This post was more relevant during the bubble of 04-06, but still kind of applies today. I’m not saying not to buy. I’m saying that you need to fully understand the risks involved. Sure people have gotten VERY rich on Real Estate, but you rarely hear about those that go bankrupt. They tend to be less vocal.
People think that “buying bricks” (a house) is far less risky than the stock market. Heck look at the Nasdaq that dropped 70% after the .com bubble! That can’t happen with a home, how can it lose 70%?
Well if you put only 10% down, it pretty much happens on day 1!
How? Why? One major difference (stocks vs houses) is being ignored…
LEVERAGE!! LEVERAGE!! LEVERAGE!!
Lets take a $500,000 home as an example. If a buyer puts 10% down, or $50,000, that leaves them with a $450,000 loan. Because of leverage (using 90% of the banks money to buy your home) all you have to do is close on your house, and on day 1 you have recreated the Nasdaq 70% drop! Since that same day you have lost about 7% (closing costs plus those rascally Realtor fees) in value. That 7% drop in your house value is the same as a 70% drop in your investment (you put 10% down and 7% is gone, that is a 70% drop)!
Just like they say about used cars, the moment you drive it off the lot, the car drops $5k to $25k in value immediately.
I’m not trying to scare you. If you are asking “then why does anybody buy,” the flaw in the scenerio above is that people usually don’t sell their house after holding it one day. And unlike cars that depreciate, houses tend to go up in value… But not always.
And with appreciation and leverage you can make a killing! One client was saying how she put down 10% and bought a $150k condo. And 4 years later sold it for $300k. She was saying how she had doubled her money! Actually since she only put down $15,000 (10%) she turned that into $150,000 and actually made ten times her investment, a 1,000% return!!!! Party time!
So LEVERAGE significantly increases your profit if things go up, but it can wipe you out if things go down. That is why it is recommended to buy only if your time horizon is long enough. The longer you hold a place, the LOWER your risk (usually). I do however know somebody that had to hold a condo for 10 years just to break even.
There are a ton of statistics out there showing that Real Estate is the #1 fastest way to riches.
So I gave an example of a buyer that made 1,000% (and actually over the last 4 years that was fairly common), but what you never hear about is the down side. Here is one example:
Now an example of a bankruptcy and $150k loss:
“Evelyn” was encouraged by her brother to buy a condo conversion (apartment complex that was upgraded and sold off as new condos). The pitch was “This is DC, DC can never go down! Jobs, government, etc. Everyone is making $100,000 in 1 year and it is a sure thing. The sister said she was very conservative and worried, but still decided to buy a $600k condo in Ballston. She put down “only” $10k-$20k.
She put it under contract a year earlier, closed on it and 9 days later went to flip it! Starting at $665k! She would pocket $30k after fees and double her money! Champagne all around. But it didn’t sell.
This is where I came in. I got a call from a friend that referred her to me. Why? Supposedly the Realtor “stunk.” I didn’t take the listing, it seemed way overpriced.
This is an actual email exchange we had:
- “Frank, it was good speaking to you. Your resourcefulness and dedication is what we need to sell [condo name]. We look forward to hearing from you.”
This is my actual reply after looking into it in 10/2005:
- “While I’d love to bash your old Realtor, I can’t. Nothing has gone under contract in this building so there is no precedence. He didn’t know what it would go for, since nobody knows, so he worked backwards to try and make you some profit (which is fine).”
Thank God I didn’t take the listing!
- It continued to drop. Here is the timeline:
- Paid $600k, tried to flip it 9 days later.
- $665k to $645k over 51 days
- $575k to $540k over 104 days (new Realtor, gotta be the Realtor’s fault right?)
- $520k to $485k over 126 days
- Taken over by the bank at $580,000
- Sold for $465,000
With about $35k in mortgage payments.
That makes for a loss of $165,000!
Real Estate is NOT a sure thing.
People can make millions quickly in Real Estate.
People can quickly go bankrupt in Real Estate.
- I suggest running the 1/3rd Buyer Scenerio analysis.
- 1/3rd chance of the property going down
- 1/3rd chance of it staying flat
- 1/3rd chance of it going up.
If you have run the numbers and understand what COULD happen, then consider proceeding.
Shameless not so subliminal ad coming… Keep in mind that one way to lower your risk is by getting an agent that will help fight for that extra $5k or $50k when helping you buy a place.
Love to hear your comments.
– Written by Frank Borges LL0SA- Broker/Owner FranklyRealty.com
Videos at YouTube.FranklyRealty.com
22314, Fairfax Va, DC Realty, Realtor