The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (26 page)

As we have already seen in the first phase of the real estate bubble pop, second homes and vacation properties lose value even faster than primary residences. They are a discretionary purchase that is not needed in the same way that one’s primary home is needed. The market value of these less needed homes will be devastated in the Aftershock, and before then they will drop in stages as the other bubbles fall.

So unless you have strong sentimental or other reasons for keeping it, selling all second homes and vacation properties as soon as possible is a good idea. Don’t wait for more evidence that the real estate market is not recovering. By then, the pool of potential buyers will be even smaller than it is now and you will likely have to sell for a lot less than you could sell for today.

In the shorter term, the value of some vacation properties in certain areas of the country may be somewhat protected, especially at the higher end of the market where some potential real estate buyers may be temporarily buoyed by the stock market bubble. In the longer term, however, all real estate will fall.

If you want to sell now but have been unable to get a buyer, lower your asking price if necessary to make the sale. Remember, if you don’t lower your price now, you will only have to lower it even more later.

Please cheer up! There will be many wonderful second homes and vacation properties available for pennies on the dollar during the Aftershock—but only for those who were savvy enough to protect and grow their assets now so they have money available to buy those bargains later.

Right now, it may seem like owning rental property is a good idea. In some areas of the country, demand for residential rentals has gone up as the real estate bubble has come down. More people are renting because they have lost their homes to foreclosure or have put off buying, either because they are waiting to see if real estate falls further or they cannot get a loan. In the short term, this higher demand for rentals has led to higher rents in some areas, and will likely continue for a while longer.

However, in the longer term, these higher rents will not last. Future rents will decline because . . .

• Rents always eventually track real estate values. As real estate falls further, rents will eventually fall, too.
  
• Later, as unemployment climbs, rents will fall because a growing number of renters will lose their jobs and will stop paying rent altogether. Renters are usually the first to get hit in a downturn. In the Aftershock, the courts will be too backed up for a quick eviction and your renters will simply squat in your property without paying anything, perhaps for years.
  
• When enough people are squatting without paying rent, those who do still pay rent will not be willing to pay too much.
  

If you are willing to own these properties after they no longer produce significant rental income, then there is no reason to worry about any of this. Maybe you will use it for other purposes by then (perhaps as future rent-free homes for your friends and relatives who didn’t read our books).

But if you don’t want to hold on to rental properties when they no longer bring you income, then you will at some point want to sell these while you still can.

It is hard to let go of income-producing real estate while the money is still coming in, especially if you count on that income. So it’s understandable that you would want to put off selling for as long as possible. However, the longer you wait to sell, the harder it may be to find a buyer who is willing and able to pay your asking price. And if you wait too long to sell, you may not be able to find a buyer at all. Our ideas about timing your exit from income-producing real estate are offered later in this chapter.

As the bubbles fall, commercial real estate will decline for the same reasons that residential real estate will decline: rising supply (because more properties will be up for sale) and falling demand (because there will be fewer willing and able buyers). Right now and in the near-term future, commercial real estate values are not dropping significantly, if at all. Some have dropped a lot but have more recently rebounded. So now is the best time to sell, while there are still potential buyers who think we are on the verge of an economic recovery. As we keep saying, if you wait until there is a lot of proof that there is no recovery, there will be far fewer potential buyers.

In the long term, commercial real estate values will decline substantially in the Aftershock because unemployment will rise, consumer spending will drop, and demand for rental space will fall dramatically. Retail, wholesale, warehouse, and office space will simply not be needed at current levels.

We don’t have to be 100 percent right about this for you to be 100 percent out of luck. Even a 20 percent drop in your occupancy rate could kill your profits.

We agree with conventional wisom that
medical
commercial real estate is different—but not that different. Medical commercial real estate will take longer to fall in value but will not be immune. Some medical practices will be more Aftershock-proof, but many will not, particularly discretionary practices, such as cosmetic surgery and medically supervised weight loss centers, as well as high-end boutique practices in general. Even basic medical and dental practices will sustain a big income loss and will seek lower-cost leases in order to stay in business. At first, you may see only a slight decline in medical real estate values, and then as the bubble economy falls further and pops, a faster exit of high-end medical practices and then other medical practices, as they can no longer pay their leases.

We also don’t recommend that you count on government programs, such as “Section 8” housing payments, to hold up forever. Even if they continue, they will not keep pace with rising inflation, and in time your costs will outstrip your income on these rentals.

There are two very separate types of farmland: income-producing farms and non-income-producing farms. Our advice depends greatly on which one of these you have.

For farmland that is non-income-producing, the value of the land will fall with the rest of the real estate bubble. Most family farms that are currently being used for residential homes and perhaps family recreation (hunting, fishing, etc.) should be considered as any residential property, rather than a “farm.” If the farmland does not have a house or other usable structures, it is essentially raw land that will rapidly fall in value as the bubbles pop.

However, if you have farmland that is producing an income, either from crops or livestock, then you have more than just a piece of real estate; you have a business. In valuing that business, the general trend of falling land values is only one consideration. A larger consideration is the current and future business income, plus the value of the equipment the business may own.

As inflation rises, the price of agricultural commodities in the United States will increase as well, so if you own farmland that produces food, your gross income should rise with inflation—which is much better than most businesses will do as inflation rises. More importantly, as the dollar falls exports of agricultural goods will increase and real prices (adjusted for inflation) will rise. However, your expenses will also go up, at the same time that government agricultural financial support declines and credit becomes increasingly tight. With real estate values down, the selling of farmland will be mostly on a cash basis during the Aftershock, based almost entirely on the value of the agricultural business. For owners of farmland and those looking into it, the land value itself will be far less important than the value of the commodities produced on the land.

Regardless of the type of real estate you may wish to sell, our general advice for exiting is the same:

Sooner Is Better than Later

Unlike stocks and bonds, you cannot unload real estate at the click of a mouse. It takes time to sell real estate, so you have to plan ahead. Remember that evaporating pool of potential buyers we described earlier. The longer you wait to sell, the more potential buyers will figure out that real estate prices are not going back up and are continuing to go down.

Also, the longer you wait to sell, the higher mortgage rates will rise, which will have a very negative impact on real estate prices (see
Figure 6.1
). As mortgage interest rates rise, buyers with a set monthly payment for real estate can only afford cheaper and cheaper purchases.

Figure 6.1
Home Values Decrease as Mortgage Interest Rates Rise

This chart assumes the current mortgage rate is 4 percent. An increase to 5 percent would force home prices down 11 percent to maintain the same monthly payment.

Source
: Aftershock Publishing.

Now that you have read this chapter, you know that the combination of falling demand and rising mortgage rates will push real estate prices down dramatically in the longer term. However, in the shorter term, most people don’t know this yet. Therefore, while the economy is still relatively strong, the sooner you begin the process of trying to sell your real estate, the more likely it is that you will be able to find a willing and able buyer.

If you already know that you want to sell your primary home or vacation home, put it up for sale as soon as you can. If you are still thinking about it, don’t think about it for too long.

We often hear people complain that they can’t sell their homes or other real estate. Here are some potential solutions for upping the odds of attracting a buyer:

• Engage a real estate agent who will do more than just take their commission
  . Get recommendations from friends or from good customer reviews on the Internet for an agent who is willing to work hard to help sell your property. The right agent can make the difference between selling quickly or stalling out. If your home has been on the market for more than a few months, consider taking it off the market for a while and trying a new agent.
  
• Make your property stand out from the pack
  . You can distinguish your place from others for sale by offering something extra or unusual that gets you noticed. For example, throw in a flat-screen TV in the living room. Or offer to include a paid vacation, cruise, or one-year membership to the local pool or country club for the buyer and their family. For higher-end homes, we’ve seen sellers include a brand new car in the driveway or a six-pack of tickets to the Super Bowl. Don’t laugh—sometimes this works.
  
• The number one fix for a property that isn’t selling: Lower your price
  . Nobody likes to hear this but it works extremely well. Find out what similar places are selling for in your area and cut it by 5 to 10 percent. As time goes on, you will likely lower your price anyway, along with all the other sellers. By doing it before the other sellers, you increase your odds of finding a buyer before the other sellers.
  

In an ideal world, you would naturally want to continue to collect your income for as long as you could and then sell your property later when it is no longer producing a profit. The problem with this plan is that by the time the property stops being profitable, the value of the property will have fallen significantly. So each month that you continue to earn income on your real estate, you are one month closer to the time when you cannot sell your property without taking a loss.

How do you time your exit out of something that brings ongoing income now but will fall in value later? On one hand, you want to wait as long as you can so you can keep getting that income; on the other hand, you want to sell before the price declines enough to wipe out the gain for that income. If we knew exactly how much the selling price would fall and we knew the rate of the fall over time, we could create a formula to figure out the golden moment when it makes the most sense to sell, in a way that will maximize both your income and your selling price.

Unfortunately, we don’t have that level of precision when predicting the rate of decline of various real estate prices in each local area. So the first thing you must do when deciding when to exit your income-producing real estate is to come to grips with the fact that it is nearly impossible to time this perfectly. Therefore, you are either going to be a bit too early or a bit too late. No one wants to be way too early, but a bit too early is clearly better than a bit too late. The closer we get to the Aftershock, the faster real estate prices will fall. Given that we expect to see inflation and interest rates begin to rise significantly in the next couple of years, selling before that occurs would be ideal—or just as it begins to occur is okay too.