Investing in a Real Estate Bubble

In March 2013, I find myself investing in a real estate bubble. In my city the real estate market is officially on fire.

First, some background.

2006-2007

In 2006 I was living 1,000 miles away working in consulting. The hotel I lived in kicked me out so around August 2006 I bought a cheap condo in a rough part of town (~$175k, foreclosure). Right after moving in I got an offer to move back home (March 2007). I listed my place for $225k and it sold. Wow. I probably put $5k in it and cleared more than $20k net profit in mere months.

By early summer of 2007 I was settled in my day job and ready to buy another place back in my hometown. I had only been gone one year. When I left there were nice condos available for $220k. When I returned there was nothing under $300k that had 1,000+ square feet. I became a renter.

2008-2009

Everything felt irrational: signing bonuses, stock markets, tech companies. I paid a lot to live in a crappy part of town. Finally the recession I imagined took hold of the real estate market. It took years, but in 2009 I bought a duplex.

What Makes a Bubble?

To me, housing bubbles have a few simple characteristics. There is tight inventory, loose lending standards, speculators and flippers. A surprising amount of people are making money…really good money. But a lot of the profits are traced to leverage.

In my town, sales are happening in a couple of days (seriously). There is less than 2 months of inventory in several hot sub-markets. Many offers are cash. Ugly properties are being bought with cash, minimal cosmetic work is done, and they are re-listed for 20%+ more amidst bidding wars. Walking distance from my house someone bought an empty distressed property for $198k and re-listed for $269k. They didn’t even remove plywood from the broken windows.

How To Invest in a Bubble?

This is a hard pill to swallow; I don’t know. I have capital I have to put to work; I can’t sit on the sidelines indefinitely. I’ve been out-bid repeatedly over the last few months. I’ve been bidding above asking price, then re-bidding above that and still losing most deals.

I try to stay rational by looking at hard numbers.

Looking at the duplex I bought in 2009, I paid ~$265k. The rents were ~$1,850. I paid about 12x gross rents. Three years later the market rent is $2,500. At 12x rents.. this duplex would be worth ~$360k, a gain of $100k in a few years. Wow.

Those numbers are so hard to digest. Small neighboring lots are selling for more than this duplex. In just a few months I went from considering this duplex worth ~$300k to considering listing it at $500k in a package deal with an identical property next door (also at $500k). There is irrational money chasing investment property in my area right now.

But this increase was driven by rents and low inventory. Are rents going to continue to go up? What is the supply of new apartments in the coming few years? The investors I know in this neighborhood have no plans to sell. A lot of people are still moving to this city.

So What Am I Doing?

I’m still digging around for deals. I’ve expanded my scope a bit on what I’m willing to do for rehab. I’m more open to estate sales, or to warehouse deals. I’m considering property further away.

I’m also willing to wait. I’ve never lost money in real estate. The competitive nature of bidding makes me want to get aggressive and win a deal. But I keep going back to my hard numbers, and losing bids.

My last accepted offer on a house is falling apart. There are crazy liens against this new property; it’s the worst I’ve ever seen. Almost comical. The deed is so screwed up I can’t believe it was ever listed (ethics?). When I bid, I had 4 hours to do any research. I went 7% over asking and beat 3 other cash offers. I still don’t even have a signed contract after 2 weeks (thanks, seller’s attorneys).

Part of me wants to list my other properties but I have no idea what I would do with the cash. Nothing seems cheap.

Conclusion

Sorry for the sad tone of this post. I know people are making fistfuls of money in real estate in this city. It’s killing me to be patient. I haven’t changed my strategy (buy and hold) but am unwilling to sell yet for lack of ideas.

I’ll keep looking at my models and using reasonable assumptions. Until something new meets my criteria, I’ll sit on the sidelines (again).

Any better ideas out there?

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