- Low interest rates and relaxed lending guidelines are significant indicators of a bubble.
- Escalating offers and aggressive contracts (no contingencies?) are something to keep an eye out for.
- Try to always keep at least 20 percent in equity in your properties (don't borrow too much).
Interest rates have been very low for a long time, which is great for homeowners and investors. Obviously, when money is cheaper and readily available, you can buy more with it.
An example would be if you buy a $100,000 house with a 4 percent interest rate, then your payment is about the same as an $80,000 house with a 6 percent interest rate.
We want to talk about a few things we see in our local market, in addition to describing signs of a market bubble and what you should be aware of.
In most markets, changes develop pretty quickly, and in this industry, changes stem from banks and the availability of money in the marketplace.
When money dried up around 2006 and 2007, there were a lot of quick and traumatic changes in the real estate market that occurred because banks stopped lending.
As a real estate investor, chances are you’re either flipping a house and then selling it to a homeowner who is getting a bank mortgage, or you are renting a house out, and your bank is holding a long-term mortgage on the property. This can help you see why banks are so relevant in this market.
In the Washington, D.C., and Baltimore markets, where we are, the foreclosure waves have flooded the market with distressed and undervalued inventory for investors to pick up. Short sales have been approved a lot quicker than before, so there remains really good inventory to buy.
Bank asset managers are smarter than they used to be. They know that if they want to sell a property quickly, then they must list it at the right price for an investor to buy or they need to go in and do some work themselves if they want to be able to sell to a homeowner.
Signs of a bubble
One sign of a bubble that you should be aware of is a lack of affordable homes for good wage earners in any neighborhood. This happens when you make a good amount of money, and it is still hard to buy a property — typically because the property values are so high.
Other signs of a bubble in the market are when banks are issuing high loan-to-value (LTV) loans again, when there is easy money available, when there are multiple contracts on properties that you want to buy (a sign of a seller’s market) and when it is just hard to find investment properties with equity.
There was a mini-refinance boom recently because interest rates were attractive. Creeping increases in interest rates began again, and that is potentially a sign. We have also noticed there are significantly more FHA loans available.
In the past, there weren’t as many FHA loans as there are now, which means a lot of lower down payment requirements to buy. It seems like there are a lot of younger people right out of college, good young professionals in their late 20s and early 30s that just have a hard time being able to qualify for houses because they are so expensive.
What you should know
The biggest problem for folks looking to buy is that they want to purchase the maximum amount that they qualify for.
They feel that if the bank will qualify them for a $2,000 payment on paper, then that is the mortgage they want to get. Instead, they should be responsible in planning out what they can afford to be prepared for the event that they lose their job or have to sell the house quickly. In these instances, it’s important to be in a good spot with an affordable payment.
It also makes sense to have some sort of equity in the property, either immediate equity because you bought the home at an excellent price or you made a big down payment.
If you only have 5 percent to 10 percent equity in a property, and you have to move, or something happens, then you are not going to be able to sell that property, and you will be left in a bind. Having that additional equity will give you a little bit more power during a slower market.
For real estate investors, it’s even more important to have an equity cushion on all your projects. Make sure you have put some cash in the deal or that you are buying it low enough that you gained equity in case you have to liquidate it.
Even having 20 percent equity in a property as a real estate investor isn’t sufficient. If the market takes a slight turn and the value decreases by 10 percent and if you are forced to sell the property quickly, then you might be underwater.
Make sure that as an investor you have equity, not only in your flips but also in your rental property. This gives you flexibility and additional options for your investments.