"What's hot in today’s real estate market?" is a common question.
Which city? Which town? Which neighborhood?
In my never humble biased opinion, what's hot is any property that I can buy at significant discount to current retail price that will give me a desirable profit, cash flow or cash-on-cash return after repairs, buying costs, holding costs and selling costs (the latter only for flips).
There is only one real estate investment strategy for which so-called "hot markets" make a huge difference to actual real estate investors (as opposed to retail buyers). That real estate investment strategy is lease-option and it is not nearly as common as flipping or holding rentals.
Here is why...
First, no INVESTOR buys at retail price. Retail buyers buy at retail price and if they expect to make money on their purchase, it is through appreciation over some unknown period of time. Retail buyers NEED to buy in “hot markets” if they want to make a killing and they have to buy just at the right time.
In contrast, ACTUAL REAL ESTATE INVESTORS, like the way I INVEST in houses in South Jersey, typically buy houses at 35%-50% of the retail price (more typically 40%-45%) and we typically invest roughly 20%-30% of retail price in repairs, buying costs and holding costs on top of the purchase. That typically leaves us with 20%-40% equity in the property.
Let's examine the four primary real estate investment strategies and see how "hot markets" affect each strategy.
If you are flipping, you are typically in and out of a property in 3-6 months, maybe 9 months if it's a shell. If the market is "hot", you are getting say 10%-15% appreciation per year and everyone is competing over those properties, including the newbies who tend to overpay that in turn drives up purchase price. So, market "hotness" may contribute 5% in 6 months. If I buy right, then I'll make 30-40% of retail value. An extra 5% from appreciation of a "hot market" is certainly nice, but I prefer to be able to find deals all over my 2-county area rather than be limited to 4-5 hot towns or hot neighborhoods that everyone else is also chasing.
Let's illustrate with an example. Last year I bought a townhome in a working class subdivision in the totally NON-HOT market of Atco, NJ that happens to suffer from much higher property tax rates than most of the rest of Camden County, except for Pine Hill (another non-hot market). I bought the property for $50K and invested another $32 in repairs, buying costs and holding costs. My total cash investment was $82K. The property sold at $140K minus $2.5K seller concessions and netted after selling costs a profit of $48K.
Had I limited myself to "hot markets", Atco would NEVER have shown up on that list. Think about it...I made $48K on a cash investment of $82K in 3.5 months! That's a cash-on-cash ROI of 59%. If it was a hot market appreciating at 10% per year, I wouldn't have gotten this home for $50K. If it was a hot market, then in 3.5 months I would have made another $4K-$5K which probably wouldn't have compensated for the extra price I would have had to pay above $50K.
If you can indeed get a good deal to flip in a hot market, by all means go for it. However, my experience is that it is easier to find very good deals in non-hot markets that represent a wider area than hot markets, so my choices are better. That experience includes buyer’s markets and balanced markets.
If I'm buying a property as a rental, my top two goals are the absolute number of dollars of positive cash flow per month and the cash-on-cash return. If I buy in a "hot market" and I hold the rental for 20 years, the hot market will eventually go cold, then hot again, then cold again with some “lukewarm’s” in the middle. So, the instantaneous snapshot of the market at the random time of purchase is not crucial since any effect will be dampened out over a couple of decades.
What is more important from a market cycle standpoint when buying a rental is to try to anticipate whether rents will hold up in the next decade or more. If there appears to be risk of rent erosion due to changing income demographics for that location, that is important.
On the upside, neighborhoods undergoing gentrification can represent opportunity. While gentrification is not uncommon in certain city neighborhoods, it is a lot more rare in the South Jersey suburbs (and other suburbs) when it comes to "hot markets" for rentals. I buy rentals based on fundamentals. not how hot the market is.
If you want to learn more about how to buy houses for rentals, watch my training video at www.PartTimeInvestors.com entitled “How to Choose Houses for Rentals.”
The expected term of a lease-option is typically 1-3 years, most often 2 years. Even more often, the options are not exercised but we'll ignore that right now. If the market is hot and goes up 10% per year (17% per year was the increase during the pre-2007 bubble in South Jersey), then a 20% increase over two years or more is indeed a big impact. In fact, I took a course on lease-option in 2004, which was in the middle of the bubble, and the guru taught that you can buy at full retail price and lease-option it with a 2-year term and an option price 20%-30% higher than the purchase price and make a killing! Many of the guru’s students did just that and made a lot of money!
Until they didn’t!
If the market drops 10% per year at the end of a bubble and you are in a lease-option, you may find yourself in deep sheepdip. When the bubble burst, many lease-option investors who were in sandwich lease-options or bought “Subject To” with little to no equity, went belly up.
Lease-option is the most market cycle-sensitive real estate investment strategy.
There is a way to NOT lose your shirt in a lease-option that is bought just before a bubble bursts. I now, because I did it. The key, as always, is to buy right, which means at a significant discount to retail value. If you buy a property at 30% below retail value at a moment that is unknowingly at the top of a bubble in a hot market, then you can absorb a 30% market drop and not be devastated.
There is another way to survive lease-option in a falling market and that will be the subject of the other article in this month’s newsletter.
If you are a wholesaler, you are in and out of a deal in 30-60 days. Market cycle doesn't affect you much except to the extent that it affects your C-buyers. In a hot market, you will have a much harder time finding the great deals, though you will be able to unload them very fast. So, it is worthwhile to look in hot areas for wholesale deals but I wouldn't count on them exclusively because you and every other wholesaler is knocking on doors and sending postcards to those neighborhoods.
Summary of My Bias
Therefore, I don't look for hot markets in affordable suburbs like we have in South Jersey. I look for solid deals that I can buy at a great discount to retail price that I can flip at a great profit or rent with high cash flow and cash-on-cash return. I find those deals often enough to meet my modest goals in the past few years which were to increase my net worth by $100K per year plus increase cash flow by $1,000/month per year without requiring full time contractors. Last year, I had active new projects for only 5 months out of the 12 months and met my goals. I have not bought in a hot market after 2005.
That doesn't mean that you shouldn't. But I wouldn't obsess over hot markets.
If you get a great deal in a hot market, go for it.
Biography: Marc Halpern is a successful part-time investor who has achieved financial freedom in terms of passive income and net worth mostly through rentals and flips using “regular” money and self-directed 401(k) funds.
E-mail Marc Halpern directly if you want to improve your profits through coaching by a local expert in South Jersey/Philadelphia with track record.
Do not take any action or make any decisions based in whole or in part on the content of this article. ALWAYS consult with licensed professionals in YOUR state before making any investment.
Now watch the streaming video lectures of Marc Halpern’s Smarter Real Estate Investing Series:
Top 10 Essentials for Successful Flipping
How to Choose Houses for Rentals
Landlording: How to Establish Acceptable Standards of Behavior with Tenants, Tenant-Buyers, Other People’s Children and Other Humanoid Life Forms
How to Effectively Choose Renovations for Flips and Rentals
Should I Flip? Rent? Wholesale? Lease-Option?
Advantages of Self-Directed 401k’s vs Self-Directed IRA’s
Leverage of OPM: The Good, The Bad and The Ugly in Real Estate Investing
Wholesaling from the Buyer’s Perspective
Decision Making, Happiness and Daily Lifestyle Aspects of Real Estate Investing
How to Recover from Bad Real Estate Deals
Overcome Barriers to Buying Your First or Next Investment Property