Contrarian Real Estate Investing. Is it for You?

Contrarian Real Estate Investing. Is it for You?

In a down-turned economy, contrarian real estate investing offers profit to investors who take action based on strategies that are “opposite” to the masses of people who follow conventional wisdom.

Based on circumstances such as market conditions, real estate investors “follow the herd” regarding when to buy, wait and sell. Although an investing approach may have worked in the past, when market conditions change, investors need to be adaptable and adjust their strategy to meet the new reality of the marketplace.

In this month’s newsletter, I’d like to discuss contrarian investing and how it can benefit your real estate portfolio.

CURRENT REAL ESTATE MARKET CONDITIONS – CANADA

Latest statistics from The Canadian Real Estate Association (CREA) indicates that national resale housing activity remained stable from June to July 2012. The real difference is in the price levels, where prices are off their recent peaks in Greater Vancouver and Greater Toronto, but remain above or close to a year-ago levels in those markets.

What does that mean for Real Estate Investors?

With the shift from a sellers’ market to a buyers’ market, many real estate investors are waiting to invest. They are looking to see what happens with:

  • Interest rates
  • Home prices
  • Economic growth.

In my experience, shifts in prices can offer many opportunities to become a contrarian real estate investor – once you consider your real estate investing objectives and your current portfolio.

In previous newsletters, we have discussed the importance of knowing why you invest in real estate … if you are investing to augment your portfolio and diversify your assets, or if you are looking to create a legacy for you children. By considering the purpose of your portfolio and your propensity to manage risk, investing in the current economy may make good sense.

Timing and Buying Real Estate

People invest in real estate from an emotional point of view. It is not simply a transaction, there are real emotions tied to whether you have timed the purchase of your investment right.

The Typical Investor Emotional Cycle

 

Understanding this cycle and taking a contrarian approach can greatly assist you in determining the motivation of the seller, which in turn can benefit you when negotiating a purchase price. If the fundamentals are correct, but the positioning of the masses in the cycle emotional has most people holding off, smart investors taking a contrarian approach reap the benefits. A strong example of this can be seen from real estate investors who took advantage of the opportunity of low prices in Phoenix, Arizona during 2010-2012.

Across Canada, each province and each major city has distinctive sets of “micro real estate markets”. For example, Edmonton and Calgary – although in the same province, are positioned at a different parts of the real estate cycle. Certain areas within each city may have dramatically different market results even though each city will be presented as one market. Geographically diversifying your real estate investing portfolio by investing in different markets can improve your return on investment by selecting areas that are poised for growth.

For many Canadian real estate investors, this goes against the conventional wisdom of having all of your real estate in one market. Often, individual investors don’t have the resources to invest out of their individual markets – due to limited knowledge of other markets.

Here are the top 5 reasons to consider investing now….

  1. Market Timing

The whole notion of effective market timing (buy low/sell high) is the foundation of a successful real estate investing portfolio. While it is difficult to time when a market has reached the bottom of the real estate cycle, investors need to understand a number of factors, including:

  • seller motivation
  • supply and demand
  • interest rates
  • employment trends
  • population growth.

These elements can point to where a particular real estate market is positioned within the cycle and can significantly affect pricing and therefore your returns.

With projected growth, many economists feel that Canada is outperforming other nations like Japan and Europe. With crude oil (Canada’s biggest export), reaching a three month high, many believe we are making our way out of recession conditions.

Source: businessweek.com/news/2012-08-20/canadian-dollar-trades-close-to-3-month-high-on-growth-prospects

  1. Economic Indicators and Financing

With slightly lower economic growth forecasts for 2012 and 2013, The Bank of Canada has kept its overnight rate target at 1 per cent – ensuring that borrowing costs remain unchanged since September 2010. Rates are expected to change in 2013, according to several industry publications.

For real estate investors, 10 year interest rates have never been this low, allowing new and seasoned investors the opportunity to get started in real estate or leverage their current portfolio.

 Trend Comparision using Canadian 5 year interest rates starting from 2005

 

 

 

 

 

 

 

 

Source: CREA: http://creanews.files.wordpress.com/2012/07/bank_rate_hires_en.png

Another element to consider it that long term rates are tied to the bond market. As the bond market changes, the bank rates change accordingly. The Bank of Canada has two documents that clearly highlight this relationship:

Spreading out the financing terms for real estate investors is one thing that you can do to manage the due dates and risks associated with your mortgages. Once the Bank of Canada decides to increase interest rates, it is unlikely they will decrease them to the levels available today.

With this in mind, having a strategy to spread your renewal dates to different years can reduce your risk of interest rate shock on your investments if they shift rapidly. Historically, the rates can change significantly overnight – increasing at a faster rate than when they decrease.

  1. Leveraging Your Mortgage Financing

When you use your rental income generated by your investment property to pay down your mortgage financing – you leverage your investment. The rental income earned by your property will usually be sufficient to offset your mortgage payments and all associated expenses for your unit.

Reviewing and structuring mortgages for your properties may offer additional opportunities to invest in additional investments for your portfolio. I’ll discuss my thoughts at the end of the article.

  1. Appreciation

Future selling price minus original purchase price equals appreciation. Over time, real estate typically grows in value generating appreciation when you decide to sell. Doing your research on market conditions, rental demand and property improvements before you invest are an important key to improving appreciation when you sell.

  1. Cash Flow

A fundamental benefit of real estate investing is its potential to generate income, especially over the long term as your mortgage is reduced. The income generated from your investment property will often be sufficient to offset your mortgage payment, taxes, condominium fees and other expenses, while still providing you with positive cash flow.

Your cash flow will be strengthened over time as you pay down your mortgage and funds can then be used to supplement your retirement income.

The Current Opportunity

In today’s record low market conditions, these five benefits can make a big difference. In my opinion, the biggest opportunities for investors are items two and three – financing and the economy. Ultimately creating cash flow is a key part of your real estate portfolios performance.

In recent years, the Canadian and US governments have used economic bailouts to support the economy via major cash injections. I am not here to argue the merits of these actions, but only to present the potential results based upon history.

During the 1970’s – 1980’s, a change in monetary policy resulted in inflation and unprecedented interest rates. Investors were left paying significantly higher mortgages each month, forcing some investors to sell at a loss.

I believe that eventually, we will have to pay the price for these cash injections and huge deficits – so being prepared for higher inflation and interest rates is something to consider as we head to a strengthening economy.

As the economy improves, these low financing rates will change. For investors, the important thing is to stabilize and structure your mortgage financing to ride these adjustments. Should the interest rates change, having a stable financing is essential.

Questions?

Because I have been personally working on rearranging some of my portfolio financing I have respected strategic alliances (value partners) who focus on this very point. If you are interested they can help you determine the right mix of financing to reach your real estate objectives.

Taking a contrarian view in uncertain markets can uncover opportunities that occur infrequently. By understanding the right opportunities and having a team to support your decisions, you can rest easy know that your portfolio is strong and optimized to create results.

 

By Andrew Schulhof
30 Aug 2012