Experienced investors often proclaim that investing in real estate is a great way to protect your wealth and build your passive income streams. Real estate, unlike other investments, is a tangible asset with intrinsic value. It’s also got a great historical track record that demonstrates its ability to weather economic turbulence and remain in demand. Real estate has proven to be more consistent in growth compared to other asset classes.
Timing is an important factor when it comes to succeeding in real estate. Deciding when to sell or invest in a real estate property such as an apartment building is more challenging than selling or buying a stock. Despite what some investors may claim, timing the real estate market is difficult to do.
We’re going to explain why this is the case, and what you can do to factor in timing in your real estate investments.
Why Do Investors Time the Real Estate Market?
Most investors understand that the real estate market consists of booms and busts. This means that the market will rise, involving increasing real estate property values and prices, until they fall when property values and prices decrease. These changes in real estate prices occur due to multiple different factors. Also, the price of debt may fluctuate, which makes it cheaper or more expensive to buy real estate properties like apartments.
If there is a buyer’s market, that means that there are more real estate properties on the market than there are buyers who want to purchase them. This results in lower prices.
If it is a seller’s market, that means there are not enough real estate properties to meet the demand of buyers. This causes prices to increase.
Ideally, an investor will purchase a property at the bottom of a buyer’s market, and ride the market to the top of a seller’s market, where they can sell and maximize their profits.
But, this approach to investing is flawed.
Issues with Attempting to Time the Real Estate Market
Many investors have claimed in the past that the market was “too hot” or that they were going to wait on the sidelines until the market crashed so they could scoop up discounted properties. This hardly ever worked out for them, because predicting what the market will do is nearly impossible.
Investing in real estate is complicated. The cost of housing isn’t just determined by how many properties there are on the market. Interest rates, inflation, and the availability of debt all impact real estate. It can be nearly impossible to factor in all of the variables that influence the real estate market, and some trends you see may not be explained by COVID-19 or the rising cost of construction.
Consider the current real estate market. Despite what many experts believed, it recovered quickly from the COVID-19 pandemic.
For context, the normal real estate cycle lasts 18 years, and consists of four stages: “recovery, expansion, hyper supply and recession,” according to Forbes. However, the challenging part is identifying which stage of the cycle you’re in while you’re in it.
This is why it is so hard to predict what the real estate market will do next. While an investor may be able to determine that housing prices will increase in the long run based on historical evidence, it isn’t that simple when you’re looking at the span of one, five, and ten year periods. Many economists and investors were confident that the real estate market was going to crash when COVID-19 hit and yet, the price of housing only increased. Many market experts who were confident in the strength of the real estate market were proven wrong in the 2008 crisis. Both of these examples support the notion that even the smartest minds struggle to determine where the real estate market is headed, because no one can predict the future.
One reason timing the market is so difficult is because real estate is local. This means that the local factors of a particular market have a major influence on the real estate there. A housing crisis in Phoenix, Arizona, may have no impact on New York City, for example. This is why generalizing the real estate market and looking at it from a regional, statewide, or national perspective is tricky. Many changes in the real estate market are caused by local changes in the market.
Thinking you will be able to time the market is likely to be setting yourself up for disappointment. Not only is it unrealistic to accurately predict where the market is headed, but you’re also more likely to make rushed investment decisions. Rather than creating and sticking to an impartial investment strategy rooted in research and objective facts, you are going to be in a reactive mode when you believe the market is peaking or crashing. When it comes to actively buying multifamily, this process takes time, so it is difficult to make a quick decision. However, as a passive investor, you may rush into an investment if you are trying to time the market rather than falling back on a tried and tested investment philosophy. If you already have a large real estate portfolio and are in a position to take more risk, this may be okay. However, if you are interested in preserving and building your wealth in a risk-mitigated approach, you’ll want to make sure your investments align with your existing investment criteria, and aren’t just an impulsive decision.
While an investor’s projections can be accurate for an economy as a whole, when it comes to submarkets, there are too many confounding variables that play a role to accurately predict what will happen within that submarket. If an investor is waiting for prices to come down, they may be waiting multiple years. This means that they missed out on all of the opportunities they would have benefited from had they kept on looking.
Meanwhile, some investors luck out, appearing to have timed the market perfectly without really meaning to. In the wake of the COVID-19 pandemic, Florida and Texas developers saw massive market growth.
Timing is an important factor, but it isn’t the only one. It’s also one we don’t have much control over.
How to Mitigate Risks of Timing
Real estate is a sound investment to make, even when you take into consideration the risks related to timing the market. And there are a few factors we can influence to hedge against this risk.
The Experience of Your Team
The general partnership team plays a key role in the success of a real estate deal. Making sure your general partnership team has extensive experience is invaluable. If they’ve gone through a few market downturns, this will ensure that they have the prior knowledge and experience on how to best deal with hard times if they occur.
Have Market Knowledge
Understanding the markets you invest in is essential. Knowing the intricacies of the markets, and submarkets you prefer will help you remain vigilant and enable you to quickly take advantage of opportunities as soon as they come across your table. It will also help you efficiently determine whether or not a property is undervalued or overpriced.
No one knows what is going to happen in the future. Therefore, it’s important to make conservative assumptions in the underwriting of a deal. To learn more about conservative underwriting, check out our article on that topic here.
One way is to utilize the strategy many stock market investors use, known as “dollar cost averaging.” This involves investing a certain amount at specified intervals, regardless of how the market is performing. Investors can change their timing a bit if the market has a strong or poor performance. Consistency is key in this strategy, because it allows the investor to mitigate the impacts of severe changes in the market.
Perform Due Diligence
Another option is for an investor to perform extensive due diligence in the market before investing. In real estate, the actual location where the property is located is one of the biggest risk factors. Choosing the right one, with population growth, a strengthening local economy, and a good median household income and a declining trend in crime will allow you to invest with confidence. Picking the right market is more critical than investing at the right time, and it’s a factor you can actually control.
Multifamily real estate continues to be one of the most in demand investments. It’s not only a great way to diversify and strengthen your portfolio, but it has also performed well during the 2008 crash and more recently during the COVID-19 pandemic.
Timing the market might seem like a good investment strategy, but the consequences can be painful. The concept of “buy low and sell high” isn’t as simple as it may seem. This is why it’s important to really look into a market before investing there. You may find yourself investing in assets that don’t align with your overall investment criteria, or are located in markets that don’t have the fundamentals of a strong investment location. Or, you may find yourself sitting on the sidelines, waiting for the right time to invest, and missing out on the opportunity of a lifetime.