Are We in a Housing Bubble and How Do You Protect Yourself?

Are we in a housing bubble? How do you know? What should you look for?

I’ve been investing in real estate full time since 2005 which means I definitely lived through the last bubble and, more importantly, the burst that happened in 2008-2010. Painful!

So are we in a bubble which means, ultimately, heading for another burst?

I’ve read a lot of articles lately denying that we’re in a bubble, but I don’t know if we should trust them because that’s what the articles said before the last burst. They claimed we weren’t in a bubble but that the economy was strong and prices would continue to rise because, historically, they always go up.

What you discover is that yes, prices do go up over time, but not necessarily every single year.

If you buy during a bubble, you over pay and lose value when the prices drop.

Some markets are going up quickly again, maybe too quickly in relation to replacement/construction cost value, but many economist say that’s justified because there’s not enough housing for the rising demand. New home construction has still not increased to demand levels because many builders went out of business during the last housing collapse.

The difference between what we’re experiencing today and what happened in the 2008-2010 crash is that house price increases can be explained, so the experts say, where they were going up pre-crash simply based on emotions of the market. Because values were rising, everyone wanted to jump on board assuming they would continue to rise. I think we all learned that assumption was wrong!

And lenders got in on the excitement when the last bubble was inflating. If you were there, you remember how easy it was to get a home loan. We used to joke that, if you had a pulse, you qualified. That wasn’t really much of a joke because lenders were doing “no-doc” loans where borrowers didn’t even have to show proof of income! Eventually, banks realized that house prices may not continue to go up so they cut off these easy loans which added to the collapse of the whole economy.

We don’t see that happening in today’s market. Lenders still require that borrowers actually qualify and give loan amounts and interest rates based on those qualifications.

By the way, specific areas can have bubbles, it doesn’t have to hit the entire nation at the same time. Here’s a chart by FreddieMac showing large metropolitan statistical areas (MSAs) with unusually high house-price-to-income ratios currently, something else FreddieMac tracks as indicating a bubble. A lot of these areas are ones that got hardest hit in the last bubble burst.

Pretty much everything I’m reading says that the number one reason for high house prices is the shortage of available housing. This means we shouldn’t be in a bubble like we were last time.

However, as I mentioned earlier, the “experts” were denying that we were in a bubble the last time it happened and investors everywhere seemed very confident that there was no need to worry.

So, bubble or not, what can you do to protect yourself against a potential drop in the market?

Here’s what we do:

1. Buy conservatively. I like to have a lot of equity the day I buy. If I hold the property long term, I want to know I can cashflow it today but lower rents in the future if necessary and still have it cash flow. I prepare for a drop in the market rather than betting on appreciation. If we get appreciation, hey, that’s a bonus!

2. Get in and out quickly. Our number one exit strategy is wholesale. I’ve written about wholesaling in the past – what it is and how to do it. Buy cheap, do nothing to the property, sell to an investor who wants to rehab it. With these deals, we typically own for less than 2 weeks. Great thing here is we won’t get caught with properties we need to retail if the market turns.

3. Do only small rehabs. Again, the idea is to be in and out quickly. A lot of investors went under in the last crash because they were in the middle of rehabs when the banks stopped lending and sellers went away. Many of these investors ended up with multiple properties that they couldn’t sell and couldn’t afford to pay all those mortgages.

4. Pay attention to your local market indicators as well as what’s happening with the national economy. Even the experts get it wrong when predicting the future, but pay attention in order to make your own best guesses for your own micro and local economy changes.

5. Shift with the market. Right now most of the country is in a “seller’s market”, meaning there are more buyers than there are houses for sale which increases house prices. Because of this, we are selling a lot of our rentals as they become vacant. If they’re not performing as well as we’d like, we’re selling and taking profits. We know this seller market won’t last, they never do. When it becomes a buyer’s market again, meaning too many houses on the market so house prices have to come down in order to sell, we’ll stop selling and start holding more for rentals.

6. Don’t count on appreciation. Too many investors figure appreciation into their profit strategy – “This is how much I will have in 5 years when the value of my property goes up.” Appreciation is a wonderful thing to hope for, but when it doesn’t happen or worse – when values drop – investors who add appreciation into their value strategy are hurt bad. Don’t count on it, just love every bit of it as extra profit when it happens.

7. Bottom line, don’t bet on the future. Buy and sell for profit today.

Even the experts can’t predict what’s happening and only you are ultimately responsible for your own success. Make it happen!

What can you add?