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Where To Be Cautious In 2006 ~ By Chris Anderson, Ph.D.

January 25, 2006

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What real estate investments, if any, should you be looking for in 2006?  If you have been following along with our articles this month, this has been our main topic of discussion.  So far, we have addressed the all important issues of what we mean by a market , and what investments are likely to work

In today's article, we take the flip side and ask what investments are we most cautious about as we get into 2006?  As discussed last week, you can only answer this question based up your BELIEFS in the market. 

Just as a reminder, our "beliefs" that guide all our investments here at are:

- Long term baby boomer trend is well underway and is impacting areas like Florida, Georgia, Carolinas, Nevada, Arizona, etc.;

- Areas attractive to boomers WILL DO VERY WELL over the 5-10 year horizon (but there could be a short term dip somewhere);

- Florida's population will nearly DOUBLE over the next 25 years;

- In areas impacted by boomers, AFFORDABLE housing is, and will continue to be a huge issue because demand will escalate prices.

But these beliefs, which are also held by many others, have at times lead people to excesses in their real estate investments.  Whenever there is excess in investments, there also exists great risks. 

A great example of this point was the last class I taught at the NYC Learning Annex about investing in Florida.  In that class, we did a fictitious investing exercise where everybody has to decide if they want to "invest" using play money.  Typically for these exercises, we present 3 "projects" and get people to make the invest/don't invest decision.

When people first come into the class, if you offer them waterfront in Florida they typically will buy like there is no tomorrow!  For those people that invest in the exercise, I always ask them why?  Typical answers are:

- The baby boomers are just driving the prices wild;

- Waterfront never goes down;

- They only make so much waterfront;

- Etc.

If I do this exercise early enough in the class, most never question the price (which I tell them before they decide to invest).  I could probably ask $300/Sq ft or $600/Sq ft and get the same number of investors. 

Unfortunately, this is more than just an academic exercise since many people have brought the same investing mentality to the boomer areas.  However, WHEN (not if ) the markets return to normal (not even a crash), these investors will have nobody to sell to.  Then the mortgage payments start, and then things can get ugly.  When you then ask what to avoid in 2006, my answer is avoid the projects where investors have already gone crazy.

Let me give you a very graphical example. We have a project that is about to release on our website in the Las Vegas area.  Now Las Vegas has BOOMED and can be considered the poster child for excesses in investments.  Their population and job growth is phenomenal but that still does not mean that you can invest blindly.  The neat thing is I can show you what I WOULD INVEST and what I WOULD NOT INVEST in at the same time, in the same location.

Referring to the figure below, the blue dots show all the listed properties that are 10 years old or younger in the zip code for this project.  This plot shows the square footage of the property versus the price.  Suppose you where considering a project shown by the YELLOW dots.  A couple of years ago, these high end properties were exactly what you wanted to buy. 

Now, with changes in the market, you have to ask yourself a few questions:

- Even though population is expanding rapidly, will the demand for these upper end units continue?

- Who now owns a lot of these upper end properties?  If investors have bought many of them, how will they act in a market downturn?

- What reward do I expect, relative to the risk I am taking?

Even though I am a big believer in the Vegas market, I am not sure that I would want to invest in the fictitious "YELLOW" project.

Let's contrast that with the actual project shown in "RED".  Now we are playing to the "affordable housing" side.  When you look, you find there is VERY LITTLE for sale at or below this price.  But yet I know that the population keeps streaming into Vegas.  What this plot tells me is that down in the range where most buyers are located (on the affordable side), I am buying a property that is very, very competitive in a market that is a "no brainer" to keep growing over the next 1-5 years.

Of course, we have to insure that the price is not only low (relative to the market) but that it is a quality project as well.  To me, when I find a situation like this, I know my risk is very low, thus making it an attractive situation based on my belief system for investments.

So when you are thinking about what to invest in for 2006 and worried about the risk, then you have to really address if the investment you are buying is truly in demand by a lot of people or just a select few.  Stealing a quote from a recent developer, "it is hard to get hurt falling from a basement". 

About The Author

Dr. Chris Anderson is the founder of one of the largest preconstruction groups on the internet today and is referenced in many venues including the New York Times and USA Today. Get access to wholesale property investments today.

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