What Happens To Real Estate Investments When The Market Changes
Real estate investing comes with risk. This is something we all know. Always have and always will. But how do we look at that risk, what are the risks, and can they change over time? One could argue that risk goes down with education and knowledge. The more you know, the more you can plan for and understand the risks. But what happens when the market changes?
Over the past decade, we have seen a steady supply of properties on the market and have benefited from the ever-appreciating market values. We have been lulled into a false sense of security. There have been some tears forming in this security blanket over the past couple of years. As we fell into the COVID pandemic, we began to see some changes in the market and our businesses. Supply chain issues began slowing down our projects and labor dried up. Now as we head into a recession (or are we already in one?), what other issues will be coming up and how do we address this ever-changing landscape?
Be Prepared: Market Changes Can Mean Extra Time And Decreased Profit
I had a conversation with a client the other day as I saw they were selling one of their flips. I called to congratulate them, and I heard two contrasting assessments from them: gratitude and exasperation. Gratitude over finally getting out of the deal, and exasperation at all the issues they had on the project. I talk to a lot of folks every day, and everyone is asking similar questions about the market and how things MIGHT change, but here was an investor that was living the changes.
The investor has done several flips in Denver and knew the area well. The plan was to do a quick cosmetic remodel and then sell the property. The original repair budget was going to be $35,000 and the ARV was going to be $570,000. As we began talking, I quickly found out that they were selling the property for only $550,000 and the cost of the rehab was almost $60,000! These 2 numbers caused a $45,000 swing in profit! But that wasn’t all, the changes also cost the investor time. There were 3 months of added holding time, and with the cost of hard money, the holding costs had added up. The investor had said they were going to break even and that he was very comfortable with that. I believe he saw that it could have been worse, and he was thankful to just be done with the project and able to move on to the next one. Even though he is a cautious investor, and we often talk about what is going on in the market and brainstorm on deals, what happened on this particular flip took him by surprise.
Over the past several years, investors have often inadvertently avoided the plethora of the hurdles and heartaches inherent to investing by the ever-increasing values and ARV’s of our deals. In the past couple of years, there have been several deals that I thought were going to be too thin, and possibly not profit, but the investors made more money than even they thought they would because the market had been going up so quickly. In discussing these deals with the investors, they were very open and honest with the numbers because they had made money. They would share how they had run over budget and of course took much longer than originally planned, whereas in a more balanced market, these same investors may not have fared so well.
What A More Balanced Market Means For Your Investments
It seems we are returning to a more balanced market. What are you doing to prepare? How are you adjusting your due diligence? What adjustments are you making to your deal analysis? The three major changes I’ve been experiencing are:
- Holding times are increasing
- Construction costs are increasing
- ARV’s are decreasing
As we see more properties coming on the market and less buyers, properties are sitting longer. Buyers can be a bit pickier with the homes they choose to make offers on. We need to be prepared for our properties to sit on the market longer. Gone are the days of multiple offers on the first weekend. We need to be preparing ourselves for weeks and possibly even a month or more of our property sitting on the market waiting on an offer.
Realities Of A Changing Market
Construction costs are still all over the place. I recently heard that lumber was down 40%; however, that is based on the inflated costs that were over 400% higher than before the pandemic! Similarly, a client who is building new construction projects in Denver mentioned their concrete and rebar prices were substantially higher than when they submitted the construction budget, which had only been about 2 months prior! Supply chain issues seem to be resolving, but we are not out of the woods yet. The silver lining to this possible recession is that labor seems to be freeing up a bit and you can now contact a contractor and even get them to your jobsite relatively quickly!
I see updates daily about price drops on properties. I don’t believe that this means prices are going down, but I do believe sellers are facing the realities of our changing market. They are seeing that, just because their neighbor had sold their property for X amount doesn’t mean that they can now sell their property for X plus more appreciation. They days of values skyrocketing seem to have passed. We now need to be planning property ARVs more carefully by looking back not just 3 months, but possibly 6 to even 12 months, when running comparables.
A Recession Could Mean A Great Buying Opportunity, But Consider Your Risk
A recession on the horizon could be a great buying opportunity. I know several investors that are stacking cash and preparing to pick up several properties in the coming months. But as we prepare our finances for this buying opportunity, we should also be preparing our due diligence and revising our criteria and risk tolerance.
- We must be prepared to hold properties longer and have higher holding costs.
- We must be paying close attention to the cost of construction and the ever-moving price of both labor and materials.
- We must be prepared to pivot when our normal material choices are no longer available or have extensive lead times.
- We must be prepared for prices to stagnate and possible even go down.
- We must be more conservative as we look at comps and plan what we can sell our flips for and value our rental properties at.
Due Diligence Is Key! Let Pine Help With Your Investment Risk Analysis
If we can improve our risk analysis and gauge the moving markets, we will be able to weather this storm and emerge as better investors. At Pine Financial, we speak with hundreds of investors each month in markets across the United States. If you every want to share your thoughts and pick our brains, any one of us here would be happy to chat with you.