Will You Be Protected When The Real-Estate Bubble Bursts?

I love investing in real estate. It’s a fair amount of work, but I enjoy just about every aspect of it. I’ve been fortunate enough to realize triple-digit profits on properties several times in under a year — as the result of leveraged appreciation, net rents, and amortization. On other properties, I expect to get at least 15% to 20% annual compounded returns, doubling my money every four to five years. I don’t know where else you can get numbers like that without taking on a lot more risk. But as an investor in real property today, you have to be especially careful.

Prices in many areas have doubled in the last three to five years, though real estate traditionally doubles in value about once every 12 years. That means you may be buying after much of the easy-money appreciation has already occurred in your neighborhood — and if you get caught up in a bidding frenzy, you could get hurt. That’s why it’s critically important to become an expert in gauging the true value of a property if you’re going to be a profitable, but risk-avoiding, real-estate investor.

But even if you do all the right things, that won’t answer the question that a lot of people are asking these days: “Are we in the midst of a real-estate bubble that’s about to burst?” Some of the best advice I’ve seen on investment timing comes from Steve Sjuggerud, editor of True Wealth, an excellent investment publication, and an investment panelist for the Oxford Club. In an article he wrote a few weeks ago, he provided a hint as to his current thinking when he quoted Yale economist and investor Irving Fisher: “Prices have reached what looks like a permanently high plateau.

I do not feel there will soon, if ever, be a break from present levels, such as [bears] have predicted. I expect to see the market a good deal higher within a few months.” Fisher wrote those words, referring to stocks . . . in early October 1929. In Steve’s hometown neighborhood, as well as mine, everybody seems to believe that real-estate prices can only rise. He says, “There is nobody here who believes that real-estate prices can fall . . . which is exactly my cause for concern. Longtime readers of mine know that I don’t think U.S. real estate is wildly overpriced . . . yet. But I think it’s about to be.” I too am becoming very cautious.

Everywhere I look, the market is getting extremely expensive. Many neighborhoods in my area have doubled in value in just the past two to three years. Traditionally, real estate doubles in value about every 12 years. Bubble? It’s the Goodyear blimp. Or will it prove to be closer to the Hindenburg? I’m not so sure the current boom in real-estate prices can last much longer. If it goes more than another year, I’ll be surprised. And if interest rates do start to rise, if unemployment skyrockets, or if there’s some terrible turn of events in the global political situation, things could go bad quickly. Trees don’t grow to the sky.

That said, what am I doing? I’m buying real estate. But, in this market especially, I “wait for my pitch,” as the baseball saying goes. I don’t chase balls that are way out of the strike zone, “hoping” to connect. To put it in terms an equity investor can easily grasp, think of the approach Jimmy Rogers took. He’s the former co-manager (with George Soros) of the astronomically profitable Quantum Fund, which produced something like 31% compounded annual returns over about two decades. Rogers has said that his approach to investing is to wait and watch for the right investment — one loaded with value. He looks for a situation, he says, where he practically finds a pile of money just sitting in a corner . . . and all he has to do is walk over and pick it up.

This is, basically, the approach I try to use with my property investments. I probably see listings on 100 properties before I find three or four that might be worth looking at. Then, when I see one that might be a deal, I do even more homework and make an offer that I’m confident will give me plenty of downside protection and upside potential. Fortunately, even in today’s frothy market, this has been working for me. And I’m in South Florida, where properties have really skyrocketed.

Using this approach, I’ve been able to add three properties in just in the last two months. In a negative-case scenario, rents could drop 15%, housing prices could stall or fall double digits, and I would not be pressured to sell a single property. I could hold them as long as I want (and my preference is for the very long term) and in the worst case simply have my tenants pay off the property for me. I’m also focusing on neighborhoods where there is a great deal of immigration from other parts of the state and country, buoying demand. Now, more than ever, you have to be a sharp buyer.

Lately, I’ve heard property investors saying things like “You can’t lose in real estate.” Those are the words you hear at the times when you can lose the most. And what if you’re currently holding significant amounts of real estate in your portfolio? This a good time to review the cash flow of each investment and consider unloading any that will hurt you if the bubble bursts and your rental income drops significantly. Just because the market may have peaked doesn’t mean there’s not a ton of money to be made in real estate — if you do it right. Take care of your downside first, make sure you know your local market cold, and the profits will follow from there.

(Ed. Note: Justin Ford is the editor of Main Street Millionaire, ETR’s real-estate investment success program. For information, click on http://www.agora-inc.com/reports/700SMSMO/W700E461/.)