The dangers of investing in real estate  

Mark Twain (1835-1910) is attributed with saying “buy land, they’re not making it anymore”, and it wasn’t just the famous author and humorist who thought so. Real estate investing has always been considered a lucrative investment vehicle, for both investors and private owners of commercial, industrial and residential properties.

Historical advantage and recent disadvantage

Fast-forwarding from Mark Twain’s lifetime to more current times. Since the US real estate crash in 2008 and the 2007 housing crisis in Israel, real estate was a great place to invest, until the beginning of 2022. The rising prices and increased values for investors over large swaths of the real estate investing value chain, led to large gains without significant carrying costs or interest payments for purchasers and investors alike.

The 2007/8 housing crises caused interest rates to drop dramatically, in order to prop up the economy and the real estate market in general. With those rates close to 0% for almost a decade and a half, real estate markets received a major boost, with prices often pushed up into bubble territory. Until about a year and a half ago.

In March 2022 the US Federal Reserve, followed by central banks around the world, began raising interest rates in an unprecedented manner from close to 0.25% to over 5% – making the current rate approximately twenty times higher than the low of 2022.

The drastic result is that borrowers now face far higher interest payments, with investors who were using leverage being doubly hit. Increased interest expenses, have caused valuations to drop and many investors have had trouble refinancing at current rates, given the profitability or lack of profitability of investment properties at the new rates.

Investors who lend money to real estate companies, who then lend money to developers, also face increased risk as projects are delayed. With higher interest rates, reduced sales and increasing inflation, there is a greater danger that the developers will run into more financial difficulties, making the likelihood of investors receiving their money much lower.

Safe as houses, or banking on the bank?

Whereas the rising interest rates made existing fixed rate loans and bonds much less attractive, the rise has benefited savers with deposits at the banks (although obviously the bank never offer the same interest rates on their savings, as they charge on loans). Savings rates now give people the ability to earn significantly more with their money, as bond yields and saving accounts interest rates in many countries have gone from 0 to the 4-6% range, for secure investments.

It was fine to pursue higher returns when the banks were paying nothing to hold your money, but given the new reality, investors and savers need to evaluate how they are investing and whether they are receiving enough increased interest or returns, to compensate them for the higher risk and lower liquidity.  Do some homework – if you are in this situation, ensure the groups you are investing with are strong.  Make sure you have enough cash flow to carry your current real estate investment, or else plan to draw cashflow from other sources in order to enable you to make payments.  Even residential real estate owners need to re-evaluate their investments.  If rental income is only 2-2.5% of the value of an apartment before operating costs (eg the rent to value ratio) and safe savings at your bank can earn over four percent, with looming increased weakness in prices going forward, the once simple decision to hold property might not be so simple.

If, after doing your due diligence, you doubt the companies’ solidity and profitability, see if there are ways to redeem your investments early.  Evaluate whether this is the time to sell your real estate at relative market highs, to create more liquidity. Unfortunately, it appears that we are approaching a recession in the USA and a slow-down in Israel, which will only make these trends more extreme. Behatzlacha raba!