The most common confusion in the world of investing is that of price and value. Almost every time I speak with an investor the first question is, “do you think will prices fall further?” and I admit that price matters.
However, an investor should be more concerned with value… There is a difference between price and value and how they each impact an investment.
I ask you, what is your house worth? Really… what is your house worth in terms of dollars? 100k, 400k, 800k, or 1mm… I say you’re wrong whatever number you picked! The dollar price of your home or any property for that matter can never be anything other than a best guess.
The real answer to the question is this: Your home is only worth what someone else is willing to pay. Its just that simple. In a down market, other people won’t pay you as much so that house that appraised for 1mm is now really only worth 600k perhaps to someone with cash and ready to buy.
So where does the value in a home lie? For an investor, the value lies in the equity or cash flow that property can provide. That’s it.
Sure, all markets fluctuate… the investor knows to watch prices for opportunities to sell or pull money out of a property, and then continues to watch prices for opportunities to buy cash flow.
For example, lets say you’re a smart person and you understand that markets will fluctuate. You see prices rise from 01 – 07 and in some cases double and you realize, hey… this is not sustainable!
If your house was paid for or you had a lot of equity built up you can do some really creative things with the equity or value of your home because of the high price. Just to keep it simple, lets say your home was paid for… so in 07 you borrow out 50% of your equity because you know that home prices are inflated and when they collapse your equity will too.
If that house was worth 400k, you would now have 200k to play with… So you wait, you put the money in a high yield account and earn interest while you wait for the market to correct. You also use the borrowed money to make the payments on the loan while it sits idle.
Then sure enough, the real estate market crashes! And your equity crashes right along with it. If you are worried about your home’s price thinking that is wealth, you are screwed! you just lost 50% of that. But, so did everyone else.
But… because you had the foresight to pull out that liquidity when prices were high, you now have a golden opportunity. With that 200k, you now scoop up three condos at 50k each, which you can rent for 700 per month, you keep the remaining cash in the high yield account and save it for repairs.
Your 200k loan costs you about 1300 dollars per month, and your condos generate an average of 2100 per month before expenses. So you net about 800 per month in profit on the deal!
Now I ask you… Does it matter that your primary residence lost 50% of it’s equity?
You now own 4 properties, 3 of which produce cash flow which pays your mortgage and provides a strong profit. So again, how much do you care about price now? would you rather have your equity subject to market conditions or would you rather put it to work for you and multiply your real wealth which can be measured by the cash flow you create.
You see cash flow investments work for you and they pay you. Your equity locked up in a home is ALWAYS at risk.
But, “I always though I should own my home outright you cry…” and I say you still do. Because if you wanted to, you now have other assets that you could sell to pay off your mortgage. Its just that now, those assets created by your equity are not subject to or limited by the price of you home.
