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How To Get Really Rich In A Rising Real Estate Market

I am writing this in England in July 2015. Over here we do not talk about 'real estate' but rather we talk about 'property'. However, I will use the term real estate because globally I think it is the more popular expression.

In broad terms the situation here over the past twenty or thirty years has gone something like this. In the late 1980's the real estate market was rising strongly. In 1990 it basically stopped dead. Transactions dried up and prices started dropping, rapidly at first and then more slowly. The market continued to stagnate until about the middle of the decade. The market bottomed out (I am talking about the residential market - I really have no knowledge of the commercial market) and then it began to rise gently. From about 2000, activity and prices began to heat up increasingly strongly, and then in 2007 came the inevitable crash. From that time until now, outside London, the market has basically flat-lined. London, however, essentially became a separate real estate market as foreign money flooded in from developing nations and corrupt nations. At the moment the London real estate market is probably at or near a peak. It is not particularly important from our point of view, but that is probably because nations such as Russia and China, which provide many of the buyers for the London real estate market, are having their own economic problems, so people from there are not as able as before to invest/launder their money into London real estate. Also this year our government increased stamp duty (the tax that a real estate purchaser must pay to the government) so that a purchaser of, say, a $3,000,000 house would have to pay 12% of that amount to the government.

The period I want to focus on to illustrate how some particularly aggressive, and occasionally foolhardy, real estate investors got very rich is the period from the mid-1990's to 2007, and then on to the present time.

I will take an imaginary couple (actually based on a real-life, well known couple here in England) whom we will call Jane and John Doe.

In the mid-1990's John and Jane had a house near London. They wanted to move to another house nearby. However, the real estate market then was still rather dead and it was not all that easy to sell a house, so they decided to keep their existing house and rent it out so that there would be a tenant essentially paying the mortgage on it, and then they went ahead and bought their new home and moved into that. So, they now owned two properties, both with mortgages secured against them. The tenant in their old home paid rent that covered the mortgage payments on that house, and John and Jane, who both had jobs, paid the mortgage on their newly bought house.

The real estate market gradually began to pick up, and house prices began to rise (in John and Jane's area at least) and real estate transactions increased in number and in the speed with which they took place. What also happened as the year 2000 came and went was that it became very easy to borrow money. Lenders were essentially falling over themselves to lend money, especially against real estate. It was possible to borrow an amount equivalent to the value of the real estate that was being offered as security against the loan. In fact occasionally it was possible to borrow 110% or even 120% of the value of the real estate being purchased.

Another couple of things happened in the world of real estate finance. Firstly, if you took out a mortgage, you could arrange to pay back only the interest on the mortgage until you eventually sold your real estate (or, which was very unlikely, you got to the end of the mortgage term, which was likely to be after something like 30 years). The other thing that happened was that there developed a huge laxness in the requirements that needed to be met by borrowers to show that they could make the monthly repayments on the mortgage they wanted. Indeed if the real estate valuation was acceptable, and the anticipated rental income looked as though it was good enough to meet the monthly interest-only repayments on the proposed mortgage, then the only other requirement was that the borrower had to show that they had sufficient income to meet the monthly repayments if the real estate became empty or if the tenant stopped paying the rent for any reason. What happened was that borrowers said they were self-employed or they owned a business, and they then 'self-certified' their income. In other words they simply said that their income was … well, whatever the lender wanted them to say it was.

All the ingredients were in place then for a perfect storm in the buy-to-let real estate market.

There is a saying. “Be aggressive in a bull market.” Real estate was now definitely in a bull market.

Jane and John looked at their situation. They were both holding down lower middle class jobs that did not pay well and that they did not particularly enjoy. They owned two houses, both of which were worth well above the prices they had paid for them, and also worth well above the mortgages secured against them. There was a real estate boom going on, and house prices were rising 15%, and maybe 20% or more depending on location, a year. As John and Jane talked things over, they realized that here was an opportunity for them to do what they wanted most, which was not to be wage slaves. They wanted to be their own bosses. Better still, they wanted to be financially independent so they did not have to work at all if they did not want to.

The things to bear in mind about becoming financially independent are these. All you need to be financially independent is to own sufficient income-producing assets, which you personally do not have to work to maintain or simply to keep owning, such that they give you sufficient income to live on without having to go out to work. It does not mean you cannot have debt as well assets. It just means that your assets must produce income sufficiently in excess of the repayments you make on your debt that the difference is adequate for you to live on without needing to work. In practice this means your assets are likely to have to be quite a few millions (of dollars, say, or pounds sterling in this case) above the amount of your debts.

So John and Jane Doe knew that if they wanted to be financially independent, they had to be involved with millions - millions worth of real estate, and therefore of necessity with millions worth of debt.

They got on with things straightaway. Immediately they went to their mortgage lenders and asked to borrow more money. There was sufficient equity - the positive difference between total asset value and total debt - for them to be able to increase the mortgages on both of the houses they owned. They got the new, bigger mortgages they asked for, so now they had cash in their pockets.

Next is where they displayed the aggression necessary to make real money. They used the cash they had raised from increasing their mortgages to buy more properties. As they did so, wherever possible they put down no money at all, and if they did have to put down some sort of deposit to secure a mortgage to buy another house, they put down as little of their own money as possible. Sometimes they were even able to buy houses entirely with borrowed money and also be given some extra money by the lender, thereby increasing the cash they had available to go towards buying yet more houses.

As the real estate boom reached fever pitch, John and Jane were able to revalue real estate they had bought several years ago and, because those houses had dramatically increased in value since being bought, they were able to take out new, bigger, mortgages on them and so get more cash to use to buy yet more houses.

And so the game went on - borrow, buy, borrow, buy. Eventually John and Jane ended owning something like a thousand houses before the party fizzled out, as all parties must. It is generally agreed that the party ended in in 2007, although some people might argue that the end came a year either side of that.

It would be nice to say that Jane and John, seeing that the years of excessive real estate price rises were coming to an end, stopped buying and borrowing in 2006, sold all their properties, cashed in their chips, and pocketed the cash that was the difference between what their houses were worth when sold and what the total amount of their debt was on those houses. Indeed some people, who had been playing the same game as John and Jane, did, either through good judgment or good fortune, do just that, and they took their profit, taxed but otherwise debt-free, and lived happily ever after. If you looked at those people, rather than John and Jane, then at this point you have all the information you need to know in order to know how to get really rich in a rising real estate market.

Here are the things you need.

You need house prices to be rising way above the interest rate being charged by mortgage lenders. (It is this difference between rising asset values and the cost of borrowing that eventually gives you your profit when you cash in.)

You need the rental income you get from your properties to be equal to or more than the interest that your lenders are charging you.

You need to be able to buy properties with 100% borrowed money, or at least with as little of your own money being put towards the cost of the real estate purchase as possible. Better still, get lenders to let you buy properties entirely with their money, and then also they lend you some extra money so that you come away from the deal with not just some real estate but with cash in your hand as well.

You need to be able to access interest-only repayment mortgages, so you do not have to pay back any of the capital of the mortgage until you sell the real estate you bought with the mortgage.

You need (whoops! I forgot to mention this!) a government that lets you deduct the interest you pay on your mortgages from the income you get from your properties. This not only keeps your taxable profits down, but it also helps you maintain a positive cash flow so that you always have cash available to keep on buying more real estate.

You need to remortgage the real estate you own when it has sufficiently increased in value above its purchase price for you to be able to borrow more against it and thereby get your hands on more cash to continue your real estate buying spree.

Lastly, you need to see when the real estate bubble in which you have been participating is going to pop. That is when you stop buying, stop borrowing, sell everything, pay off all your debts, and you take your profit and live happily ever after without ever having to work again (although of course there is nothing stopping you from working or doing some sort of business or other money-centric activity if you want to).

As mentioned, however, Jane and John missed that last step. Just out of interest though, I will tell you what did happen to them.

Jane and John did not sell at the top of the market in around 2007. They did, however, stop buying and stop borrowing. There was a moment when their lenders were worried, because real estate prices started dropping rapidly and some houses that had been bought most recently became worth less than the amount of the mortgages that had been taken out against them. Eventually, however, the situation stabilized and the moment of panic passed. Jane and John had enough rental income coming in to pay the interest on all the mortgages on their real estate, and so for a while the situation just sort of ticked along. Then two fortunate things happened that conspired to secure John and Jane's fortune, admittedly only on paper initially, but then increasingly in actual cash.

Governments and central bankers invented the absurdly named 'quantitative easing'. Central banks everywhere flooded the world with newly created money and dropped interest rates to practically zero. John and Jane therefore were able to refinance their debts at much lower interest rates than had been applicable on the original mortgages and they thereby were able to ensure that they maintained a positive cash flow. Secondly, the London real estate market was flooded with foreign money, both honest and dodgy, which pushed prices up, and this produced a ripple effect where prices of real estate just outside London, including in the area where John and Jane owned their real estate, went up.

So, because of low interest rates, Jane and John were able to keep paying the interest on their debt, and, because of rising real estate prices, their paper wealth - the difference between the value of the real estate they owned and the amount of their debt - actually increased. As a final bonus, because people who worked in London could not afford to buy homes in the city itself but nonetheless had to buy a home somewhere in a location from which they could commute to work, John and Jane found it increasingly easy to offload their real estate. They were gradually able to pay down their debts, and so get steadily nearer to the day when, once all their debts had finally been paid off, every house they sold would then put cash straight into their own pockets.

I hope you found that whole saga interesting and edifying.


How To | Business | Finance | Investing


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