Wednesday, August 7, 2013

33 Guidelines to investing in real estate....................

Guideline #22:  Don't borrow just because they will lend you money.

Just because there is a willing lender doesn't mean you should become a willing borrower.  While this certainly applies to investment property, it is doubly applies to single-family, owner-occupied houses.

While this quote is now "dated," it offers some insight into what I would call a faulty philosophy held by many very smart people:

"Many commentators have noted the effect of home mortgage refinancing and equity extraction on economic growth, particularly consumer spending, over the period 2000-2006.  For example, former Federal Reserve Chairman Alan Greenspan (2002) stated:

     'Especially important in the United States have been the 
      flexibility and the size of the secondary mortgage market.  
      Since early 2000, this market has facilitated the large debt 
      financed extraction of home equity, that, in turn, has been 
      critical in supporting consumer outlays in the United States 
      throughout the recent period of economic stress.' "

(source of quote, and erudite paper on the subject, is here)

How "extracting" equity to pay for "consumer spending" can be considered economic growth is a mystery to me.  What did they think was going to happen when all the equity was gone?  How did they think the newly acquired debt was going to be repaid?  While the trend line of real estate values over time is upwards, we often forget to remember that is a "trend," not a constant.  If you are going to buy something with borrowed money, make sure that something has enduring value.  Jet skis, boats, hot tubs, fancy cars, super large screen TVs, and the like do not have enduring value.

There have been a few times that our favorite bank has denied us financing.  In one particular case, our loan officer said,  "We know you can buy it, we just don't believe you can afford to own it."  A classic line that proved to be true.  Since we were not able to secure financing, we sold our contract to purchase this particular investment to another group of investors.  The new buyers owned the investment for about a month when a particularly nasty cold snap swept through Ohio.  Somehow, part of the sprinkler system froze and broke, flooding the basement, including the boiler.  While this group of buyers could afford to solve the problem, we would not have been able to.  We were thankful for the denial and appreciate those particular lenders who know that sometimes saying "no" is the path to successful investing.

There have been a few times we wish the lenders had said no when they said yes.  Banks are in the business of lending money.  Wealth accumulation is easier if you don't make a lot of mistakes, or one big mistake.  Eager lenders sometimes contribute to our ability to make mistakes.   Don't borrow just because the bank will lend.  Make sure borrowed money gets put to a safe and productive use.  Some independent thinking and a little discipline goes a long way.

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