So the housing market tanked. It caused many people to run away from real estate investing, but the real estate opportunities are growing. I’m not talking about the ability to buy properties for cheaply and sell them for more.

This video examines how investing for income differs from investing for gains. The two objectives carry different risks and different levels of predictability and control. If you are a real estate investor, you can’t afford to not incorporate this information into your investment philosophy.

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Three years ago real estate investing was hot. Today, many people act as if the opportunity has passed. I contend that the opposite is true. In the past, as a mortgage banker focused on originating mortgages for investment properties, I started listening to and learning from my real estate investor clients and noticed two categories of real estate investors: real investors and blind investors.

Real Investors have the following in common:

• Profiting when they buy. Rather than believing an entire market is hot or cold, a real investor knows that the purchase price is what dictates the return on the investment. You can look in any real estate market to see property values and rental rates. Those are things the investor doesn’t control. The investor does control what he is willing to pay for a property, and that’s how a real investor knows what his return on investment will be before buying the property.
• Investing for income. Real investors buy assets because they produce income. What a property is selling for doesn’t even matter if you can achieve a good return on investment from the property’s cash flow. A real investor might pay full asking price for a property, possibly even above the selling prices for comparable properties, if he is able to achieve a good return on investment through rental income.
• Taking advantage of market cycles. Rather than expecting to buy low and sell high in a short period of time, a real investor often buys real estate when the entire market is cheap and sells many years later when the entire market is overpriced.

Blind Investors have the following in common:

• Focusing on selling for profit. Blind investors will buy any piece of real estate when they believe real estate is hot. If prices are rapidly increasing, a blind investor just hopes that the trend will continue without understanding it. Hope is not a strategy.
• Investing primarily for appreciation/gains. Blind investors don’t want to own assets; they want to trade assets. They want to buy low and sell high. Buying low and selling high can be a good thing, but it’s not always easily achievable, especially in short periods of time.
• Being on the losing end of market cycles. A real estate market can become overpriced if too many people are buying properties (especially if for the wrong reasons), and this is often the point at which blind investors choose to join the fun and start buying. Then once real estate prices start correcting downward, blind investors will sell in a panic bringing prices even lower, which creates extraordinary buying opportunities for real investors.

[More to come in Part 2 of this post]

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One of the reasons that everyone seems to act so surprised at the “economic meltdown” is because we measure everything in U.S. Dollars while paying little attention to the value of the dollar itself. The dollar is a floating currency. The amount of dollars in circulation can dramatically increase or decrease in any given period of time as seen fit by the central bank, the Fed. An increase in the money supply will push prices up, while a decrease in the money supply pushes prices downward. Therefore, an asset’s true value can remain constant while it’s dollar denominated value can fluctuate – and vice versa.

Looking at statistics or charts denominated in U.S. Dollars can be very deceiving, and if that’s what you’ve been doing, then you were blindsided by the recent collapse of various markets and institutions. If during the past decade you were looking at real prices (as measured in grams of gold) it would have been quite apparent that housing prices were experiencing erratic growth that was likely unsustainable. Gold has been the real currency used by humans since the dawn of time, and even after Nixon took us off the gold standard in 1971, all markets continue to follow logical boundaries of movement as priced in gold.

The good news is that we can now look at this type of data to more comfortably estimate where the bottom is. Warren Buffett commonly perpetuated the addage attributed to Baron Rothschild: “Buy when there’s blood in the streets.” This means that you should be buying (greedy) when most everyone else is selling (fearful) and be selling (fearful) when most everyone else is buying (greedy).

That said, the charts over at www.pricedingold.com show the Case-Shiller Home Price Index as returned to 1997 levels (top). The chart for U.S. Median Home Prices (below), however, tells a less clear story:

To me, this all translates to a crystal ball that says housing is near its bottom, but median home prices may fall a bit more. This would support investment into inexpensive housing. Keen real estate investors will be diverging from trendy lofts and luxury homes in order to focus on where the real money will be found – affordable housing. Many American families will be financially destroyed by the acts of Wall Street and our central banking system. They will need to start over. At the very least, many American families will start living within their means… which they will find to be much more modest than previously thought.

The housing prices that should remain strong will be those at the lower end of the spectrum. In today’s chaotic marketplace, buying an $80k home for a 50% discount should be a solid bargain. On the other hand, buying U.S. real estate for cash flow may be a confusing (often losing) game in years to come because I suspect rent raises will be unlikely to follow inflation beyond 15%.

All in all, my perspective for wealth preservation in the next few years can be summarized in a few points:

1. Anything that is bought and sold in U.S. dollars shouldn’t be held for the long term due to monetary instability.
2. Demand for affordable housing will continue to grow while demand for luxury housing will continue to shrink.
3. If you can find a bargain (at least 50% under fair market value) on an affordable-priced home, buy it because you should feel confident that its market value is fairly solid. Buy it if you feel like you can liquidate it for its market value in one year or less.
4. Stay away from cash flow real estate if it is bought, sold, and rented in U.S. Dollars or any currency pegged to the U.S. Dollar.
5. Stay away from investing in mortgage notes or trust deeds whose return is paid in U.S. Dollars.

Once you start checking your assumptions against prices in gold, you gain an understandable, logical, and predictable viewpoint.

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### Update ###

The five guidelines above are for a person who is interested in growing wealth. If wealth growth is not high in your priorities, long term ownership of affordable-priced U.S. real estate should still provide a good hedge against inflation. This means you will likely experience double digit price appreciation, although this will be accompanied by double digit costs of living increases. That can be an effective means of wealth preservation.

I’ve pasted our Instant Message conversation below (with the screen names changed for privacy). I didn’t correct capitalization, punctuation or spelling errors, so you’ve been forewarned.

I thought this would be a useful post because of how tightly this gentleman seemed to grip onto his investment strategy he’d been using since 2004. How tightly are you gripping onto your investment strategy?

[19:00] re_investor: HI Jeff
[19:00] re_investor: How are you buddy?
[19:00] jeff_nabers: Hey there
[19:01] jeff_nabers: I’m doing good. How are you?
[19:01] re_investor: How have you been doing?
[19:01] re_investor: Im alright!
[19:01] jeff_nabers: How’s the RE market up there?
[19:01] re_investor: OH its tight!!
[19:01] re_investor: Its flat and declined over the pervious 6 months
[19:01] re_investor: TOUGH
[19:02] jeff_nabers: what about cash flow?
[19:02] re_investor: Its cashing …
[19:02] re_investor: but, its still tight. I actually was in the process of buying another one
[19:02] re_investor: I stoped canceled the purchase/sale
[19:03] jeff_nabers: how did your previous investments turn out?
[19:03] re_investor: Oh great actually..
[19:03] re_investor: I sold the one in Fairview park
[19:03] re_investor: I got a cash buyer
[19:03] re_investor: The other three are turning out fine
[19:04] re_investor: The one house I have I have 67K in equity right now
[19:04] re_investor: I am currently renting it for 1K
[19:04] re_investor: but, I cant do anything with it until the maket comes back
[19:04] jeff_nabers: Sounds decent
[19:04] jeff_nabers: how’s the cash flow return?
[19:04] re_investor: Its about 300 dollars
[19:04] jeff_nabers: renting it at $1k what do you net per year?
[19:04] jeff_nabers: i see so 6k per year
[19:05] jeff_nabers: how much money did you put into it?
[19:05] re_investor: I was just in the process of refinancing it
[19:05] re_investor: and the mtg company I was using closed up
[19:05] re_investor: so the refi stoped
[19:05] jeff_nabers: how much money did you put in tha tone?
[19:06] re_investor: I was bummed out
[19:06] re_investor: I put in 15K
[19:06] re_investor: to fix it up
[19:06] jeff_nabers: and the down payment was?
[19:06] re_investor: It was alot
[19:06] re_investor: I cant remember…
[19:07] re_investor: I am trying to do something with the equity.. but, I dont know what
[19:07] re_investor: There is not much I can do
[19:07] jeff_nabers: you don’t remember how much you put down?
[19:08] re_investor: why are you wanting to no such details?
[19:08] jeff_nabers: i’m curious what your return is
[19:08] jeff_nabers: cashing out would only decrease your cashflow
[19:08] re_investor: I got into it on no money down
[19:08] re_investor: I had good credit
[19:08] jeff_nabers: well then i would never refi it and never sell it
[19:09] jeff_nabers: you are making a 40% annualized return on the cash you put in
[19:09] re_investor: yeah. Its only worth so much you know
[19:09] jeff_nabers: why would you ever want to take an asset like that off your books?
[19:09] re_investor: To use the equity in the house
[19:09] jeff_nabers: with 10 – 15 of those you’d never have to work again
[19:09] jeff_nabers: to use the equity to do what? continue working real estate like a job?
[19:10] re_investor: right. I just need 9 – 14 more of them
[19:10] jeff_nabers: do your other properties cash flow like this one?
[19:10] re_investor: to use the equity to buy another house
[19:10] jeff_nabers: yeah but if you that equity you’ll lose your cash flow
[19:10] re_investor: No the others dont cash like this one
[19:10] jeff_nabers: *if you USE that equity i mean
[19:10] jeff_nabers: well i’d be worried about selling the others and keeping this without refi-ing
[19:11] jeff_nabers: borrowing to buy properties makes sense when the market is appreciating
[19:11] jeff_nabers: it’s depreciating
[19:11] re_investor: right, but If I dont refi I wont have any money to do anymore houses
[19:11] jeff_nabers: if you borrow equity to buy more in this market, you’ll lose the bit of wealth you have
[19:11] jeff_nabers: well use other people’s money
[19:12] re_investor: right. but, lenders money is more expensive then refi rates
[19:12] jeff_nabers: don’t use bank’s money
[19:12] jeff_nabers: use people’s money
[19:12] re_investor: yeah. other relatives
[19:12] jeff_nabers: no, other investors
[19:13] jeff_nabers: or relatives, sure. but don’t limit yourself
[19:13] re_investor: right, other investors want want a percentage of return from the deal
[19:13] jeff_nabers: so what
[19:13] re_investor: thats higher then borrowing
[19:13] jeff_nabers: but it doesn’t require repayment
[19:13] jeff_nabers: if you borrow your cashflow away you are paying $6,000 per year
[19:13] jeff_nabers: every year no matter what
[19:14] re_investor: yes, but, if they are wanting 20% profit when you sell the property
[19:14] jeff_nabers: don’t sell the property
[19:14] re_investor: An investor dont want to stay in the deal forever
[19:14] jeff_nabers: if you flip properties then those type of investors aren’t smart enough to be interested in a good deal
[19:15] jeff_nabers: a real investor wants to stay in the deal forever
[19:15] jeff_nabers: you should try networking with people with money
[19:15] jeff_nabers: they don’t want money
[19:15] jeff_nabers: the dollar is wasting away, they want to store their dollars in something valuable
[19:15] jeff_nabers: if you talk to people who don’t have money they just want to make money quick
[19:15] jeff_nabers: but they don’t know how
[19:15] jeff_nabers: and you probably don’t either in this market
[19:16] jeff_nabers: people with money just want something to put it in
[19:16] re_investor: yeah. I am pretty much a person who is up in coming
[19:16] re_investor: I can not afford to buy and hold without turning it over quickly
[19:16] jeff_nabers: you can’t afford to buy and sell if it doesn’t make money
[19:16] jeff_nabers: nobody can
[19:16] re_investor: I am someone who will die under the payments
[19:16] jeff_nabers: under what payments?
[19:17] re_investor: If I buy a house and have to make payments on it
[19:17] jeff_nabers: buy properties that are rentable
[19:17] re_investor: without renting it or selling it
[19:17] jeff_nabers: well don’t do that
[19:17] jeff_nabers: rent it
[19:17] re_investor: Right, but, its not something that someone will take quickly.
[19:17] jeff_nabers: what’s not something that who will take quickly?
[19:17] re_investor: I will die in a matter of 3 – 5 months time making all those payments
[19:18] re_investor: A house
[19:18] re_investor: If I buy a house.
[19:18] jeff_nabers: 3 to 5 months of positive cash flow will not kill you
[19:18] re_investor: That I can not rent or sell quickly
[19:18] jeff_nabers: don’t buy houses with negative cash flow
[19:18] re_investor: I will die 3 – 5 months time making all those payments
[19:18] re_investor: No No you are not understanding
[19:18] re_investor: I am saying if I buy a house that needs repair
[19:19] jeff_nabers: well don’t buy a house that needs repair
[19:19] re_investor: generally.. house that are in need of repair
[19:19] jeff_nabers: or just hook up with an investor that can handle the vacant months and the repairs
[19:19] re_investor: yes, but, if you dont do the houses that need repair you aren’t getting the equity
[19:19] jeff_nabers: who cares about equity
[19:19] jeff_nabers: you don’t want dollars, dollars are depreciating rapidly
[19:19] re_investor: Yes. but, if they go vacent
[19:19] jeff_nabers: you want to own real property
[19:20] re_investor: You are having to make the payments and potentail repairs
[19:20] jeff_nabers: vacant? there’s a market rent and market vacancy factor in every local RE market
[19:20] jeff_nabers: work with those numbers
[19:20] re_investor: right. I know my situation and RE market and investors
[19:20] jeff_nabers: the mindset that you used in the bubble market won’t work anymore
[19:20] re_investor: I’ve been doing it and no how it goes
[19:21] jeff_nabers: you can’t be focused on equity or flipping
[19:21] jeff_nabers: but because there’s plenty of people with your mindset there are plenty of cashflow properties available
[19:21] re_investor: right. you might be able to pick them up cheep enough to keep payments down
[19:21] jeff_nabers: if you found a funding partner and worked to find one cash flow property to acquire every 2 months and that property brought you $150 a month in positive cash flow…..
[19:22] re_investor: yeah, that would be great
[19:22] jeff_nabers: 7 years of that would bring you $6300 of positive cash flow
[19:22] jeff_nabers: and realistically if the dollar continues to depreciate, rents will go up during that time and increase your cash flow
[19:22] jeff_nabers: ($6300 per month of cash flow)
[19:23] re_investor: yeah. thats pretty good
[19:23] jeff_nabers: more imporantly during that time you would probably learn a lot about looking at the numbers
[19:23] jeff_nabers: and your funding partner might introduce you to other people with money
[19:23] jeff_nabers: and maybe you could get another good thing going on the side
[19:24] jeff_nabers: but, all in all, you have to be flexible and change with the times
[19:24] jeff_nabers: you should shed the bubble mentality and come up with strategies that work in other environments
[19:24] re_investor: yes. I agree
[19:24] re_investor: good points
[19:25] re_investor: The good deals in equity are still out there
[19:25] jeff_nabers: have you still been going to RE clubs, meetups, groups, etc?
[19:25] re_investor: I like to look for both in RE equity and payments
[19:25] jeff_nabers: well, if finding good equity deals is like a needle in a haystack and the numbers don’t work with today’s mortgage financing…. then they aren’t really out there for you
[19:25] re_investor: I here you about the extra cash flow and thats great
[19:25] re_investor: I am not saying anything bad about that
[19:26] jeff_nabers: yeah, but you are being a real estate dealer
[19:26] re_investor: but, I still think the equity potion is importantt oo
[19:26] jeff_nabers: it’s like a job
[19:26] jeff_nabers: it’s like you have two jobs
[19:26] jeff_nabers: when you buy for cash flow to hold…. it’s investing
[19:26] jeff_nabers: and it puts your money to work for you
[19:26] jeff_nabers: instead of putting you in a gambling mindset
[19:27] jeff_nabers: the equity portion is only important if you are dealing real estate
[19:27] re_investor: Its not gambling its based upon market values
[19:27] jeff_nabers: market values are based on factors outside of your control
[19:27] jeff_nabers: you don’t control insurance & mortgage costs, or mortgage availability
[19:27] re_investor: yes. marketing values are outside your control
[19:27] jeff_nabers: and you certainly don’t control the buying/selling mindset of others
[19:27] jeff_nabers: putting your money on things outside your control is no different than gambling
[19:28] re_investor: I said. I agree with you
[19:28] jeff_nabers: focusing on rents instead of sales prices is less volatile
[19:28] re_investor: The cashflow is great
[19:28] re_investor: I am not disputing that factor
[19:28] jeff_nabers: what i’m saying to you is that you might benefit from completely ignoring equity
[19:28] re_investor: I see.
[19:29] jeff_nabers: in fact, if this whole time you had been investing for the past few years you might have 15 properties
[19:29] jeff_nabers: especially if you bought a lot more when mortgage financing was more readily available
[19:29] jeff_nabers: you could be retired right now if you had been acquiring income properties rather than dealing
[19:30] jeff_nabers: but dwelling on the past isn’t the idea here…. it is understanding how beneficial it investing for income is
[19:31] jeff_nabers: and, truth be told, here pretty soon the market to buy income properties just might get really good for people like you and i
[19:31] jeff_nabers: aside from a complete economic collapse, there’s always people with money out there that need to invest it
[19:32] jeff_nabers: and opportunities for sound-minded investors are only increasing during this correction from the gamblers
[19:32] jeff_nabers: so that’s some food for thought

[off topic conversation was removed]

[19:56] jeff_nabers: i’m glad we could catch up a bit
[19:56] jeff_nabers: i’ll talk to you later
[19:56] re_investor: good night

———————

I hope this can be insightful to you. I think many residential real estate investors are not actually investors at all; but dealers and gamblers rather. The fantastic thing is that each of us has the ability to adjust our thinking and investment behavior at any point in time. Have you been acting as an investor, gambler, or dealer?

Comments appreciated.