What do you do with a piece of real estate that you own in a market that is still declining? … or is the market still declining? How is one supposed to know?
As a young man stepping into the real estate world back in 1972, I heard from many that the three most important things about real estate is “location, location, location.”
In many ways that statement is very true; however it implies that location is the primary factor to making a good investment in real estate, such as land or an improved piece of commercial real estate.
On the other hand for those who have experienced a few real estate cycles, there is another phrase that my father used to say trumps “location cubed”: He’d tell me often that the key to a good real estate investment is “Staying Power.”
Think about it for a moment. Let’s say that you bought an incredible commercial corner at a very busy intersection, or a farm right in the path of residential development in 2003 while the market was still climbing.
Things looked great as you planned for the future. As the value rose, you decided to refinance and take a bit of equity out for another investment.
Then “Pop,” the market turned. You counseled with others in the real estate investment field, as well as your advisers, banker, etc. You hear hopeful statements like: “This down turn will likely be a hick-up – just a blip in the steadily climbing market.”
A year goes by; then another and another … next thing you know your friendly banker has informed you that the recent appraisal finds the value at a figure that is less that of the real estate loan on the property. The lender asks you for additional collateral or a cash curtailment to bring the loan to value ratio back in line with their compliance standards.
While you are able to pull it off this time, the forecast for the future is much different now in 2011 than when you bought it 8 years ago.
You counsel again and figure that this has got to be the bottom of the market. Your logic tells you that this is the dawn of a new year, as there are signs out there that have to mean an upswing is just on the horizon.
But what if that’s not the case? What if this economic cycle still has tough times planned for the commercial real estate market?
While the location is good and your value may not have been hit as hard as that of another investor whose property is in a “C” locale … the question is do you have the “Staying Power” to ride out the cycle long enough to still grab that golden reward you have planned for?
The above graphic illustrates a scenario that may or may not be what the crystal ball has in store for certain types of commercial real estate, but uses some typical historical swings with quick climbs as a boom cycle reaches its peak. It also displays a contrasting fall in values until the bottom of the market is reached.
The critical part of the graph to take note of is the fairly traditional slow but steady recovery part of the cycle. At the end of the day, the gap between where the value is today and the same value on the recovery side will give one cause to ask: Why hold on?
Now this chart shows offers a scenario with a 15 years gap before the value returns to the 2011 figure. While this may or may not be an exaggeration (who knows?), it is important for real estate investors to run the same kind of forecasts in these upside down times.
The key questions one must ask him/herself: Is this the best investment for me at this time? And if yes, do I have the “Staying Power” to hang in there?
Real estate cycles do add a more than interesting twist investment in any type of property, be it land, commercial, industrial real estate or even that of your own home.
For a look at the Case-Shiller historical graph of housing market cycles sine 1890 go to the MacRo Report Blog post of July 1, 2010: Seeking a “Normal” Real Estate Market: Using Housing as the Barometer.