Since the end of the Great Recession, the U.S. housing market has been on the rebound.
While the levels of recovery and prosperity vary among cities and regions of the country, it’s safe to say that the real estate market, by and large, has enjoyed success over the past several years.
Sellers have been able to take advantage of rapidly appreciating markets while buyers have re-oriented their priorities to value a home more than ever.
You no doubt saw the headline throughout 2020. While the future of real estate was called into question at the advent of the pandemic, the sudden shutdown of market activity didn’t last. Technology and pandemic guidelines allowed the real estate market — particularly single-family homes — to flourish.
Between advantageous interest rates, tight inventory, and a renewed cultural need for housing and private outdoor spaces, the residential real estate market just continues to boom.
But how hot is too hot when it comes to a real estate market? There are fears that the market is moving in an unsustainable direction. Frenzied buyers are draining the month’s supply in markets across the nation. Bidding wars rage. Buyers make compromises.
As real estate investors, these kinds of markets can be frustrating, if not downright impossible. After all, we want to buy investment properties without compromising on due diligence. Where’s the balance and how do we know when a market is just hot or headed for trouble?
Warning Signs of an Overheating Market
Before we talk about navigating an overheating market, we need to look at the warning signs that indicate these conditions. The danger in overheating markets is the potential for a bubble. Now, experts will argue that, despite some of these indicators, we are not, in fact, in a housing bubble. Our circumstances now are different from those surrounding the Great Recession.
While surface-level indicators can seem like we’re moving in an alarming direction, the underlying trends point to slow and steady growth. This doesn’t mean, however, that navigating a white-hot market is easy.
Shrinking affordability — We’ve discussed the issue of housing affordability in the United States frequently throughout the last year. Between stagnant wages and pandemic-induced unemployment hardships, it would be difficult to afford a home even without a demanding market. Appreciation is normal and expected, but in these highly competitive circumstances, buyers may find themselves overpaying for homes.
Mortgage trends — Lackadaisical lending was one of the main issues at the heart of the Great Recession. While lending standards have tightened in the years since, an indicator to consider is whether or not buyers are over-leveraging to purchase property.
Traditional wisdom says that no more than 28% of your gross monthly income should go to a mortgage payment. When you creep into 30% or more, you start seeing overburdened homeowners. They say that all of your debts combined (including mortgage) should not exceed 36% of your gross monthly income. In many markets, keeping to this preferred debt-to-income ratio is increasingly challenging, if not outright impossible.
Intense bidding wars — Between tight inventory and rising buyer demand, bidding wars are on the rise. While healthy competition can be a good thing, the intensity and volume of buyers having to duke it out for properties is an indicator of an overheating market. Bidding wars are, in part, responsible for pushing home prices up and beyond their real market value.
3 Ways to Navigate Overheating Markets
Prioritize Due Diligence
In hot markets, agility and having the best deal on the table become paramount. However, real estate investors must be wary of moving too quickly or being too determined to win the bid. Due diligence demands that we never neglect principles like home inspections and evaluations. The quickest way to make a bad investment is to try to win at any cost. You might lose out on some properties but it is far better to have all of your ducks in a row. You want to be sure that your purchase will make for a solid investment.
Invest with a Long-Term View
Investors are best equipped to succeed when they keep their attention on the long-term. The long-term investor has the luxury of waiting. We can wait for the right times to buy and sell. We can weather unfavorable market conditions with the knowledge that the market always moves in cycles. If things are not ideal now, they will be better at a point in the future. This long-term view is better for your stress management and it allows you to more clearly and intentionally target the markets and investment properties that will add real value to your portfolio over time.
Being short-sighted in this business can cause you to get caught up in the hype. You may feel pressured to act fast rather than acting smart. Thankfully, a long-term, buy-and-hold investor knows that they can benefit in every stage and season of the cycle. This approach provides greater clarity and thus, a strategic advantage.
Practice Prudence
For the real estate investor, a scarcity mindset will push you to make rash decisions. It’s important to recognize that not every opportunity is a good opportunity. Even if it is a good opportunity, it might not be the right one for your portfolio, right now. While part of investing well is due diligence, another is prudence. As real estate investors, we must carefully discern whether or not a property is truly right for us — right for our finances, right for where we want to be, and right for the strategies we want to employ.
A scarcity mindset will have you rushing to capitalize on any opportunity that comes your way. This not only causes us to neglect due diligence, but it can cause us to settle for less-than-ideal opportunities. Be prudent. Be patient. It is far better to wait for the right properties than to jump on those that don’t quite match up with your goals and risk tolerance.
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