Why, When, How We Cycled from a Cash Flow Market to a Capital Growth Market
How did we get from a cash flow to a capitol growth market in recent years? Why and when did the cash flow market and capitol growth market change? What does the change mean for real estate investors?
In the early part of the new millennium, around the 2003 to 2006 time frame, real estate values were climbing fast and furious. Many investors took advantage of capital growth (appreciation) opportunities. Many made a fortune because values were driven up so fast they could buy a property, add a quick coat of paint and new carpet and then sell for a quick profit. When real estate values climb quickly, this strategy of quick capital growth can be easy.
Where many made the mistake is they got greedy. Because everyone was watching how much money was being made so quickly, everyone wanted to buy for the capital growth. After all there were areas such as the Florida market (where I live) where home values were literally climbing by 2% per month. WOW that is 24% in one year. So everybody jumped on the band wagon and bought. They bought with the wrong strategy; they bought with the “hope” strategy. Hoping values would continue to increase.
“Know this, hope is not a strategy.”
They bought any property they could get their hands on. Because the market was so hot, the properties were selling in a matter of hours and people had the fever (sort of like auction fever). They were bidding each other up. They believed that values would continue to climb, so they did not even care what they paid because they were hoping the value would continue to climb and in a matter of a couple of months they could gain equity in their newly bought property. This hope for a quick fortune was working for others. Stories were being told at the barber shop and local saloon about all the profits people were making. So everyone wanted to buy in hope of making a quick fortune. What they were not aware of (because they were fueled by speculation and greed) was that the market was at its peak such as shown in the illustration.
One day....BAM! The pendulum started swinging the other way.
Yes, many woke up with their newly purchased property and set out to put on their new coat of paint when they started hearing about the market softening. It seemed like overnight the market was no longer hot and the values started to drop. Panic set in. The hopes of profits suddenly changed to hope of getting out from under the mortgage without losing everything. Many people (those who were not purposeful) lost their shirts, many lost everything.
The cash flow era.
After the market started rebounding, the opportunity to buy properties extremely cheaply was upon us. Many bought properties for cash flow. After all if you can buy a property at extremely low prices when the demands for rents are high, you can create some huge cash flow. Everybody and their brother started buying for cash flow. Even Wall Street investors and all the institutional money came in with the purpose of investing to get their hands on the cash flow that is being generated from these low cost properties.
As everything is cyclical and real estate is no different. With everyone buying real estate again, the normal process of supply and demand started the home price rebound. This rebound of higher prices triggers the next investment strategy.
Capital growth investing.
So the cycle continues. We reached the point in the swinging pendulum where the market has bottomed out. At the bottom of the market people buy for cash flow as the markets are rebounding investors know that the best strategy for making money is the upswing in the real estate values. NOTE: cash flow is still important and it is imperative that the property has cash flow to support itself. Cash flow always has been and always will be the fail safe. Should a sudden unexpected downturn occur in the market the property should always be able to support itself. So always, (always) make sure the property can support itself. Missing this step is what caused so many people to fail when the pendulum started swinging the last time. The true wealth building principle in this strategy however is the capital growth, the anticipation of making money on the upswing in real estate values.
So as the pendulum continues swinging in the direction of capital growth the capital growth investors are making great money. The question you should be pondering is (how long is this cycle and how do I know when this cycle ends and the next cycle begins).
Well good news, this will be covered in depth on our next post, so watch for next week’s post on: The Real Estate Investing Cycles - The Capital Growth Cycle