Is The Real Estate Market About To Crash?

There is a lot going on in the world right now that is creating a tremendous amount of uncertainty in the investment world.  The US stock market has been a roller coaster ride with huge daily swings and a precipitous plummet from record highs to bear territory in a matter of weeks.  With fears swirling around the worldwide COVID-19 virus, economic uncertainty, and political instability, many people are wondering when the real estate market will follow in a crash and burn similar to 2008.  These are legitimate concerns and not even the experts can agree what the future of real estate looks like.  As a real estate investor with a sizable portion of my nest egg tied up in residential rental properties, I have spent some time analyzing my risks and making sure that I have followed the rules to mitigate risk.  Since a lot of people have been asking me what I think about the risk and if they should stay away from real estate investments right now, I thought it would be a good time to highlight some of the rules that I pay close attention to in order to minimize my chance of losing big.  I think that we can all agree that real estate is cyclical just like most investments and there will be a downturn, possibly significant, in the future.  That doesn't have to be all doom and gloom if you are prepared for this and can use it as a buying opportunity.  Every downturn in history has eventually changed course and headed back up to new highs that exceeded where we were before the drop.  The key to staying out of trouble is to be able to ride out those downturns, or even benefit from them, so that you are still in the game when things get better.  I can't take credit for coming up with these rules, but I strictly model my investment strategies after them in order to keep myself and my investors out of the red.

1. Purchase for Cash Flow - This means that we are putting money in the bank every month because the amount we bring in from rents exceeds the amount we put out for all expenses and reserves.  The reason that this is so important is that it allows us to hold on to a property and continue to pay all of the expenses out of the property income without reaching in to our own pockets or having to borrow to pay expenses if times get rough.  
2. Secure Long Term Debt - By having a loan(s) term that is longer than the business plan allows some flexibility if the market is not performing as expected.  What we don't want is to be forced into a balloon payment or refinance if the value of the property is temporarily down or borrowing rates are extremely high.  
3. Maintain Adequate Capital Reserves - No matter how well we plan, unexpected things always happen.  Maintaining adequate liquid reserves smooths out these surprises because we can pay for them without going back to our investors to raise more capital or risk losing the property.
4. Underwrite Conservatively and Stress Test - It all starts with conservative underwriting and stress testing at the time of purchase.  We don't assume that everything will be fully occupied and all roses for the duration of our hold period.  We include vacancies, bad debt, capital expenditures, etc. in our underwriting to determine how much we are willing to pay for a property and how much debt is safe to take on.  We also stress test by calculating how bad things can get before we go into a negative cash flow situation and then look at how realistic it is that it could happen.
5. Don't Pay Retail - This is a function of the conservative underwriting that I talk about in point #4.  A brokers job is to get the seller the maximum price that they can so they generally list properties at a price that is based off best case scenario operations.  We have to dig into those numbers and apply our experience and market knowledge to determine what the property is really worth to us based on our business plan.  

By following these five rules, we are confident that we can survive and provide excellent returns to our investors throughout the ups and downs of the overall real estate market.  We aren't going to base our plan on "market timing" or speculation on pure market appreciation.  If times get a little rougher, we may have to delay a sale, refinance, or major rehab project but we are going to preserve our investors capital and avoid the whip saw fluctuations of the equities markets.

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