Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question. Jim from outside Louisville, KY asks: Hello Brian, I’m a big believer in real estate as a secure investment with a reasonable ROI. However, I’ve been hearing and reading a lot of chatter about how the residential market is bound to soon have a downturn. I currently have one house flip near completion and another just beginning the process. My flips average about 5 months. I don’t know how to time the residential market but I certainly don’t want to be caught holding a couple of houses in 2020 if the market is going to tank. What is your insight into the current market timing?
Answer. Hi Jim. The ability of smaller investors to time the real estate market is limited at best and mostly unrealistic. Today, many professionals are predicting that a downturn in real estate is inevitable but few agree on when it will happen. The bright spot is that not many believe the real estate market will take the brunt of an economic downturn the way it did in 2008 and 2009. In fact, that downturn in real estate had been unprecedented since the Great Recession of the 1930s. The risk to real estate investors isn’t as great as many fear.
Real estate investing numbers are difficult to understand. According to a mid-year CoreLogic report, the number of houses bought by investors in 2018 was 11.3% (full 2019 numbers are not yet available). That implies that 88.7% of houses were purchased by people intending to live in the house as a primary residence. How can that be, since U.S. Census data finds that only 64.3% of people are homeowners? It would seem that many more sales would have to be to investors to support the rental market. But this is where you have to be careful understanding what goes into the numbers. The 11.3% investor number only applies to single-family houses. The bulk of rentals are apartment buildings owned by corporations and institutions. These are tracked as commercial real estate that is separate from residential real estate, which is defined as four units or less.
Commercial residential investors can and do time the real estate market. Two of the biggest market makers are new apartment building construction and residential REIT investing. These institutions have the capital and research resources to invest in multiple markets rather than local markets as individual investors are most likely to do. Recent years have seen high-rise cranes abundant on the skylines of major cities with housing shortages and highflying real estate values. While the surge in new apartment buildings in select cites isn’t completely over, more effort is now going into renting out all of this new inventory rather than building new inventory. This is a clear sign that the market is shifting into the next segment of the market cycle. Historically, apartment buildings that come online late in the cycle have trouble filling units at fully profitable monthly rent payments. The lesson here is that even the big institutional investors aren’t always right at timing the market.
This is one of the best explanations about how real estate investing is incredibly local. Definitely for small investors. While the big apartment contractors are pulling back, Realtor.com data shows small investor activity was up 5.6% in the second quarter of 2019, accounting for 7.1% of all sales (compared with 11.3% for 2018). And 7.1% is still down from 2012 – 2014 when CoreLogic reported investor purchase rates at 10.3% – 10.9%.
Jim, a little more specific to your house flipping question, a couple of different data sources show that flipping activity is up substantially at about 70% in many major metro areas. Raleigh, N. C. is showing the biggest increase at 72% compared to last year. But a strong word of caution, the same data also shows that the return on investment is slipping for house flips. ATTOM Data Solutions’ Home Flipping Report shows flipping profits at a nearly eight-year low. But that isn’t in the major metro markets. What this sounds like to me is that there are investors jumping into the flipping segment late in the game (much like the late apartment building developers).
Ultimately, it’s impossible to perfectly time the real estate investing market. What we do know is that a downturn in the cycle is inevitable but also that it will not likely be the same as the downturn in 2008. It is wise keeping an eye on market fundamentals like mortgage rates, affordability, and the general economy. The time to back out of the market is coming but whether that is in 2020 or 2022 remains the big question. Jim, you could make a decent profit flipping as many as 8 more houses between now and 2022. Or you could end up selling the last house or two without a meaningful profit. That is the risk of flipping houses when the market is changing.
Your own business circumstances and local market are the two most important considerations. This is a very important time to have a plan B or an alternative exit strategy. Your plan B might be selecting your next flipping project based on its rental potential in case the sales market goes soft. The rental market still shows signs of remaining robust as the sales market enters the next cycle phase. If you have the financial capability, the biggest profits are made buying during the bottom of the cycle (whenever that might come). Becoming a landlord could be your bridge to the next high point in the sales market as a flipper. Here are a few key things you can to do to prepare for an investment alternative:
Please share your thoughts by commenting about what you think will be successful in the evolving small investor rental market.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].