If you search hard enough, you can find properties for sale in almost any market in the world. Still, there are bearish market signs that could suggest that investing there is simply not a good idea.
What is a declining market?
A declining real estate market is when there are more sellers than buyers. People are not moving to the site or upgrading their homes by moving. As a result, a property takes longer to sell and property values are significantly lower than usual. These markets are highly volatile, making it difficult to predict whether investors can take them and still make a profit.
Another term for a bear market is a bear market. A bear market occurs when the prices of an industry drop by 20% or more. It is not ideal for the real estate investor and you should do your best to avoid these markets.
Why do you need to know when a market is declining?
Every real estate investor needs to know if a market is declining. You don’t want to be stuck with an investment that you can’t resell. If you hold onto a property because you can’t sell it, you lose money every month.
When it comes to real estate, the location is crucial. You not only invest in the property, but also in the location. It is important to know the future of the neighborhood and the local market that you are looking to invest in.
Let’s go over the eight red flags that a real estate market is declining.
Prepare for a market shift
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1. Population decline
The urban population is growing and shrinking for various reasons. Long-term population decline is bad news for housing investors. As with most businesses, it all comes down to supply and demand. A falling population corresponds to a falling demand.
If people move away instead of going to a particular market, demand and purchase transactions will decrease. As a result, vacancies can become significantly higher and values stagnate. This can happen even in affluent and established markets, where taxes are high and the population is aging.
Many cities in the US are shrinking, some for a long time. It is therefore not surprising that housing cap rates are significantly higher in many of these markets than in markets with booming population growth.
At first glance, those higher cap rates seem like better business. However, it is not worthwhile to take long-term rental growth and occupancy into account. In most cases, fair business in safer markets outperforms good business in riskier markets. This may seem obvious, but it’s surprising how many people fail to make the connection.
If all the younger generations, talent, and workers move away and stay away, local real estate can become less profitable. A quick Google search can reveal which cities have had steady population growth over the past few centuries – and which are declining or could be boom-and-bust markets.
2. Super high vacancies
Investors always have to expect vacancies. It should be part of your projections even if the acquisition utilization is 100%. Vacancies that are unique to a single building may not be a bad thing. They can be an opportunity to renovate or put in better management to add value.
However, if a market averages 30% or more vacancies while the national or city average is 5%, there could be a bigger problem. It’s definitely a red flag to watch out for.
3. Falling real estate values
Unless you’re a wholesaler who can get in and out of the market faster than the market shrinks, or you can shop at an incredible discount and hold out cash flow indefinitely, buying a rapidly decaying asset doesn’t make a lot of sense . If the local property valuation has recently dropped 10-30% and this activity is just getting started, this is no different from buying a new car because you know it will be worth half as much after the exit.
4. Environmental hazards
Noticing declining market signs means more than just Googling population and property values. Often you have to know the neighborhood and fulfill your duty of care.
Environmental hazards such as contaminated groundwater, underground storage tanks or industrial air pollution add to the more frequently inspected problems with lead and asbestos. What seems like financially good deal in a growing, stable market could be near a Superfund location. Without a thorough due diligence process, a buyer would pay the price to own this “good deal”.
Eliminating such hazards is not always possible, and when it is, the cost can be enormous. That is why it is not uncommon to find heavily discounted properties that involve environmental hazards. But don’t jump on the discount. The resale market is very limited for environmentally hazardous properties.
5. Disturbed labor market
Some markets can survive with little local employment. The Florida Keys and other nearly 100% vacation home and retirement driven markets are examples of these exceptions. However, they can be severely affected by disruptions in travel and vacation patterns, security crises, and weather. Singularity of jobs in a location could be a red flag for a market that could decline overnight.
When we look at the markets, we like to see the diversity of job centers. We like a mix of government, private sector, and college jobs. The diversity of jobs avoids the risk of catastrophic losses when an industry collapses.
In extreme cases, cities created by individual job centers become ghost towns when massive unemployment occurs. Military cities and the destruction caused by the realignment and closure of bases (BRAC) in the 1990s are a good example of this.
Today, some cities across the country derive a significant part of their economies from military spending. Cities like this can get up to half of their GDP from the military. However, no matter how good their current economic situation is, they are always one BRAC away from total disaster.
For the long-term investor, this is a sign that the market could fall at any time. Think about Detroit. When major automakers went bankrupt, it had a big impact. Even though Detroit’s situation improves 10 years later, investing where a city depends on a large employer or sector can still pose great risks.
6. Pro-tenant laws
When evaluating the markets to invest in, population growth and employment rates are important. That being said, several markets in both areas are showing exceptional numbers that are still not worth investing in. Local and state laws for landlords and tenants can make a huge difference to success or failure in a given market.
Changes in the legislature could be a sign of a declining market. Subtenant states can have rental price controls, extensive eviction orders, and other barriers that make it difficult for homeowners to be successful. While these challenges are not necessarily unique, some areas take their pro-renter-friendly attitudes to another level, such as banning criminal background checks. These laws can lead to a declining market and make it difficult for sellers to succeed in them.
7. Unreliable government
You can find incredible real estate investment returns in all kinds of exotic locations around the world. But one of the main reasons global investors choose America is because of its safety and legal system. In many other countries, police and governments can effectively take control of your property and hand it over to someone with less money. There is nothing you can do about it.
While this mostly happens overseas, some US markets may be more susceptible to this type of activity than others. Look for a high level of local government interference with landlords, especially if the city or county is buying profitable rents from individual landlords to hand over to larger developers.
8. Too rural
You can find super cheap deals if you are far enough from the city. This is mainly due to the fact that most investors stay away from these sub-markets and most lenders do not grant loans there. The demand is too low. The potential pool of buyers and tenants is too small. Comps can be scarce. Dependence on annual crop production and profitability can be too volatile.
This can also apply to remote suburbs, which experience tremendous boom-and-bust activity as the market changes. When the economy is strong, people go there to buy cheaper property, turn around quickly, and make a good profit. If the economy shrinks, these areas can become the Wild West again.
Pay attention to the market sentiment
Most real estate investors focus heavily on “the business” (the property itself) and any discount they can get on a purchase. They want good business, they are looking for good business, and they must have good business.
However, the great deals (e.g. assets that are discounted in the market) are like that for a reason. Typically they are more stressed – with delayed maintenance, tenant problems or many other factors forcing the owner to offer the property at a discount. These deals may have a greater potential chance, but they also come with greater risk. It is important to know if you got a really good deal or if you are investing in a declining market.
As a serious investor, you should be aware of market sentiment. How do others feel about the real estate market? Are you investing locally or looking for property elsewhere? Before investing in any market, do some research.