How to Prepare for the Coming Double Dip in Real Estate Prices

Are we facing a double dip in real estate prices (most markets nationwide)? YES.

Are there specific actions real estate investors can take to prepare for this risk? YES.

The Argument for a Double Dip

It is getting harder and harder for people to argue a sustainable recovery is in progress. Admittedly only time will tell, but there are several strong arguments against a near term recovery.

Unemployment continues to hover around 10-percent.
Unemployment correlates to serious mortgage delinquencies.
Serious mortgage delinquencies correlate to foreclosure sales.
Foreclosures put downward pressure on prices.
Low prices leave many owners “upside down”
Strategic foreclosures perpetuate and exacerbate the cycle The crest of serious delinquencies historically trails unemployment by one to two years. And, it does not yet appear as if our unemployment trend is heading the right way. Until the overall economy gets turned around, we should expect to see more of the same.

In fact, the massive rise in serious delinquencies has yet to fully translate into short sales and foreclosures. It is interesting to note that the loans in foreclosure are beginning to crest while the delinquencies continue to climb. Many experts are predicting a flood of foreclosure homes to hit the market. I believe that philosophy is flawed because, unlike a damn giving way releasing all the water at once, foreclosures and short sales have to go through a human process which necessarily limits the rate. I would argue this is the only reason we are not completely drowning in foreclosures already. Perhaps the cresting in the number of loans in foreclosure is telling us the threshold of human capacity. (Of course we won’t know that for some time to come.)

If delinquencies and foreclosures continue to increase the number of homes for sale (supply), while the demand dies because it is no longer artifically high, then prices are most likely to fall back a notch or two which feeds into the vicious cycle.

The market really only has two things going for it.

Current diminished supply in certain price ranges in some areas. Here, an increase in foreclosures and a decrease in demand will cause sellers’ markets to revert to neutral or possibly buyer’s markets.
Low interest rates. Although there is some risk of increase, the Fed recognizes that continued low interest rates are crucial to a recovery.
Robert Campbell wrote a great book some years ago called Timing the Real Estate Market, wherein he describes a scientific method of monitoring market momentum to determine optimal buying and selling periods. He looks at the trends of key determinants (existing home sales, new home building permits, notice of defaults, foreclosure sales, and 30-year fixed interest rates) as indicators to signal the coming peaks and valleys of real estate cycles.

Using Campbell's key indicators, we see only one positive indicator of five – that is, interest rates are awesome. But, when 4 out of 5 indicators are against a recovery… it really is kind of hard to argue against a stagnant or double dipping market.

How to Prepare – 10 Specific Actions
Maintain a long time horizon. Unless you happen to be flipping properties, know that you should not expect much appreciation for a while. HOWEVER, keep an eye on the increasing potential for inflation or hyper-inflation. The U.S. has printed a ton of money lately and other than limited devaluing of the dollar, we have yet to see the true effects of all that new money. See the newsletter Bernanke Running Amuck. The higer inflation is, the cheaper your investments become because the nominal dollar amount remains the same for the life of your fixed rate loan while the purchasing power of those same dollars diminish. A small drop in price can be easily erased by hyper-inflation.
Look for the best house (or at least not the worst) in the best neighborhood. The price difference between average and best is as small as it will ever be. School districts often help define the best neighborhood – go for the highest regarded school system.
Follow people and websites that backup their claims with supporting facts and data.
Fix and flip is high risk right now.

Work areas with which you are intimately familiar.
Take extra care accounting for all costs, especially the transaction costs. If the ARV were only half the distance from the purchase price, would the deal still make sense?
Be sure to use tools like www.FinestExpert.com to ensure you are buying property at a discount and that could cash flow if you got stuck with it.
One interesting strategy right now is to flip properties to other investors: Find that sweet deal, get a tenant, and then resell with a lease in place.
Stick to cash-flow properties because they can provide you an infinite hold time. Don’t worry so much about finding the property that is going to appreciate best, (all ships rise with the tide), right now you need to withstand the rough weather.
Some sellers are more desperate than others. Use www.FinestExpert.com to search for properties that are listed at a discount from the comps.
Stay in a cash position until you find just the right property. Rinse. Repeat. (If you have a 1031 exchange, try to use your full timeline – although that is seldom a problem.) Be picky! Even if the market as a whole is declining, there are still properties that just make sense. Don’t let these slip by because the market is generally off. BUT, do not pick up an average property at this time.
Take advantage of the crazy low interest rates. Consider the tradeoffs between a 10% price drop and a 1% interest rate increase. You might be surprised. Although you have missed the rock bottom interest rates and there is risk of them increasing, rates seem to be stable for the moment. Keep an eye out for a general economic improvement before we see much movement in interest rates. I don't think Bernanke will spike it again (as in 2004). But even if 30-year fixed rates go to six-percent, that is still pretty dang good. When I bought my first home, interest rates were in the high 9’s. My preferred lender is W.J. Bradley. They also have access to some private lenders for investors above the 10-loan limit.
Keep an eye on the pending sales counts. I expect them to start dropping (seasonally adjusted) after May 1st. This is the “must be under contract” deadline of the homebuyer tax credit (although it might take a month or two to clear the queue of buyers who got off the fence because of incentives, missed their window of opportunity, but decide to buy anyway). As long as pending sales continue to drop, hold off on purchases (except for the killer deal, of course or signs of inflation).
Unless you happen to find the rare find, I recommend investors hold-off on purchases for four to six months… and then review the situation again. I recommend against selling to avoid the loss because the transaction cost is just as heavy. Also, I believe the inflation risk is a good reason to stay in the market.