Weathering A Real Estate Storm

During a real estate downturn, the key to success is risk management. Many financial indicators are showing that the real estate market is turning south. The next downturn will hopefully not be as bad as what occurred in 2008, but it is always wise to prepare for the worst.  

One of the hallmarks of the previous downturn was that many investors leveraged themselves to the point of being overextended. Then when the market turned down, they found themselves in a very vulnerable financial position. Rehabbers often wound up stuck with properties they couldn’t sell (for lack of buyers). Flippers were afraid to make offers because they didn’t know if the prices were going to keep dropping over time.  

This doesn’t mean you should stop doing what you like to do best.  What this is about is reducing risk as much as possible, while still engaging the market as an active investor. Here are some ideas on how to weather the storm during a downturn in the market.  

Buy Lower Loan To Value

It is important to try to buy at lower LTVs (loan to value) in uncertain and down trending markets.  You will have to market to find owners that are motivated, somewhat distressed and willing to be flexible.  Lower LTVs mean that you are offsetting the risk that comes with higher LTVs. 

Save Your Cash

Try to minimize the amount of your cash you have in a deal and increase the use of OPM (other people’s money). OPM can include getting private loans or buying “subject to” or getting the owner to seller finance.   

Owner Finance

You may want to convert some of your rental properties to an owner finance installment sale.  This will lower your tax burden via an installment sale. You want to get a good-sized down payment to start.  You are essentially acting as the bank. Advantages of taking back a note via seller financing include limiting your tax liability since only pay on the amount collected that year like payments and the down-payment.  Another advantage of owner financing is being able to get a higher selling price.  By making it easier for buyers to purchase a property via seller financing, this can serve to increase the pool of available buyers, which in turn can result in a higher overall selling price for the property.  

Deleverage

During normal times, it is wise to leverage as much as you can to maximize returns. However, when the market starts heading south in your area, you might want to give serious consideration to reducing investment-related debt. Maybe pay down the smaller loans especially the higher rate loans or ones that have adjustable-rate payments.  Deleveraging can include selling off assets for cash or bringing in an equity partner to pay off any debt.