The Housing Bubble: Buy for Cash Flow, Or Else...

This is a real story that took place in 1997-98, when I was working for a real estate broker in Montreal. I had the chance to meet some interesting people who where very active in the business. They were buying many three to sixplex income properties.

You need to know that at the time many people still had in mind the huge drop that the market had suffered in the late '80s. Our team, as I will call it, was always on lookout for great cash flow. The goal was to find a decent house with very attractive cash flow. We were using very ingenious and exotic ways to finance the deals. Basically, someone was buying and then flipping the property to help increase the selling price and the mortgage that we could contract on it.

For example, A buys for $100,000, A and then sells to B for $140,000. But A and B are related (they're from the same group), and B then mortgages the house for $110,000 and is able to cash out $10,000. I think you understand the trick here.

Many people think that we were some kind of dangerous speculator back then, because of the way we financed our deals. But they didn't have the whole picture. Even without cash down and a good cash back taken on the house, we were able to generate cash flow. The house generated anywhere between $200 to $400 a month, helping us build some good equity for the long term, while enjoying some current cash to pay for an upgrade on the house. The strategy was very safe and low risk. But instead of being considered a conservative investor, we were considered to be the cowboys of real estate in Montreal.

Going forward almost 10 years to today, many people are buying real estate not for the great cash flow it can generate, but for the potential upswing in price. Though these people are not speculators, they will be mad as hell and they will tell you that real estate is safe and the easiest way to make money.

In the last months I've seen houses on the market that were selling for $110-120,000 in 1997-1998 and are now selling for $350-450,000!!! Back then, the revenue you could earn on such a property was in the range of $18-20,000. Now the range is 21-23 000$. WOW!!! Great investment, each month you have to take out a large sum of money to pay the mortgage, and all these geniuses are telling you that real estate is the best investment?! What gives?

Something is wrong, really wrong, when real estate is not being bought for cash flow but for a quick price increase. It's when you know you have a bubble that will burst sooner or later.

Comments

[DavidNeubert]

Speculation is always a bad sign. I bought my place in New York City in 1999. What I can get for rent has hardly moved. However, the price has tripled. This is more than just a lower interest rates affecting real estate yields, this is speculation and too much cash. Why does this low yield environment in real estate exist? I think people just have a huge preference for owning over renting. I think it's time to sell and rent.

[MathieuLagarde]

Low yield exist only because lots of fools think that this time it is different, real estate will continue to go up and can not go down! Same as in 2000! The economist has a article a year ago about renting vs owning in the UK and the conclusion was that renting is a better choice. You have to the you homework in your down, with a present value and you will know which is best right now.