Overheated Markets (I’m Confused)

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Regardless of whether you invest in real estate or the stock market, I think we can all agree that this much is clear — This bull run has persisted for some time now (6+ years), and the overall markets are overheated. And although that much is certain, I’m finding the thought processes and strategies used between real estate investors and stock market investors tends to be drastically different…

Since I invest in both type of assets, yes, you could say that I’m feeling quite confused these days…

Earning “Interest”

In my last post, I talked about not really wanting to stay actively involved with the markets because I didn’t want to risk underlying principal. I thought that I had found a reasonable strategy that would allow for me to earn some “interest” on my cash out refi funds ($200,000), while at the same time reducing my overall exposure to these scorching hot markets.

Sure, I could have simply left my $200,000 in the bank, but I didn’t want to earn 0% interest, either…

So, I put together a plan to accomplish such a goal, and somehow have been lucky enough to have already met my income objective for this year (exceeding $1,897), after trading in the stock market for 5 full months (January to May).

With the income goal fulfilled, I decided to exit out of most of my individual stock holdings, with the exception of retaining 3 positions (~$15,000) to further trade with. By doing so, I limited my risks because I went from a stock portfolio of $100,000+ down to $15,000.

This all seemed to make some sense to me… but probably not to many others.

Real Estate Philosophy

With real estate investing (REI) it’s very easy to know when the markets are expensive and it no longer makes sense to invest anymore. Since most real estate transactions are funded through the use of loans, the analysis is as clear as day — Cash flow after all expenses (PITI + HOA + landscaping + utilities + maintenance/vacancy reserves + etc.) needs to be positive, or at MINIMUM break even, or it’s a bad deal!

This type of analysis is very black and white. There’s no room for misinterpretation… When I first started investing in Bay Area real estate in 2012, cash flow was abundant and it was very easy to locate deals that provided a Cash-On-Cash (COC) Return of over 10%+. Over time, as this bull run continued, the returns got increasingly smaller and smaller. Cash flow started to vanish from $800/month, to $500/month, to $200/month… to basically NEGATIVE dollars every month, today.

So, as a real estate investor, there’s a clear demarcation line that’s been drawn in the sand. Earlier this year, I completed what was probably my last Bay Area deal (for the foreseeable future) when I closed Rental Property SH #3 for $470,000. That property is essentially cash flow break-even, so I knew that I was basically getting in as the door was slamming shut.

Since closing Rental Property SH #3, the local market has continued surging, and that property has appreciated by a MINIMUM of $80,000 (supported by recent comps) in the time since. Yeah, good luck to any new owners (if they are an investor) attempting to earn cash flow with that kind of purchase price!

The Bay Area’s hot economy and the limited number of properties for sale have pushed the median price for Santa Clara County homes to a record high, $879,000, and the rest of the region is not far behind.Apr 17, 2015

It’s no surprise, then, when I speak to other local real estate investors, that most everyone says, “Yup, the days of investing for cash flow in the Bay Area are basically over… It was fun while it lasted, but now we’ve just got to kick back and wait for another opportunity to arise again.

That’s the kind of chatter you get with real estate investors! Again, because cash flow is so easy to calculate, most EVERYONE knows when it’s a good time to invest, and when it’s a bad time to invest.

Here’s an online thread with a great discussion regarding market tops in my own local market. As you can see, this current hot streak has almost everyone cognizant of what is going on and proceeding with extra caution. Deals can always be found, sure, but the buying velocity has slowed down considerably.

Buying a NEGATIVE cash flow property is usually a cardinal sin with REI, so only the truly brave attempt it…

Previously, Bay Area investors were able to depend on rent appreciation to bail us out, but with rents having climbed as much as they already have these past 3-4 years, how much more can we really expect to keep pushing things? Incomes have to keep going up to keep pace!

Here’s how ridiculous rents have gotten in the Bay Area (15 cities in Top 30 list nationwide):


But of course, we all know that cash flow can be made positive… just put together a larger downpayment, and there you go! Artificial “cash flow”… sort of.

And although you could do that, most real estate investors choose not to… Why not? Because we know that pumping more money into a “bad deal” doesn’t really make it any better… The returns are still too low to justify purchasing…

Here are some more wonderful graphs from Paragon Real Estate Group:




Real estate is cyclical. The Housing Affordability Index has dropped far too precipitously for my own liking. A pullback seems near, if not imminent at this point of the cycle… Maybe we’ve got another 2-3 years left? Wanna test your luck? Is whatever juice that remains unsqueezed in this cycle worth the risks?

Instead, we can simply stop investing… Or we can go and find another market that’s much more affordable.

Stock Philosophy

When you’re investing with stocks, it’s a totally different approach and mentality. For starters, most everyone (except the most daring) who invests in stocks does so with their own money. It’s not the norm to find stock investors who invest with margin, or leverage, which is something many real estate investors rely on!

So, when you eliminate “mortgages” or “loans”, it becomes a lot more challenging to try and calculate “cash flow”. Regardless of what P/E Coca-Cola (KO) is trading at, it will ALWAYS earn you a positive dividend yield on your investment. Even if the valuations are absurd, hey, you’re at least earning POSITIVE passive income so you’re not gonna know what it’s like to be bleeding out every month (unrealized paper losses are NOT the same as having to shell out extra funds each month to make a required monthly mortgage payment)… An experience that has haunted (and continues to haunt) a countless number of real estate investors…

Investing in stocks (without using margin) is like buying a rental property with 100% downpayment; no matter how terrible the deal is, as long as the unit is rented out, you’ll never be cash flow NEGATIVE!

As such, the lines get blurred a bit… With stock investing, the red flags are less apparent, and marginal (bad) deals will slip through the cracks, almost without notice.

Further, the belief that one ought to stay invested in the game at all times becomes an acceptable (and often recommended) strategy towards wealth building…

Mixed Views

The mainstream, our employers, the media, etc. have all taught us that we need to stay invested in the markets at all times. As it pertains to stocks, this means making regular contributions to a 401k, or IRA, regardless of rain or shine. Over the long run, history has shown and proven that this type of approach tends to work out, and your compounded annual returns will be more than respectable. If nothing more, this clockwork style of investing has helped many people achieve financial independence and early retirement.

So, it most definitely works…

Not only does it work, but it’s an approach towards investing that has now been ingrained into our brains and the very fabric of our being. This type of approach makes sense to everybody… Why would you even suggest doing anything slightly different? Stock investors have all been conditioned to invest this way, regardless if you invest in index funds, ETFs, dividends, etc.

But you know what? That’s not at all how a real estate investor thinks…

Real estate investors know that you can’t time the market (but you always gotta know at least where you roughly are)… With REI you also can’t simply “buy an index fund” every month and be done with it… Again, with REI, it’s really, really, really tough to win a property without utilizing some sort of financing (of course we are limiting the scope of this discussion to normal folks aspiring to reach early FI; this obviously won’t apply to the super affluent who can drop it like it’s hot…).

And when you use financing, you’ll undoubtedly run into the cash flow NEGATIVE problem at some point in a sizzling bull market, which there is basically no escape from…

No cash flow, no bueno! Speculation and the overuse of leverage have brought down many real estate investors and their respective “empires”. More deals mean a heavier debt burden, that you’ll just keep racking up with every new purchase… In my own situation, I’ve got over $1MM in debt to be concerned with… Clearly, there are a lot of risks involved with just going with the flow and buying more properties without any regard for where we are in a given market cycle

Luckily, if the cash flow doesn’t work, we stop investing… It would logically seem like the right thing to do… But in the minds of a stock market investor, are we are thinking too much and trying too hard to outsmart and “time the market”? Shouldn’t we just keep on investing, regardless?

There’s a world of dissonance that can exist between REI and stock investing because one school of thought believes that you should pick and choose your investment windows carefully, while the other advocates staying in the market at ALL TIMES and investing without regard for peaks and valleys…

But take a look around, and you’ll no doubt find many real estate investors sitting on the sidelines these days… flush with CASH!

Let’s take some snippets from around the web (remarks from savvy investors):

In all seriousness, it takes a wise investor to take his/her time to find the right property and not simply jump at the best available.  Sometimes that may take years…

One, no matter what, I would be shocked if anybody out there wouldn’t still consider you investors. Bottom line is you own multiple units.  Whether you manage them yourself or not or whether you’re buying more or not doesn’t really matter. You are what most investors aspire to become.  And I agree with Brian that an investor doesn’t have to always be acquiring more to maintain the status of their “investor card”

About 24 months ago I started liquidated my buy and hold at what I thought was a mini peak…. IE when Hedges were paying double what I paid for my stuff 12 months after I bought it…

We haven’t bought anything in 14-months now.  We’ve been close on a couple and missed another.  We’ve done serious analysis on a couple dozen buildings this year, sent LOIs on perhaps a third of them … had other folks come overtop of us on most of those (some paying ask) … there’s just not a lot of value at the moment.

As you can see, taking a break, or time off from a HOT market, is actually rather normal in the REI space..

Perhaps I’m more real estate investor than stock market investor?


Since I invest in both real estate and stocks, I’m constantly jumping back and forth from one school of thought to another…

Up until most recently, my strategy with stock investing has always relied on conventional wisdom: regular contributions into index funds, or passive income through Dividend Growth Investing.

My latest approach to take up Dividend Growth Trading is obviously heavily influenced by my real estate mind, I believe…

Because of that, I can see how a stock investing approach with only intermittent activity and transactions can seem foreign and illogical to a pure stock investor.

By no means am I claiming to have any right answers, or solutions, but perhaps this post better explains why I’ve been thinking the way I do as of late…

I find all the above most fascinating… You can make money investing in stocks and/or real estate… But the mindset you take with each can be so diametrically opposed… It’s almost like you’re wearing different hats and trying to find a way to bring harmony between the two approaches.

This upmarket has really tripped me up and gotten my mind spinning out of control… My REI mind wants to do one thing, and my stock investing brain is used to following an entirely different set of protocols…

DGT was my attempt to try and merge the two worlds… I thought it made sense to me… but perhaps I’m really just more confused than ever…

In any case, this bull run is too HOT for my tastes, and it’s causing me to want to withdraw any excess capital away from further investing into EITHER market, regardless if it’s stocks or real estate…


Maybe I’ll go buy some gold coins, silver, and other precious metals, instead. 😉


No one said investing was easy…


Fight On!


What do you think? Time the market? Invest, regardless of rain or shine? Does this current bull run scare you at all?

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5 years ago

I stand by my comment on your last post, but don’t have much to add to it other than that people have studied various strategies on trying to intelligently shift between being invested and being in cash based on hot markets or whatever rationale and 1) most of these strategies don’t work and 2) most investors fail at doing this (likely some combination of hard to consistently execute and faulty strategies). If by cash flow you mean dividends, it has just about nothing to do with predicting market return. This is has been tested at the market as a whole… Read more »

5 years ago

I have been reading your blog recently. You have a nice strategy going on.

It seems you have a cash flow negative property. Do you consider selling it? This way you have more cash flow buffer if something goes wrong.

Alternativly, you could sell even more until you only own mortgage free properties. Then wait for the next correction and start again? You then have a risk free cash flow that creates a great stash for the next correction.

Jason@Islands of Investing

I definitely don’t try to time the stock market, and am always fully invested. So many of my investment regrets are selling far too early and missing out on some tremendous gains! The only downside of course is that when a market crash does eventually come and stocks go on sale big time, I’ll be wishing I had a pile of cash to pour into those cheap stocks! We can’t have it all, but this strategy works for me, knowing my own temperament. If I had access to 1% interest loans, I’d probably use that to take advantage of any… Read more »

Income Surfer
5 years ago

I think you made the right decision Fighter, but maybe that’s because I’ve made a similar one. Reducing your exposure is clearly not about beating the stock market’s return. It’s obvious to me that you’re trying to maintain a high level of liquidity, in case your highly leveraged real estate investments were to go wrong. This especially makes sense now that you don’t have your large salary to fall back on.

You’re doing great and have made huge progress in the last 4 years! Fight on

Midwestern Landlord
Midwestern Landlord
5 years ago

Real estate investing and stock market investing are definitely two different animals and thought you had some really good points in this article. Particularly with it not being extremely obvious when a stock is overvalued. With real estate, obviously negative cash flow after expenses is a real good indicator that the market is risky and can only continue to be sustainable based upon appreciation. Keeping strong liquidity in your situation is absolutely warranted. You are already highly invested as it is. Your largest holdings (real estate) are working for you everyday with ongoing rental income, principal reductions, and appreciation. Your… Read more »

5 years ago

‘With REI you also can’t simply “buy an index fund” every month and be done with it’

I buy VNQ monthly…

I’ll admit you were losing me a bit over the last few posts, and I thought you were going off into the land of speculation and active trading. However, this post made it worth it to get some insight into your investment decision making.

At the end of the day, I don’t have the REI mindset. It will be interesting to see where the market goes and how your strategy works out.

5 years ago

It’s definitely becoming a challenge to get the returns we could a year or two ago. With rents so high, our current plan is to renovate each unit as it becomes vacant. For example, in our 4 family, one 3bed rents for $1700 with hardwood floors and a decent kitchen/bath. On the other side of the house a 3 bed rents for $1250 with old carpet and a similar kitchen/bath. To match the rents, we could take $6k and tidy up the other unit after the lease is up. This would allow for an additional $5400/month, almost a 100% ROI.… Read more »

5 years ago
Reply to  JP


Adam @ AdamChudy.com
5 years ago

We have the same problem in Houston. Over the past 2 years prices have run up so much you can’t find properties that cash flow.

I continue to fully invest my 401k, but have a pretty good cash cushion in my brokerage and IRA.

No Nonsense Landlord
5 years ago

Real estate moves are definitely slower and more deliberate than the stock market. With RE, prices are a function of wages. The price cannot go up for too long, continuing to outpace wages. That includes rents. At some point, they have to equalize to whatever a ‘fair’ rate for the area is.

In the long run, RE is almost always a great investment.

You cannot have people making $15 an hour buying $1M homes forever…

The Professor
5 years ago

Agree with your comments on real estate. I think I’ve made this comment before to you, but where I’m from, if you put 20% down, you won’t have positive cash flow on a rental property. Everyone is betting on capital appreciation, which is frightening.