Two Fears of Real Estate Investors
Interest rates are at historic lows right now. There are a lot of new real estate investors and buyers entering the market. Due to the lower inventory this year, a lot of properties for sale in the Greater Boston area receive multiple offers.
Some buyers get intimidated by this situation, which is also nothing new based on how the market has been in the past few years. For many people, it still makes sense to become home owners, especially given how high the rents are and the opportunity to build your own equity rather than your landlord's equity.
I’ve personally been involved in many bidding war situations before, including when I bought my own properties, so I can completely understand how it can be intimidating for someone new to the market. However, in my experience, the multiple offer situation is just a psychological barrier to overcome. There are many markets in the nation that operate similarly, with multiple offers being common, so dealing with multiple offers in transactions is nothing new. In fact, investing in this kind of market seems a lot less risky to me than investing in markets where demand and affordability is much lower.
There are two kinds of risk for new investors:
1. Overpaying for first properties
2. Buying a property that requires a ton of renovations and the renovations go over budget due to construction delays
1. Overpaying for first properties
I personally think risk no. 1 is a lot easier to control for newer investors than risk no. 2 because we can all study the comps. My experience with supply vs. demand in real estate tells me that the concept of “overpaying” is sometimes a result of the sales data being delayed for two months (due to the time it takes to close a transaction for the sales data to become publicly available). This is because when the inventory is particularly low, the very few sales that become the new comps in the sales history will impact the market substantially and drive appreciation. So what might look like "overpaying" may in fact be just paying the new fair market value.
In my real estate blog, I wrote an article in 2016 called “what happens when we overpay,” that explains this concept.
The 2019-2020 market is not as competitive as in 2016, so the bidding situation this year is actually not as bad as 2016, even though the seasonal cycle seems to start earlier this year.
Now, let’s talk about risk No. 2.
2. Buying a property that requires a ton of renovations and the renovations go over budget
Risk No. 2 is riskier than risk no. 1 (overpaying for properties) because a lot of unexpected things can happen with construction, but in my experience this risk can be mitigated by studying the property and bringing contractors on site to discuss the project before making an offer. I have used this strategy for my previous transactions, and I always help my clients analyze the renovation costs and risk components before they take on a project.
Some buyers wonder if buying a property that requires more work could be less competitive.
Buying a property that requires more work doesn’t necessarily mean it’s easier. Some of these properties attract more 100% cash buyers because the condition of the property doesn’t qualify for a conventional loan. These conditions could be exposed wires, lack of heating system, etc.
Most of the first-time landlords I have worked with in the past were more comfortable with Risk No. 1 instead of Risk No. 2. If the buyer “overpays” by two months of appreciation to win the bid and get the property, the price they pay is less relevant if their goal is long-term investment. The “high” price they pay is only temporary and is often necessary to even acquire the property.
When I bought my first investment property in Cambridge in 2016, there were 7 offers, and the price I paid seemed very high. But even just a few months later, the property had appreciated and the price I paid seemed relatively low.
I think what is happening now is that there are a lot of investors looking for conservative long-term investments due to too much cash and equity sitting around. The alternatives are just letting money sit in the bank or other investments that might be less appealing to them on a risk-adjusted basis.
I also think what is contributing to the pricing stability or appreciation in various hot locations is the fact that many investors or first time buyers are buying with a long-term goal in mind.
Financial institutions still consider multifamily investments in good locations to be one of the least risky asset classes.