Making Profit in a Downturn
It can be hard in a downturn to think about ways to make money when so often whether by conditioning or the media we are programmed to think about the worst case scenario. This is especially true in cyclical markets like Calgary’s oil sector. An interesting fact is that most of the worlds real estate billionaires make their money on the downturn & not the upturn. This can also work for the small investor even though we are not all billionaires.
Calgary’s 7 Year Cycle
Every 7 or so years in Calgary there is a downturn like the one we are seeing, granted this one is much worse than anything we have seen since 1983, but by that same frame of thought, shouldn’t this also open up opportunities for Calgarians that haven’t been seen in two decades. The answer is, “kinda!” We all wish it was that simple. Real estate is a lagging industry due to it’s very nature.
In the stock market if a company gets a bad press release the stock drops 10% that day, where as in real estate it may take a year for this effect to happen. When it comes to peoples homes they are often unwilling or unable to sell their home at a loss. It is a much more fragile and personal item and as such homeowners will often ride the market up and down. Whether this is good or bad depends entirely on your personal situation and is a conversation that goes much deeper.
How to Profit from a Downturn
Once you understand more about how the market works and how the psychology of downturns affects sellers you need to position yourself to make money in the bottom. There are many criteria you are looking for when trying to pick up great deals in the market. I’ll point out a few of the common pitfalls first here:
- Do not bother viewing properties that are at or above historic sold price in years above current levels. Your REALTOR® will often be able to tell you if and what the property was previously sold for. These people are 95% of the time unable or unwilling to part with their property at it’s “new” actual valuation.
- Foreclosures are not for everyone – It seems like a great strategy to pick up foreclosures, but foreclosures are often “foreclosures” for a reason. It may be an awkward floor plan, poor location, or hazardous situation that is causing these properties to be unsaleable. Yes there are times when it’s purely financing of the existing owners, but even in these cases it “mandatory” in Canada for the bank to get the absolute maximum for these homes to protect the owner and the bank. You can spend a great deal of time and energy for very little gain in the end.
Now here is what you should be doing:
- Look for homes that need a little bit of work in prime locations, great communities, that have built in equity at the current price.
- Find owners that bought at or before the current downturn pricing that have “lots of equity” in the home. They will be more willing to part with some of this diminished gain because they can buy another home for cheaper in a low market.
- Land. Often in a downturn over financed builders and land flippers will get caught “with the hand in the cookie jar” and you can get parcels of land at 5-10 year historic pricing.
- Calgary’s economic future is bright and it will continue to prosper in years to come. Now is the time to look at picking up revenue properties that will cover based on current rental rates, but speak to a professional (i.e REALTOR®) that knows about historic rental rates in an upturn or in normal economic conditions. When things do turn around you will have bought yourself a nice little “cash machine” to fund your rental portfolio for years to come.
- Move-Up. Now is the perfect time to let go of your smaller property at a lower level and pick up the dream home you’ve been saving for. It doesn’t seem logical, but I’ll explain in an example below.
i.e. Jane and John bought a condo for $400,000 four years ago and are planning on having a family over the next two years. They bought the condo then because housing prices in Calgary were so high. At the time houses in the community they wanted to be in were priced at $700,000 (average) and they can only qualify up to $600,000 with their current income from their jobs. Jane and John put $40,000 down on their condo (10%) when they bought it four years ago and have since paid off another $40,000 of the mortgage ($80,000 equity). Unfortunately, Calgary has hit a “bump in the road” and their condo is now only worth $380,000 (5% decrease).
Jane and John do not want to take a loss on their condo, but speak to a professional for advice. He say’s “are you still looking to buy a home in that favourite community of yours in the years to come?” They of course answer “yes, we love Calgary!”. He advises them that now those same homes that were $700,000 are now selling for $600,000 (15% decrease) in current market conditions. If you were to sell your condo now, yes you would lose $20,000, but with the remaining $60,000 you have from your sale you can now afford to purchase your dream home with 10% down.
They think about as he prepares the math and shows them a few things:
- They lose $20,000 short term
- When the market recovers, “yes” the condo will go back to $400,000, but the home price will also rise back to historic levels quickly of $700,000.
- If the home was bought today at $600,000 when values do go back you are positioned to make $60,000-$100,000 in equity on the home, but if they wait until the condo price returns to $400,000 and sell then they will still not be able to qualify for the mortgage and have missed out on that equity appreciation during the upturn.
- Large future mortgage payment if you wait.
- Another additional benefit for some is taking a loss on the current condo gives them a capital gains deduction to carryforward and write off on future gains on their taxes.
The two scenarios are stay with the condo:
Paid: $400,000 – Current: $380,000 =Loss: -$20,000 = net $60,000
Buy home $600,000 + appreciation 10% = Future Value of home: $660,000 =
Net Equity= $120,000**
*Bonus* Capital gains deduction carryforward = $20,000
Condo Paid $400,000 + wait two years to sell: $400,000 = Breakeven = net $80,000
Buy home (if possible) at future value of home = $660,000
Net Equity = $80,000
Downside= Larger mortgage payments.
**This does not include the additional difference of two years pay down on a house vs. the condo which would increase the equity even more under scenario I
After this was explained to Jane and John they decided it was a “great opportunity” and not an unfortunate situation to buy in a downturn and move up to that 10 year home they wanted for the future.
If you have found this helpful or want to hear more about this strategy call me today at 403-607-4575.