Believe it or not, real estate is cyclical. It ebbs and flows, usually affected by the general economy. So, it’s not a question of if but when for us. The future is not exactly like the past, but it usually has rhythms.
No one can answer that question, though there can be hints at times. You won’t fear it if you are ready for a slowdown. Take steps to mitigate the risk of a potential downturn. Be Conservative in the Amount of Debt You Take on
First, be conservative with the amount of debt you take out on properties and always try to buy on a better basis than the market (actually buy good deals). The reason is that you want to be able to absorb about a 25-30% hit and still break even. This could result from rent decreases, vacancies, or sudden increases in expenses. Something catastrophic would have to happen nationwide for that even to come close. The other bonus is that if you do lower LTV(Loan-to-Value) loans, you can get better loan terms like more extended interest-only periods.
It is crucial to complement the above, have substantial reserves, and add to them over time. It’s ideal to keep a minimum of 2,000 per unit in reserve. Have some room in your CAPEX budget that will be left for additional reserves. On top of that, monthly, leave some money aside. If you are doing well on the property, keep even more aside for later surprises. So even if you need to come out of pocket some months, you have plenty to back you up.
When modeling deals, do not take a refinance into account. You can’t forecast the market and do not know what debt terms will look like in 3-5 years. Interest rates could change drastically, as could other terms like no interest-only periods. So, if the market takes a hit, you aren’t relying on a refinance at a certain point to hit our numbers.
Location Continues to be Critical
Location is critical. It’s essential to be in the best submarkets close to economic drivers. It’s worth paying a little extra for those locations today. If the market takes a hit, the better areas stay filled.
Have conservative underwriting. Always keep yearly rent increases to market averages or below.
So, we keep a steady hand and wait for the right opportunities. With enough digging and persistence, they pop up.
You Need to be Less Susceptible to Market Fluctuations
A long-term approach to this business makes you less susceptible to swings. You can hold longer-term through the cycle where fluctuations in values in the short term won’t matter. Usually, the only time to sell is to buy something newer in a well-timed 1031.
Lastly, it is necessary to keep operations in tip-top shape. Even though things are going well, always find ways to improve and do things better. The ones that take asset management seriously and the day-to-day will shine when shit hits the fan. You won’t fear the inevitable if you protect your downside. Ultimately, some recessions have always brought more opportunities that you can strategically position yourself to take advantage of.