The Waiting Game

When you’re not confident the market will continue to rise, it’s better to be cautious about acquisitions. What do you think the future holds?

This post originally appeared on the Hermit Haus Redevelopment website on 2018-06-18.

I’m back.

I haven’t posted anything for a while, mainly because I haven’t felt like I had anything constructive to say. You see, we’ve been selling off our inventory, as Suna and been talking about. But we haven’t been buying anything. Not since December.

Other people were buying things, but we kept walking away without buying or letting other people out bid us. That made me feel as if it were my fault. I must have been doing something wrong.

But I wasn’t.

You see, the only thing worse than no deal is a bad deal, and bad deals are all we’ve been encountering for the past few months. And I’m not the only one.

According to Sovereignman, Warren Buffet has been going through the same dry spell.

So… here is the most successful investor in modern history who:

1. Didn’t buy anything in 2017;
2. Is stockpiling a mountain of cash;
3. Is now selling an asset that he would typically hold forever, because another company made an absurdly high offer for the business

...[I]t seems pretty clear from Buffett’s actions that it might be a good time to take some money off the table and wait patiently for the compelling opportunities yet to come.

Buffet himself has noted that he walks away from more than 100 “opportunities” for each deal he closes.

That got me thinking about my friend Shenoah Grove who points out that the Austin market is now almost ten years into our five year business cycle. And even though the market doesn’t show any signs of slowing down, you have to worry if it is too hot.

Following Buffet’s lead, I think it’s time to wait for deals that are so compelling that they’ll fund themselves or make money even if the market turns down. We may even have some of those on the horizon.

Stay tuned. Or better yet, help us find a really good deal. We believe in sharing the wealth.

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.

Austin’s “Affordability Crisis”

High prices mean more people, especially young people, are renting again. Pricedoutforever.com argues that this is a good thing. I’m not certain if its good for them, but it is a good thing for investors. Photo by Pricedoutforever.com

This post originally appeared on the Hermit Haus Redevelopment website on 2016-07-23.

The median price of a single family home in the City of Austin rose 3% to $350,000 in June. When you take the surrounding cities into account, the median price was up 8% to $295,000. This sounds like great news to investors, but it actually makes our game riskier. Just as the higher prices are denying many first-time home buyers and lower income families the opportunity to buy a home in Greater Austin, they make it harder for investors to find the margins we need to sustainably run our businesses. Not impossible, just harder.

If you talk to a real estate agent, they’ll say, “Buy high, sell higher.“ But remember agents are motivated by commissions, and they get paid no matter which way the market trends. They get paid more if it goes up, but they still get paid if it goes down, assuming it doesn’t collapse and they can still sell something.

The more people get priced out of the market, the fewer people there are to buy any given home. That doesn’t seem to be a problem yet—along with the "affordability crisis" the ABOR article mentions, we have a supply crisis. Our inventory levels remain at historical lows, less than two months. I’ve even heard speculation we may see a one month inventory in the near future. That means, despite the price, someone is buying all the houses that are for sale, and it’s not just investors.

Remember, a stable market has around six months of inventory. So we are still in a really hot market.

While the trend in median home price continues upward, it is not a straight line. You can’t count on appreciation to save your donkey. Data source: Austin Board of Realtors^®

But consider this: this business is cyclical, and it can turn on a dime. Add to that what our mentor Shenoah Grove says: "We’re currently eight years into a five year cycle," and you can begin to see why some investors are starting to talk about bubbles. And finally, I’ve seen a market correction in the first year of every new administration since I can remember, regardless of which party was involved. So you have to ask yourself if we are approaching the crest of the wave.

Over time, real estate has always appreciated. But that appreciation isn’t a straight line, unless your talking about the very long run. It’s downright bumpy. And as I’ve always said, to reap the long term benefits, you have to survive the short term. Or as I once heard Alan Greenspan quote John Maynard Keynes when asked why investors don’t plan for the long term, "In the long run, we’re all dead."

So how do we continue to help people and make money in times like these? We have to stick to basics.

• Don’t buy assuming appreciation will fix our mistakes. I think it will...in the long run—if we survive the short run.
• Know your end buyers well enough to improve the house to the right level, neither over improving nor under improving.
• Remember your time lines and try to eliminate slack from your schedules. This one is really hard right now when contractors and subs still have more work than they can handle. Why do should they care about your schedule?
• Manage your holding costs. Use private money rather than hard money. Use bank money rather than private money.
• Partner up to spread the risk. You only shoulder half the risk with a seasoned partner, but you only get half the profit.

That said, don’t forget the motto I learned from my mentor Than Merrill: “People first, profits second.“ This business revolves around solving other people’s problems. Even in these high-priced times, even when the market turns down, if you can help people solve their problems, this business will continue to be rewarding and profitable.

For the full report on the June market from the Austin Board of Realtors, see Austin-Round Rock home sales on pace to surpass 2015 record levels amidst affordability crisis