A dollar today is worth more than a dollar tomorrow.
So, the farther into the future one expects income or a sale to occur, the less it is worth in today’s dollars. In my opinion, investors don’t contemplate this factor enough when considering a real estate investment.
Factors that are commonly considered for real estate investments include location, market, available financing and current cash flow. But when you invest and how long you plan to hold can strongly impact how well you do.
The Effect of Timing + Buying
Let’s look at some examples:
- Those who bought properties at the market peak in 2006-2008 with 3- and 5-year loans know the pain of debt maturing in a down market.
- While it is always prudent to buy in a down market, it is possible to buy too early. This could result in debt maturing before the market recovers or in anticipated cash flows and future sale occurring much later than anticipated, both resulting in returns falling woefully short of expectations.
- Even buying well in a good market can turn into a bad deal over time as markets shift, demographics change or unanticipated developments in the area occur, like a road closure. Oakbrook Business Park on I-85 in Northeast Atlanta is an industrial park that enjoyed its heyday in the late ‘80s and early ‘90s only to be hurt by demographic changes in the area and rearrangement of the road network providing access.
- Another interesting study is West Midtown in Atlanta. An industrial district developed in the ‘50s and ‘60s, the area declined in the ‘80s and ‘90s as buildings became obsolete. Now experiencing a renaissance, West Midtown attracts young professionals and artisans with its restaurants, multi-family developments and loft offices replacing old industrial buildings. In this scenario, long-term (and I mean very long-term) property owners with zero debt are now realizing a handsome profit. However, those who made shorter term investments relying on debt to increase their yields suffered a much different end result.
Emphasis on IRR
The impact of the debt and time combination is made even more significant by the emphasis on Internal Rates of Return (IRR) to determine an investment’s financial desirability.
A highly leveraged investment with significant appreciation over a short time frame can easily result in an IRR well into double digits. Yet, failure to achieve the desired result in a short period of time dramatically decreases the return and significantly increases the risk. If the plan is not executed before the loan comes—well, how do we say it, “You are screwed.”
Here are my final thoughts on timing and real estate investment:
- Make sure you understand the business plan for the investment.
- Pay attention to the property dynamics and how they align with market conditions.
- Be aware of micro and macro market trends, and adjust your strategy accordingly.
How do you take timing and debt into account for your real estate investments? Do you have other examples to share?