The Economic Impact of High Risk Investing

Risk

My husband and I live in Miami. This was a hot real estate market just two years ago–white hot. The one bedroom condo that my husband had purchased just a couple years before doubled in value. Expecting our first child, we needed more room. Fortunately for us, real estate was moving fast and mortgage brokers were giddy with big commissions.

Unfortunately for us, when real estate is moving quickly, it’s considered a sellers market. In a sellers market, eager buyers are competing for the same property making it difficult to get a contract much less a great deal. Pre-construction homes were selling out in hours with buyers waiting in line for days. Determined to find just the right house, at just the right price, we celebrated our daughter’s first birthday just days after moving into our new home. Getting the mortgage was easy; it was outbidding the other buyers that proved to be difficult.

 

Then the market cooled. The amateur investors who had been driving the prices up panicked. Sell! Sell! Sell! It was like watching online investors dump everything when the stock market has a bad day. What some might call a housing slump, others viewed as a dive.

 

Amateur investors operated under the false assumption that the Miami real estate market was a sure win. Watching their friends and neighbors make money hand over fist (and lulled into false expectations by 30 minute real estate shows) amateur investors over extended themselves to cash in on the lucrative “real estate flip”. Flipping is the practice of buying a property, making minimal upgrades and reselling for a profit. Flipping is also the term used when investors buy at pre-construction prices and then resell once the property is ready for occupation.

 

Many of these amateur real estate investors signed high, interest only loans to keep the payments low while they negotiated a quick turn over. Often they would sell to a new investor, who was confident the market would go even higher. Many of these individuals signed multiple mortgages with high risk lenders.

 

When the housing market went into a slump, buyers (mostly amateur investors who where no longer interested) stopped competing for contracts. As a general rule, homeowners aren’t really fazed by housing slumps. Like investors who hold stocks long term, they can ride it out. If now is not a good time to sell, they simply take the sign down and wait.

 

For amateur investors, a housing slump can be their worst nightmare. Generally, amateur investors can not afford to pay a full mortgage on their investment properties. When the market begins to cool, when head lines read “housing bubble about to burst” they need to get out fast. The sell, sell mentality drives the market down as “for sale” signs go up.

 

When the neighborhood is littered with for sale signs, buyers realize the market has changed in their favor. The property feeding frenzy comes to an end. Welcome to the housing slump.

 

But it gets worse. The housing slump also creates a renters market. Amateur investors desperate to at least rent the homes they can no longer sell must compete against each other, often renting below the monthly mortgage just to offset some of the cost.

 

Unable to sell their investment properties, or even keep them rented, some over extended investors find themselves in foreclosure. The flood of foreclosures drives the market down even more, and the high risk lenders who founded it all are faced with bankruptcy.

 

This down turn has little effect on professional investors. Although the value of their portfolio might take a temporary hit, unless they’ve over committed their resources, they’ll be able to ride out the housing slump just like the average home owner. It’s the investors who took the biggest risks that are now in the biggest trouble, stalling the market for everyone.

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