The End of Free Money [Make A Smarter Decision]

by Osman Parvez

After nearly a decade, the Fed has announced the end of its bond buying program and a return to normal activity. In other words, expect rising rates in 2015... eventually.    

When?  It's everyone's obsession and anyone's guess.   

The latest Federal Reserve meeting minutes have a fascinating discussion over the timing of tightening rates and signaling to markets. My suggestion is to watch for signs of a healthy labor market and for inflation indicators. Given the Fed's indecision, I expect rates will rise too slowly, not too fast. 

What's the Impact?
The answer depends on how the economy continues to grow in our region, when and how quickly rates begin to rise, and many other factors. 

Here's what rising rates looked like the last time around.

The Past
During the last real estate cycle, the Boulder market was impacted from top down. Higher end homes (at the time $1MM+) saw inventory rise and prices fall first. Eventually it trickled down to the middle of the market. At the very tail end of the cycle, the entry level saw a brief and shallow decline. 

When the top end of the market stagnated, some developers capitulated and liquidated new inventory at 40% off the original asking. The high-end slump lasted years and primarily affected properties without high quality views, proximity to downtown, or adjacent open space. These factors are anchor to long term value. Entry level houses saw prices fall around 5% and the drop only lasted a few months. 

Will history repeat itself? There is no clear answer.   

The Future
In the long run, Boulder real estate has performed very well compared to other real estate markets. I'm a believer. Not only am I focused on advising investment oriented buyers, I'm seeking investments for myself and my client-partners.    

While my "rating" on Boulder real estate is "strong buy," there is no certainty. No investment short of U.S. government securities are risk free but holding cash is a losing strategy.

Make a Smarter Real Estate Decision
If you're thinking about deploying capital in the Boulder real estate market, here's how you can best insulate yourself from the end of free money and rising uncertainty.    

1. Increase your margin of safety. Only acquire assets that are in solid, time tested locations. Do not take location risk. In other words, don't buy a high value asset in a location that has no track record. 

2. Buy mainstream properties with conventional layouts which will appeal to a majority of potential buyers. Two bedroom houses and one bedroom condos are risky when it comes to resale, unless there are offsetting factors such as protected view corridors or open space/downtown proximity. In general, buyers should choose two or more bedrooms for condos and at least three bedrooms for houses. Don't forget about storage. Almost everyone who lives here has three or more bicycles, camping gear, and skis/snowboards.   

3. Be ready to pay a premium for properties that meet the above criteria.   The inventory shortage is driving bidding wars for desirable assets. You need to know what's worth a premium and what isn't. Choose your Realtor carefully.

4. Don't skimp on due diligence for view corridors, easements, and regulations restricting expansion/remodeling. In Boulder, it goes way beyond zoning. This particularly applies to historic properties and houses on small lots.   Don't assume you can expand it or add a carriage house until you check current regulations. Longmont, Louisville, Lafayette, and unincorporated Boulder County are less restrictive.   

You should also get a sense of the trend for regulatory changes in Boulder. Talk to your Realtor, talk to developers, talk to the city planners, and talk to the neighbors. Whatever you do, don't tear down a historic coal shack and put up a basketball court.   

5. Understand Boulder real estate value indicators. Value investing is about knowing the real, or intrinsic value of an asset. There are clear north/south and east/west real estate value delineations in Boulder. For example; if you're buying to rent to students, proximity to CU is your biggest factor. If you're buying to rent to future Google Employees, you want to think about access to 30th and Pearl. If you're looking at the luxury market, aim for neighborhoods and locations that have a history of supporting those valuations. 

In my opinion, much of South Boulder - particularly Table Mesa - is undervalued. It has easy access to open space and great schools. The revitalization of Table Mesa plaza is something to keep a close eye on. Certain trophy homes in north central Boulder are trading for far more than they should and will see a substantial haircut to value when the market turns. 

Once clients know my background, they almost always ask for my "rating" on a property. Back when I was an analyst, the managing director of research insisted on strong buy ratings for what were obviously crappy stocks. Today, I don't have a boss breathing down my neck and no investment banking relationships to protect. Here's the truth: very few properties in Boulder are A+ investments. Most are B's and C's. There are many D's and F's, the dregs of the market that you should avoid at any price.   

6. Real estate is the only investment class that you live inside. The best investment doesn't always make the best living situation. This primarily applies if you intend to occupy the property as your personal residence. Most of the condos in Boulder have poor sound insulation. You'll likely hear your neighbors from time to time. If they are students, you'll know. Buy something that you won't outgrow in 5-7 years. 

7. Think about regulatory risk. Investors have been repeatedly burned by assuming that their project is "by right." Guess again. Whether you're building large or small, you're taking serious amounts of risk. Boulder has some of the most restrictive codes in the country and an intelligent, vocal, activist community. Talk to the investors who bought the old Robb's Music building next to Liquor Mart. Talk to the developers of Baseline Zero who are currently facing stiff community opposition (rightfully so, in my opinion). Note City Council's attempt to pass an emergency development moratorium (a favorite tactic) and the likelihood of a comprehensive development plan being pushed forward this year. 

8. Be patientIf you're buying, remember that selection will grow between now and early summer. Inventory is at record lows but it will rise seasonally.   Currently, too much money is chasing too little inventory. Some buyers are clearly paying a premium for sub par assets. In a bidding war, don't get caught up in the frenzy. Only engage when the asset is truly desirable.  

To help prepare for bidding wars, I show my clients the following: How many similar properties sold during the past twelve months? How many closed for cash? How many went above asking and by how much? This information gives a sense of what to expect in the coming year and increased confidence to walk away when things get too bubbly in a bidding war. Not getting that from your Realtor? Get a better adviser.

Sellers, remember that you don't want the highest offer, you want the highest price that will close. Be cautious with variable commissions to your listing agent. The real estate commission has recognized this as a potential conflict of interest, especially if the property was not offered on the open market (i.e. a "private sale."). See Commission Position #44. Ask for verification of funds. Consider negotiating a gazumping provision. Force your Realtor to use selective transparency to cull the herd of offers to no more than 3 to 5. If he shows up with more than 5 contracts, he's not doing his job. 

9. Watch for game changers. Like it or not, Boulder is experiencing rapid change. The Boulder Transit Village Area Plan has jump started development around 30th and Pearl. Google has announced a 3-4x increase in its workforce and a local campus right across the street from Whole Foods. Everyone is talking about the impact on real estate.   

Game changers are happening in other markets too. Note Longmont's redevelopment of the Butterball Turkey plant. It's a game changer in a market that's only a twenty minute drive from Boulder where home prices are often half the price.  

10. Choose your adviser carefully. Because barriers to entry are low, the real estate industry attracts a huge amount of rookies with little professional experience. Most last a year to two. The largest real estate brokerages prefer it this way because they churn and burn new agents for fees.   

Do your research on agents but don't put much credence on easily manipulated reviews on websites like Zillow or Trulia. The vast majority of my transactions, for example, are not on Zillow.   

Interview at least two or three agents. Talk to them about strategy, negotiation tactics, and market conditions. Make an intelligent decision.   

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The next Boulder Real Estate Meetup is February 26th. We'll be discussing market conditions, strategies, and much more. Join us! RSVP and learn more HERE.

Like this analysis?    Subscribe to my research.          Ready to buy or sell?  Click HERE to schedule an appointment or call 303.746.6896.

As always, your referrals are deeply appreciated.  

The ideas and strategies described in this blog are the opinion of the writer and subject to business, economic, and competitive uncertainties.   We strongly recommend conducting rigorous due diligence and obtaining professional advice before buying or selling real estate. 

image:  Pawel Loj

Please Note

This document contains forward-looking statements. You are strongly cautioned that investment results are subject to business, economic and other uncertainties. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time. Always consult your financial advisor before making an investment decision.