Inflated ARV: Market Timing

Source: Austin Board of Realtors® It’s much easier to predict market cycles in real estate than in the stock market (where many would say it’s impossible), but you can still lose your shirt by assuming the market will always go up.

This post originally appeared on the Hermit Haus blog on 2016-10-24.

One of the easiest mistakes to make in renovating houses is to overestimate their After Repair Value (ARV). In this post, I’m not going to delve into motivations for inflating a house’s ARV. After all, I’ve done it to myself, so far be it for me to cast asparagus on anyone. I’m just going to talk about how it happens, and there are only a few ways:

• Use the wrong comps.
• Mis-time the market.
• Make the numbers fit the model.

I originally planned to talk about all three of these risks in one post, but I soon figured out it would be way too long. Click here to open all posts on this topic.

Mis-time the market

In the stock market, they say the fastest way to go broke is to try to “time the market”—that is to buy when the market is lowest and sell when it is highest. Real estate markets move much more slowly, and we have leading and trailing economic indicators to help us time the market. Some things to consider are:

• Special uses
• Seasonal differences
• Renovation time
• Market cycle

Special Uses

Unless you really know what you’re doing, owning a farm or ranch can be very expensive. For example, a gate won’t stand up to a tractor. Oops!

Special use properties make it easy to misjudge their value.

Farm land is cheaper in bulk; buying by the acre gets expensive. But farm or ranch land doesn’t produce any income unless you actively work it, and—while it does appreciate over time—you can be looking at decades to see significant improvement.

Offices, industrial space, and recreational properties exaggerate swings in the local business cycles. You must have a really good finger on the local economy’s pulse to play in this park—or need the office space yourself. It also costs more to get into this game than standard housing. That said, there is plenty of money to be made if you find a property where the use is about to change—like along the perimeter of where a new Box Store is going in.

Seasonal Differences

We missed the sale window for this lake house because of a combination of factors. We’re now holding it over the winter and using it as a vacation rental to make the mortgage payments until we can sell it in the spring when people are thinking about life on the lake again. Always have more than one exit strategy.

Housing in general sells better in the spring and summer, but resort housing exhibits this behavior on steroids. Many fewer buyers even think about buying a lake house when it’s too cold to get in the water or a house on a golf course when the greens turn white with snow.

We also know that water frontage adds considerable value. But what happens when a drought sucks the lake’s shoreline a quarter mile out? During the last drought, the receding shoreline exposed everything from illegal sewer lines to missing persons still sitting in their rusting cars.

Renovation Time

This is a big one—and one that has bitten every investor I know. You expect a project to take 90 days, but it actually takes six months. Maybe you find unexpected conditions. Maybe it takes longer than anticipated to get permits. Maybe you contractor flakes out.

At a minimum, that means you have additional holding costs for each of those three months, and that can really add up on a big project. At worst, it means you may miss the selling season or even hold a property into a down cycle.

Market Cycle

Given time, real estate will probably appreciate. But never assume appreciation in your purchase decision. If you do, you may wind up holding the property for decades or centuries to recoup your investment. Just look at the Rust Belt or Detroit.

The rule of thumb in Austin is that we have a five year cycle. The market goes up for three years and slumps for two. But the market is unpredictable. As my friend Shenoah Grove likes to point out, “We are now six years into our five-year cycle.” While this prolonged up-cycle is being driven by bigger economic trends—growing population, strong economy, oil boom (yes, the price per barrel is down because we have so much production right now.)—the likelihood of an adjustment makes longer renovation project much more risky.

Given the human trend to assume an up market will last forever, I’d be extra careful about every buying decision.

We’ll See

US population by age

Nationwide fewer people own their own homes as a percentage of the overall population.

Almost ⅓ of people under the age of 35 still live with their parents. This number is considerably higher than it has been for most of my life.

This post originally appeared on the Hermit Haus blog on 2016-10-26.

And Home

Sings me of sweet things

My life there has it’s own wings

To fly over the mountains

Though I’m standing still

—Karla Bonoff

Applying national statistics to local markets is always problematic. While local markets are informed by national and world markets, they are driven by local conditions. You can always find local exceptions to national trends. For example, Texas weathered the 2008 downturn much better than other parts of the US (and some parts even boomed) because of the Eagle Ford Shale oil boom. Similarly, parts of Texas were desperate during the national boom of the 90s because the farm economy was down.

That said, I’m going to show you three graphs of US census data that, according to economic blogger Barry Ritholtz, “tell the tale of the US housing market.”

The top chart shows the current population of the US by age. Surprisingly, 26-year-old are the largest single age group while Baby Boomers like me are starting to die off (but we are apparently still a large enough block to cause problems for a well-raided Social Security fund). Now, most people who buy a house buy their first one sometime between 25 and 30. So this age group should be putting a lot of pressure on the housing market.

But home ownership is still trending down (see the middle chart). Why is that?

Part of the reason is that the largest population segments—the one that would normally be powering the housing economy—are staying at home. Almost ⅓ of still lived with their parents as of 2013 (bottom chart).

I don’t want to get into a discussion of why they still live at home. Frankly, I don’t know. But it is important to understand that they do for a couple of reasons.

• Banks take this information into account in making lending decisions. Just look at the source of the graphics: Deutsche Bank’s Chief International Economist Torsten Slok.
• It speaks to the way the national economy is evolving.

Conclusions

At the risk of falling victim to confirmation bias, this data supports one of my beliefs about the way our housing economy is evolving: Home ownership is concentrating in the hands of fewer people, namely investors or landlords. This concentration has several consequences for investors and homeowners alike.

• This trend will continue and we will see more renters and people living in extended family units. Rents will go up, and more families will be concentrated into denser housing like apartments.
• As the percentage of renters increases, wealth will become more concentrate in the hands of fewer people.
• This concentration of real estate wealth will be self-reinforcing.
• It will become more difficult for young people to save enough to buy their first home.
• Investors wanting to sell single-family homes will face a shrinking market comprised primarily of other investors whose main interest will be to buy as cheaply as possible in an expensive market.

Inflated ARV: Massaging the Numbers

When calculating ARV, you have to think like a buyer, a contractor, an appraiser, a seller, and an investor…all at the same time. Any question you can ask yourself is probably important.

This post originally appeared on the Hermit Haus blog on 2016-10-07.

One of the easiest mistakes to make in renovating houses is to overestimate their After Repair Value (ARV). In this post, I’m not going to delve into motivations for inflating a house’s ARV. After all, I’ve done it to myself, so far be it for me to cast asparagus on anyone. I’m just going to talk about how it happens, and there are only a few ways:

• Use the wrong comps.
• Make the numbers fit the model.
• Mis-time the market.

I originally planned to talk about all three of these risks in one post, but I soon figured out it would be way too long. Click here to open all posts on this topic.

There are are many ways to tip the scale in favor of something you want to do. Be honest with yourself and let the numbers make your decision.

Make the Numbers Fit the Model

As I mentioned before, wholesalers know our requirements, so it’s easy for them to (intentionally or not) make the numbers fit that model. Most wholesalers understand that their long-term survival depends on their reputation, but there are exceptions to every rule. Rely on your own or a third party for your numbers.

You also have to honest with yourself. We’ve all seen (and some of us have been) someone who says, “My house has to be worth $200,000,” with the implication being “because I need it to be worth $200,000.” Buyers don’t care, and they are the ones who make the final decision about how much a house is worth. If every other house like yours is selling for less than $150,000, nobody will pay $200,000 just because you need that much.

It’s very easy to convince yourself to pay more than you should. “I can pay another $10,000. If I fix it up to be the nicest house in the neighborhood, I should be able to get $20,000 more than those other houses have sold for.” Wrong. You may be able to push the market a little. You may even find a buyer who is willing to pay that $20,000 above market, but, unless the buyer is paying cash, the house still has to appraise. And appraisers work for the bank, not you. They aren’t going to ignore the comps just because you and the buyer agree on a higher price.

Suggestions

Here’s how to avoid these traps:

• Always run your own comps and trust your formulas. Never take the word of a wholesaler, especially when you haven’t done business with them before. Be conservative with your estimates of ARC and overestimate the repair costs. It’s much better to come in under budget and sell the house for more than the inverse.
• Keep your emotions out of it. Whether you are buying, selling, or renovating, your emotions will lead you astray. If you have to, keep a disinterested professional on your team to give you value advice in each stage of the project.
• When selling, it’s okay to be near the top of the market, but don’t try to push the market higher. Price your house just below the top, and let buyers push the price higher if they want to compete for it. Depending on your project, it can cost considerably less to discount a house than to hold it for even a couple of extra months.

Moving to Canada?

Photo by Suna

Suna blogged this campaign on the Hermit Haus blog on 2016-10-06, but I helped come up with the concept. And I wanted the graphic to show up in my feed when I scroll back through this blog to remember what I have done in life. Maybe.

Both sides are so divided and hate each other so much that Canada has actually been talking about their immigration offices being overrun with inquiries. We got to thinking, “If so many people want to leave the country, they must want to sell their houses. Right? Let’s see if we can buy some of them.”

Suna found the clip art and put the sign together. We all put them out. One of them is in front of our Cameron office. Let’s see if it works.

Inflated ARV: When a Comp Isn’t a Comp

Just looking at the map, which set of houses looks more attractive? The ones facing the park or the ones facing other houses? I’ll give the answer in the body of this post.

This post originally appeared on the Hermit Haus blog on 2016-09-26

As I mentioned in my last post, 0ne of the easiest mistakes to make in renovating houses is to overestimate their After Repair Value (ARV). In this post, I’m not going to delve into motivations for inflating a house’s ARV. After all, I’ve done it to myself, so far be it for me to cast asparagus on anyone else. I’m just going to talk about how it happens, and there are only a few ways:

• Use the wrong comps.
• Mis-time the market.
• Make the numbers fit the model.

I originally planned to talk about all three of these risks in one post, but I soon figured out it would be way too long. Click here to open all posts on this topic.

Use the Wrong Comps

We rely on comparable properties—”Comps,” for short—to make our educated guesses at a house’s ARV. If we base our estimate on the wrong comps, we can really screw up. The rule of thumb is to only use comps within a mile of the subject property. But even if all the comps are within a half mile, they may not be appropriate to our estimate. We must always consider:

• Neighborhood boundaries
• Major streets
• Age
• Condition

Neighborhood boundaries are often marked by major streets. Any time you cross a major street, you’re likely to find the character of the neighborhoods surrounding the properties vastly changed, and the neighborhood influences property values. We looked at two houses in Temple that were on opposites sides of a road. The neighborhood on the north was 20 years younger than the one on the south, but the properties in the older, established neighborhood were higher than the newer houses to the north where it turns out the ground was more mobile, leading to more foundation problems (condition).

But we also evaluated a house in Round Rock where a very similar floor plan in the house directly behind the subject house—a privacy fence separated the two back yards—was worth about $20k more. Why? The subject house had once been the edge of development. All the houses one street over were 25 years newer and in much better shape thanks to a stronger neighborhood association. The subject house was worth considerably less after renovation than the house directly behind it. This was despite the subject’s proximity to a park and an elementary school. The numbers on the subject property were very attractive if we used the more newer, more appealing houses as comps but not when we only used houses on the same street.

A novice investor once showed me a map very similar to this one to justify the price being asked for a house. I pointed out that the so-called comps were in completely different neighborhoods from the subject. In fact, the only thing the “comps” had in common with the subject was that they were in the same ZIP code.

When evaluating another house in Belton, we were given comps that were on the other side of the Interstate from our subject property. Even though the “comps” had sold for more than $200k, our subject would have been overpriced at half that. Given that we were looking at a renovation budget of at least $60k, the $50k asking price was way beyond what we could reasonably pay.

The condition of the properties makes a big difference, too. When buying, if you only look at houses in similar condition to your subject’s current state, you can under value the ARV. But if the houses you use to price your purchase have already been renovated, you could end up paying way too much. The tricky part of buying a house to renovate is keeping both of these numbers in mind when you decide how much to pay.

Suggestions

Here are some basic tactics that will help you ensure you pay the right price for the houses you buy:

• Ensure your comps are as close to the subject property in size, age, and desirability as possible.
• Keep your comps close in proximity to the subject as you can.
• Don’t cross major roads, but remember to deduct value if your subject or comp is on a big road.
• Try not to use properties more than a half mile away from the subject.
• Mark sure the kids who live in the comps attend the same schools and ZIP code as your subject. I’ve seen the house across the street or next door go to a different school. Certain schools can be a tremendous motivation—in either direction—for parents.
• Always at least drive the neighborhood yourself before you decide to buy. If you can’t, make sure someone whose livelihood depends on your team’s profitability does.
• Keep both the current value and the ARV in mind. Make sure there is enough room between the price you’re paying and the ARV to pay for the rehab, your holding costs, and your profit.