Many experts believe a major economic downturn is just around the corner. Whether you are a new real estate investor or a seasoned one, here are the six things you should be doing to prepare for the next major downturn.
[This article was originally published on September 6, 2018. Yes, that’s nearly 5 years ago! A lot has happened since then, but the one thing that hasn’t happened is a major downturn like everyone predicted.]
It’s been 15 years since the last major downturn (The Great Recession of 2007).
It’s been so long, most real estate investors today have never experienced what it’s like to invest through a major economic downturn.
They’ve only experienced the market going up. So anyone investing in the last decade could have made money without any real knowledge or skills.
Kenji has been investing in real estate since 2001 so by the time 2008 rolled around, he wasn’t dabbling in real estate, he was neck deep in it.
He learned a lot of lessons, many of which he’s sharing with you in this article.
The bottom line is, if you are feeling really good about your success as a real estate investor, you might be in for a nasty surprise when the next big one comes.
You may start questioning everything, “why me?” “what happened?” “how did things go so wrong?” “how do I get out of this mess?”
However, it doesn’t have to be this way. There may be some things you can do to prepare for the next major downturn. Maybe you can even thrive and take a big step-up in wealth by taking advantage of properties at steeply discounted prices.
Maybe you can be like the investor who was quoted as saying that his biggest regret was not liquidating his entire 401k (he liquidated only part of it) and putting that money towards buying more real estate.
These same experienced investors say that the best defense against a future recession is to be prepared. With that, let’s jump into what we believe are the six things real estate investors, both new and seasoned, should be doing to prepare for the downturn.
1. Continue buying but don’t compromise on your criteria
Most experienced investors know that you shouldn’t “wait to buy real estate.” In other words, don’t try to time the market unless you are a gambler or a speculator (and please recognize that this isn’t investing!).
Good investors buy properties according to well defined criteria. So it doesn’t really matter if the market is going up, down or sideways, true investors generally don’t get into trouble because they never compromise on their criteria.
It’s true that deals will be harder to come by in an overheated economy, however, they are out there if you know how to find them.
Using this system, you can learn how to buy great deals in any market. Again, it’s not about timing the market, it’s about learning how to buy great deals even when the market is hot or cold.
If you are a new investor, consider using this time to learn and gain experience by buying your first investment property. The first property is infinitely harder to buy than the second because you have to overcome the fear of investing and the learning curve is so steep.
If you have that first property under your belt, you’ll be primed to take advantage of the steeply discounted prices rather than stumbling through your first purchase or, even worse, failing to act because you are paralyzed by fear.
2. Generate deal flow by building your network AND your reputation
This is not just about assembling the team (e.g., investor-focused real estate agents, wholesalers) to bring you deals, this one is about getting to the top of their list.
At the end of the day, your agent and wholesaler have a choice of who to call when they have a great deal.
Will they choose the person who doesn’t respond immediately, who is difficult to work with or who frequently bails on deals? Probably not. So think about how you are going to get to the top of the list and start building your reputation by being that person now.
We help members of our private community get to the top of an agent’s list by connecting them to our closed network of investor agents. Because it’s closed to the public and because the members of our community are well trained, the agents are much more likely to put them at the top of their list. You can only gain access to our network of agents by taking one of our real estate courses.
You should also consider building your network in several markets. Why limit yourself to one market? It’s difficult to predict how the recession will affect one city versus another, so to ensure that you have access to the best deals and markets, you’ll want to expand your options and build relationships with people in several markets. Our private community of investors mentioned above allows us to easily tap into multiple markets.
3. Build a stash of cash or another way to access funds immediately
This is a good time to focus on building up your savings or “dry powder,” as our one of our mentors describes it. Consider holding off on any major purchases such as a new car or an expensive home.
And wherever you decide to put saved money, be sure that the money is liquid and immediately accessible.
In addition to saving, you can also create mechanisms to tap into existing assets.
One potential asset you can tap is the equity in your home. In order to do this, you’ll have to find a lender who will give you a home equity line of credit (HELOC). HELOCs are great because you don’t have to pay any interest until you take the money out.
Other assets you can potentially tap are your stock portfolio, whole life insurance policy or your 401(k). You can usually set up a loan or line of credit from these assets, but the key is to have the conversations now.
Most people don’t know that during a downturn, many of these funding sources dry up. The fear that exists during a downturn spreads throughout the banking system and the economy. So it’s infinitely more difficult to set these sources of funding up once the downturn begins.
4. Form a banking relationship or two with a community bank or a credit union
This is the time to spread your money around among different banks and develop relationships, because if you want to borrow money for a future investment, it’ll be so much easier to qualify for the loan if you have a relationship of at least one year or more with that bank.
One of the best places to build a relationship is with an investor-friendly local community bank or a credit union, rather than a national chain.
Choose a bank that has a track record of working with real estate investors, so you know that they can think creatively when putting together financing.
Depositing money is a good way to start forming a relationship. However, there’s no better way to deepen that relationship than by doing a deal or two. Just like your first purchase, if you do a deal with a bank, it’s much easier to qualify for future loans.
The relationship we built with our local community bank led to them funding the purchase of our 160-unit multifamily property.
5. Invest in your properties
This is the time to shore up your existing properties, more specifically, work on maximizing the cashflow from these properties.
I recently reviewed our portfolio and found that two of our properties hadn’t had a rent increase in a couple of years. They were good tenants and we didn’t hear a peep from them, so it just slipped through the cracks.
It’s better to get these rent increases in before the economy tanks. Imagine asking for a rent increase in the middle of a major recession or worse, a depression!
While we talked about saving your money above, you may want to use some of that money to invest in your existing properties. Note that the key term here is “invest” in your property. This means that any money you put into the property should generate a return – either in higher rents or decreased costs.
For example, let’s say you want to add a bedroom to one of your properties and it costs you $5,000 to do so. Before you spend the money, you’ll want to be sure that the additional bedroom gives you a higher return on investment on that property. This ensures that the money you invest in the bedroom generates the same or better return than the whole property.
The other reason you want to invest in your properties is to ensure that they can weather the recession. Keep in mind that your property could sit empty or you might be forced to give rent concessions or lower the rent during a major recession. This could make your rental go from a positive return to a negative one.
The idea here is to make your property the best on the block, so it will continue to be rented in any market. Remember that if you have Real Estate Professional Status or you take advantage of the Short-Term Rental Tax Loophole you’ll also get a significant portion of the money you invest in your properties back in the form of a tax refund.
6. Optimize your portfolio by unloading the “outliers”
While prices have dipped recently, when you look historically, prices are at an all time high. So this might be a good time to sell some of the “outlier” properties in your portfolio.
Outlier properties can be on either end – those that aren’t performing as well as you expected or properties that have appreciated far above average.
In either case, you’ll want to use a 1031 tax-deferred exchange when you sell so that you can defer taxes.
The downside of selling in a hot market is that it’s more difficult to find good deals to replace the property you sell, and the 1031 rules only give you a small window of time (45 days) to find replacement properties.
We just went through this process and were fortunate to find two replacement properties that met our criteria. This allowed us to optimize our portfolio by taking advantage of a property that appreciated rapidly in a strong market. Not only that, the replacement property generates significantly more cashflow than the properties we sold.
The upside of selling before a downturn is that once a downturn starts, it’s going to be too late. If the next “big one” is anything like the 2007 downturn, property prices may drop and not recover for 7 to 8 years. So you will have missed your window to sell.
As always, we’d love to hear your comments and questions. How many of these “six things” are you doing to prepare for the downturn? What other things are you doing to prepare for the downturn?