My Insurance Insider and Finance Blog

Image via WikipediaYou may be looking at the possibility of investing in Real Estate. But all you see and hear is that the real estate market is plunging, with no end seemingly in sight. If you buy now, you run the risk that your investment(s) will probably be worth less in a year from now. Oil, gold and gas prices are reaching record highs. This needs to be considered as it will affect your holdings. A further issue is whether or not we are in a recession, and if so, how long will it last?

With this dire outlook, is it time to invest? Will banks even give you the loans to invest? We will explore the various aspects of the market to try and help you focus on what’s plausible while filtering out the hype.

BUYERS’ MARKET/SELLERS’ MARKET:

How do you know if it’s a buyers’ or a sellers’ market? One way is to observe houses being sold in the area, i.e., check the For Sale signs on front lawns. Make a note of when they go up and see how long they stay up. Note any changes, such as reduced price banners. Observe this over time. If you see that there is no status change and the sign has been posted for a while you can make a loose conclusion that it is a buyers’ market. Pay attention to listings in newspapers and online. Record information on several houses on a spreadsheet and track status changes over time. You are looking for trends. You can also speak to Real Estate agents in your area. They typically have an “always rosy” outlook but by asking the right questions you can wean out what they know.

INVESTMENT OBJECTIVE:

It is important to know what kind of investments you want to make. Do you want to flip for quick profits? Do you want to buy and hold and wait for things to get better and then turn around and sell later for a profit? Or perhaps rental units are your goal.

Whatever you choose understand that the current mortgage environment is extremely volatile. It is going to be imperative for you to have a spotless credit rating (also known as a FICO score - the higher the better.) Even with a high FICO score, banks may consider lending for investment purposes risky and refuse the loan or severely limit the amount they will lend.

THE FEDERAL RESERVE:

The Federal Reserve (Fed) keeps lowering rates. Isn’t that good for mortgages? Actually quite the opposite is true, at least in the short term. The Fed only has control over short term rates, those affecting auto loans and credit cards. But a cut in rates is considered inflationary as lower rates flood the markets with cash.

Inflation is bad for lenders of fixed rate loans (traditional mortgages are structured this way) as they will be getting paid their future obligations in dollars that are going to be worth less. This will typically force longer term bond holders, i.e. 15 to 30 year maturities. Selling bonds reduces the price paid which drives the yields of those longer maturities up. There is an inverse relation between the price of a bond and the prevailing interest rate for that maturity. For more information see http://www.investopedia.com. So a Fed cut drives longer term yields up, which is bad if you are trying to get a mortgage.

THE BANKS TODAY:

Suppose you decide that you want to go forward with a real estate investment plan. There may be other factors that affect your decision. Recently, CNBC reported that even when buyers and sellers agree on a price, banks are adjusting the property values lower, thus forcing re-negotiation of the contract. The reasons are due to banks’ outlook on the overall real estate market and the increase in record numbers of foreclosures on their balance sheets. The foreclosures bring down the price of the overall market since banks know that when buyers evaluate similar listings, and one is a foreclosure, they can get the foreclosed property at a reduced cost.

WHAT DO YOU DO?

Based on all this information, it sounds like it’s time to run for the hills and stay there for several years. But believe it or not, there are strategies that you can explore that can even be profitable, or at least not as volatile. Remember that problem mentioned about banks and foreclosures? You can use that to your advantage by reviewing the foreclosure list of a bank and making an offer on one or several of the properties. Banks don’t want these on their books so they will be rather amiable to offers that you make. A similar option is to participate in real estate auctions. Look in your local listing or online for more details.

THE STOCK MARKET:

Did you know that you can use the stock market as part of your overall strategy? Suppose you decide that even after all that’s going on, you still want to get involved with real estate investing. You can employ a strategy known as shorting stocks. By shorting the stocks of some of the building companies or Real Estate Investment Trusts (REIT) you are effectively hedging your real estate holdings.

Shorting is a complicated strategy and may not be suitable to your risk tolerance. There is another strategy that you can employ that can achieve the same desired effect but with much less risk. It is an an insurance policy of sorts. You can buy what’s known as a put option on real estate related stocks. As the price of the underlying stock goes down, the option will typically increase (there are exceptions to this). You also get much more leverage with a put option.

EXCHANGE TRADED FUNDS:

Perhaps you like the idea of using the stock market as a way to hedge your real estate holdings, but you are afraid to put all your hedging eggs in one (or a few) baskets. That’s ok because Wall Street has, in recent years created what’s known as Exchange Traded Funds (ETF). These are similar in some ways to mutual funds except that they are traded as stocks. This means you can short them and in many cases buy put options on them. They also have many sectors that you can explore, i.e., oil, financial, real estate, both commercial and residential, etc. You benefit by investing or hedging in a basket of stocks instead of one or a few that you use in your hedge.

The stock market, options, ETFs, shorting and other strategies are much too complicated to explain in a short article such as this. Further, this article serves as a very basic introduction on real estate investing and is in no way intended to advise on any strategies using stocks, options, real estate or any investment product for that matter. You should always consult an investment advisor and an accountant to determine what strategies may be right for your individual needs. You should also research these strategies and get a good understanding before embarking on them. A good start is to use http://www.investopedia.com. They have excellent articles and tutorials on a whole range of finance and investing concepts.