Generally speaking, the class of people who always invest their money in blue-chip stocks, bonds and money-market accounts usually consider real estate to be an inherently risky investment. Real estate can be risky but as I have said earlier in some of my past articles you can definitely reduce that risk by being an educated investor. Experience proves that certain types of investments in real estate can be inherently safer than others particularly in cases where the future of the market is uncertain and whether it will go up or down.
At the end of the day real estate is a game of survival – anyone can make money when markets are rising but those who survive the down markets retire rich!
Always Invest in Safe Deals
Stick to the above principle you will survive for the long run in the real estate investing business. Although there is no “100 % safe deal” but you can be thoughtful, cautious and conservative when investing in real estate which in turn will increase your odds of long term success investing regardless of whether the markets are up or down.
Invest in Deals not Markets
A lot of amateur investors try to time the market and try to ride the waves of market appreciation. Buying and selling at the perfect time when the market is at an all-time high is the easiest and most profitable way to invest in real estate. Its also the most riskiest because not too many people have enough foresight to figure out where the top and bottom end of the market is.
Instead of trying to second guess the top and bottom end of the market try and concentrate on deals that make sense to you. By using the CLEAR formula discussed in our previous article you can find unique properties sold at bargain rates in solid neighbourhoods. Buying homes at bargain prices is easy when the market is not so good and sellers are open to negotiations. But if the market is hot you can still find sellers who are willing to sell below market rates for reasons other than money – divorce, unexpected death in the family, job transfer or plans to shift abroad soon and other life changes. During such times property sellers can become highly motivated to sell off their houses fast and move on.
There are some property sellers who look outside of metro cities and try to invest in properties in Tier 2 or even Tier 3 cities. But even if you seek to invest in emerging markets around the country you can still land up with a bad deal that will not help you make any profit. The bottom line is this – Every deal must stand on its own.
Buy when others are selling and sell when people are buying
The above line is timeless advice but only works for the stock market because you can enter and exit a deal in a short amount of time. But in the business of real estate you cannot expect to time the market in terms of days.
Stick with Metro Areas
Housing markets are mainly driven by people and people go where there are jobs and income to be had. The more the number of people who live in an area the easier it is to sell or rent a property. So as an investor always stick with major areas that have a large and diverse population of dwellers. As a rule stay away from investing in resort areas or smaller towns and cities. Another good idea is to invest in towns that have a big major employer that employs a large percentage of the population. Think automotive cities, steel cities, IT cities etc. These people are not moving anytime soon.
Within cities too look for up and coming areas in which to invest. The revival of urban neighbourhoods is a national trend. Think areas like Lower Parel, Saat Rasta which were once the living quarters for the working class population of Mumbai, were laden with crime and plagued with poor schools and creaking infrastructure which have now transformed into world class residential areas. Art galleries, malls, restaurants and gleaming towers have replaced burnt-out dilapidated mills and buildings. Many people from erstwhile and hip South Mumbai areas like Nepean Sea Road, Malabar Hill, Cuffe Parade and Bandra are selling their old apartments and homes and moving into gated residential enclaves in the new residential hot spots of Mumbai like Lower Parel & Mahalaxmi in order to experience a more hip and urban way of life.
The charm of old South Mumbai still remains strong though and most of the top dollars are still spent buying properties in the older and still charming residential enclaves of South Mumbai stretching from Worli to Colaba. Every city has certain areas that are more desirable than other areas. These areas always seem to be unaffected in their property values in down times and increase by leaps and bounds when the market is good. Rupee for rupee it always makes sense to invest in the upmarket areas of Bandra and South Mumbai because housing rates in these areas will always go up despite market conditions. You may not find great bargains in such desirable areas but they are always safe investment bets in the long run than the newer developments or areas in the outskirts that are super cheap.
WOB in the MOB Near the Blob
I have borrowed the above term is taken from one of my favourite books on real estate investing. This is a great way to remember the right formula to invest in a property in a certain area of a city. What the above term means is that worst house on the block in a median-priced neighbourhood (or below) is generally the safest bet for investing. This is called as buying the WOB in the MOB near the Blob :-). This is:
- Buy the WOB (Worst on the Block)
- In the Mob (Median Price or Below)
- Near the Blob (see explanation below)
Lets break this down in detail:
Worst on the Block (WOB)
The worst home in a good neighbourhood will always turn out to be a better investment than the best house in a bad neighbourhood for two reasons. Firstly most home owners and families would rather live in a nice upmarket neighbourhood than be kings of the slum! Understand human nature – People like to boast that they live in Bandra or South Mumbai, even if they live in the cheapest house in Breach Candy. The couple get bragging rights amongst their friends and extended families and their children earn snob value!
Secondly there is always extra room to push the values up when the price is on the lower end of the spectrum than when it is on the high end. As discussed earlier in one of my earlier articles here, home appraisers always look at comparable sales figures within a particular neighbourhood. If your house is already the most expensive house on the block theres not much you can do to increase its value. But if your house is priced at the lower end for the area then you can improve its condition and correspondingly stretch the value of the house. When appraising a house, appraisers are more comfortable stretching the price per square foot of a cheap house rather than stretching the price of a house that is already the priciest one in the neighbourhood. Always remember:
Market value is what someone is willing to actually pay for a house.
Median Price or Below (MOB)
The Median price is the middle price of the price range of a certain area. Half the houses in that area sell for less and half the houses sell for more. The below median price bracket is the safest investment because there’s a growing shortage of such houses in the market.
New apartment buildings built by developers have certain fixed costs involved in the building such as the cost for the raw materials, manpower, creating amenities and maintaining a large staff for sales and marketing. While more expensive luxury homes take longer to sell, in the long run builders make more money because of the economies of scale. It only takes a few extra yards of space to make an apartment 3000 sq ft vs one that is 1500 sq ft. The profit margin on the extra size is all gravy for the builder!
Because of the scarcity of land and escalating costs, most new developments in most cities are being built further and further away from the center of the city. This results in a shortage of affordable housing in the city centers. With migration from smaller towns and villages into the metro cities of India always increasing, the demand for affordable homes in good neighbourhoods will continue to grow. Real Estate Investors who own homes in the MOB will find their properties growing in value and also offering good returns in terms of rentals.
If you are a horror movie buff you may remember that old movie “The Blob” where a giant monster jelly spread out from place to place taking everything and everyone in its path. The same thing also happens to neighbourhoods. If a certain area becomes too hot and desirable it will eventually run out of room and the next hottest area will usually be the closest geographical area. The prices of homes in hot areas may be greatly above the median price thereby increasing the investor’s risk. Therefore investing in cheaper homes in close proximity to the desirable “Blob” neighbourhood may turn out to be a safer idea.
When taking into account the “Blob” effect, you should also be considering dividing lines in the neighbourhoods. In Mumbai’s suburbs the dividing lines for the longest time has been the eastern and western express highway dividing neighbourhoods into east and west sections. In other cities the dividing line could be a hard impassable line such as a railway track or a body of water. Paris is an ideal example of a city that has a strong dividing line. If you have visited Paris you would have seen the neighbourhoods on the Left Bank and Right Bank of the Seine River. It is clear to everyone how the neighbourhoods on both sides of the Seine differ from each other.