A buddy asked me a good question recently. Since it’s one a lot of you are probably asking as well, I’m going to answer it here…
(If you’d rather watch the video version, or watch it and then read this post, you’ll find the video here.)
What he asked was, “Should I keep putting my money in a bank account and wait for the next crash, so I can buy at the bottom and make a killing? Or should I invest now, and look for returns over the long term?”
Here’s how I’ll answer this question…
We’ll use historical data, drawing on the FHFA home price index (HPI) for Kansas City, MS. We’ll work with a 10-year window, from Q1 of 2007 to Q1 of 2017 (most recent data at the time I’m presenting this). Of course, looking back, we know where the top and the bottom of the housing market were over the past decade: the peak was Q2 of 2007, and the low was Q2 of 2012.
Using this data, we’ll actually compare two different approaches based on this Kansas City market. (We’re using Kansas City because it was a good market to buy in, with positive-cash-flow properties available for purchase.)
First, beginning in 2007, we’ll wait to buy a house until we get to the bottom of the market, in 2012. We’ll get the best possible price and ride the wave back up. We’ll see where we would have ended up, almost five years later.
Next, we’ll buy at the top of the market in 2007, when we would have paid “full price.” Then we’ll hold it for the next ten years and see how we would have made out.
We’re going to keep the numbers simple. For example, we won’t factor in closing costs and things like that. This just makes things easier for presentation purposes. Also, we’re going to look at just three returns:
Cash ROI: This is cash flow ÷ investmentPrincipal reduction: The idea here is that as you pay down your principal each month, you’re creating more of a spread inside your propertyAppreciation and depreciation: Of course, if we buy at the bottom, there’s only appreciation. If we buy at the top, we’ll have a combination of depreciation as prices fall, and then appreciation as they climb back up after hitting the bottom.
(We won’t use tax benefits for this example.)
So we’ll end up at the same place, Q1 of 2017, and we’ll be able to compare the two approaches pretty well.
We should also know the answer to the question, “Can I make money by buying at the top of the market?” If you can make money then, you can make money at any point on the timeline. And then you’d have to ask yourself, “Why wait until the next crash?”
Buying at the Bottom…
So what happens here is, we hold our money in the bank, watching and waiting (and waiting) for the bottom before buying.
One thing to think about, by the way, is that while our money is sitting there in the bank, it’s actually losing value ‒ inflation is eating away at it every day. At any rate, in terms of appreciation gain and cashflow, we’ve got nothing because we haven’t actually invested in anything yet.
Again, we’re starting at Q1 of 2007, since that’s the top of the market for Kansas City. That means our money is sitting in the bank, waiting to be invested, for five years.
Then, in Q2 of 2012, we’re at the bottom ‒ and we buy a $100,000 house for $20,000. We get a 30-year mortgage at four percent interest. Our annual cash ROI is 20 percent.
So, for years 5 through 10, the value of our house appreciates by a total of $32,830. We get $20,000 in cash flow (20% per year for five years), and our principal reduction is $32,830. This totals $60,470 ‒ which is approximately a 300% ROI. That’s 30% per year…
That’s a very strong return. So there’s no question that buying at the bottom, in Q2 of 2012, would have made sense. Here’s a bird’s eye view of the numbers again:
But now, years 5-10 kick in, as the market rebounds and we begin to see appreciation again. In this case, our property’s value appreciates by $32,830. We also get our $16,000 in cash flow ‒ and we gain an additional $9,330 in principal reduction (the longer you pay down your mortgage, the more you’re paying down the principal, and the less you’re paying interest). It’s a good five years!
And when we add up all ten years, things really come into focus. In terms of appreciation and depreciation, we definitely would have come out ahead over the long haul, as we netted $10,640 ($32,830 in appreciation minus $22,190 in depreciation). Our cash flow totals $32,000, and our principal reduction comes in at $16,970.
Here’s how it looks:
Basically, we got the same return by buying at the top as by waiting to buy at the bottom. Except… there are additional benefits we would have gotten ‒ we just left them out to keep things extra simple.
For example, we mentioned before that our money would have been losing value due to inflation while sitting in the bank, and we didn’t show that depreciation in our table. Not only that, but we also didn’t show cash flow gains from rent increases.
Typically, rents keep pace with inflation. But in the most recent meltdown, they actually outpaced inflation ‒ and we didn’t show that, either. These would have made a major impact as we held our property over the full ten years.
Finally, keep in mind that we used a best-case and worst-case scenario here. We could do that because we’re looking back with the data we now have. But in real time, you can’t actually know where the bottom and top are going to be. So if you’re waiting to buy at the bottom and you miss it by even just a few months, that’s going to lessen the appreciation you’ll see, as well as any rent increases you may have been able to take advantage of.
And remember, the house doesn’t know it’s “losing value” while its market price is falling. Over the long term, it will hold its value ‒ and generate cash flow and build equity along the way.
Another Example… and Conclusion
As we wrap this up, we’ll look at another example, this time from Oklahoma City. Here, we would have made even more money by buying and holding, largely because the houses in this market barely lost any value. And the value loss they did see began to reverse itself even within the first five years.
Here’s the “wait to buy” breakdown:
And here’s the “buy and hold” snapshot:
So, the answer to my friend’s question?
There’s no need to wait until the bottom to buy real estate and “start making money.” (In fact, there are good reasons not to wait.)
You can invest in real estate whether the market is going up or down ‒ and you can make very good money doing so.
It works ‒ as long as you avoid house flipping and negative cash flow. Even if you buy at the top and have to wait five years for prices to start bouncing back, you won’t need to sell as long as you have positive cash flow. And in the meantime you’re getting a strong return and creating equity. Just ride it out, and you’ll see appreciation as well.
If you do it the right way, investing in real estate is a winner, giving you substantial returns on your investment. In good markets, and in bad…
Why would anyone wait to start cashing in on this powerhouse investment?
Give us a call at (801) 990-5109 or schedule your free appointment here to begin your personalized Wealth Plan. We’ll do everything we can to help you implement the strategies we’ve covered in this article. You’ll get truly expert advice and coaching… so you can reach your financial goals by investing in real estate.