selling your note. During a downward real estate market, your note may be worth less (or be worthless).

- Deal with low-end properties, unless the high-end is your niche and you know how to coast the storm.

- If rehabbing properties for a quick return is your business, make sure that you leave yourself enough room for a property value adjustment. Try to turn around those properties quicker, as you may be selling on a declining market.

- If you are planning on offering ‘seller financing’, be extremely careful. Select your buyers and terms keeping a declining market in mind.

 

But you may ask, what happens if everybody sells property at the same time, wouldn’t that precipitate the decline? That is a good question.

Consider that real estate tycoons like Donald Trump and the Reichmann brothers, people that were so shrewd during the up times, were caught by surprise in previous downturns.

People usually won’t admit to a downturn until the move is well under way and it’s too late to exit the market harmlessly. History repeats itself.

So, the first ones to exit the market are the ones that take their profits, cut their future loses short and come out alive and ahead. The rest may suffer.

These are just some scenarios that we have played in our minds to alert you of possible roadblocks ahead. We will continue to do so in the future.

 

Simultaneous Closings are a great alternative to speed-up the selling time of a property, while providing cash and freeing you from the risks of holding a note during declining markets.

From buying your seasoned mortgage notes to working with you to come up with a viable structure for your seller financed note, there are a number of ways that we can help you deal with the times ahead of us.

Feel free to visit our website http://www.SimultaneousClosing.com and browse our new content and services that are regularly added.

 

About the author

Phyllis Espinoza is an expert in Simultaneous Closings, an emerging field of creative real estate financing, and the owner of the website http://www.SimultaneousClosing.com. Her goal is to help as many people as possible by making this useful technique better known.

 

 

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