By Tim Houghten
It’s inevitable. A market correction is coming. The market has been on a high for years now. In 2018 alone, the Dow Jones Industrial Average broke a record high 15 times. If history has taught us anything, it’s that the market cannot sustain those highs for that long without a correction. Real estate markets across the country are still very hot. Even with the “cooling” that some markets are seeing, real estate prices are still well above records and competition is hot. “A cool-down has been predicted for over in a year in our local market. However, I’ve yet to see it. Sure there are some longer list times for sellers but properties are still selling in record time over asking price. It’s still a hot market,” says Eric Jones, Director of Sales and Marketing for Freedom Real Estate Group.
With all that being said, the question on every wise investor’s mind: how can I prepare myself for the next recession? The short answer, diversify. The long answer, diversify into buy and hold, long-term strategies.
“The short-game (fix and flip) is good. It’s instant return. But you get hit hard by the tax man. Buy and hold has some of the best tax advantages of any asset class,” Jones stated. “Depreciation, property taxes, mortgage insurance and more are all deductible expenses. Plus, with fix and flips, it’s simply not a long-term strategy. It’s not a way to build true wealth.”
To lessen the risk of any big swing in the market, the answer is to diversify your investment portfolio so all your eggs aren’t in one basket. The problem many individuals faced in 2008 was that most of their 401k or other retirement accounts were tied up in stocks and mutual funds. When the market tanked, so did their accounts. Now imagine if half of those funds were diversified into buy and hold real estate. For many, the outcome could have been vastly different. Here’s why.
The key to cash flowing, rental properties is that even during a down economy, they’re still cash flowing at the same amount. In some cases, even higher. Let’s look at it this way. If you were getting an 8% return on your stock investments, and the market crashes, you’re likely going to be reduced to 2%-4% if you are lucky. With rental properties, the rent amount stays the same. Your mortgage stays the same. Your property management fees, if you have them, stay the same. Essentially, if you were getting 8% returns on your property before, you’re still getting that. In a down economy, rents rarely go down. You may not be able to get rent increases during that time, but you will at least have a steady, consistent amount of cash coming in each month.
Rental properties tend to weather a down market in a consistent or even appreciating way. Not necessarily appreciating in value of the asset but appreciating in terms of cash flow being received. In a bad economy, a few things are happening. People simply aren’t buying homes. Credit is tighter. People are scared. The pocketbook is squeezed. Instead of purchasing, individuals and small families tend to continue renting during a recession. In addition, those that may be losing their homes to a foreclosure turn to single-family or duplex style rentals since it’s more private and familiar than a large apartment complex. Therefore, demand may actually increase in a down market which is a huge win for rental property owners.
With all that being said, a down market is definitely not the time to sell your rental properties. It’s a buy and hold strategy. During a down market, it is always best to hold these properties unless there is some absolute reason you must sell. When the market begins to climb again, then you may want to consider selling to upgrade to another investment property in a better neighborhood or better yet, purchase two and double your cash flow.
The best part of investing in rental properties is investors are wealth building while cash flowing. Very few investments offer this kind of opportunity. With a buy and hold strategy, you are receiving the benefit of monthly cash flow while also building a portfolio of tangible assets that will always – no matter the market – have value. “If you have the right plan, with a decent amount to invest, you can quickly scale up to a very healthy portfolio. We worked with a dentist who had $400k to invest and wanted to receive $10,000 a month in cash flow so he could retire. We built a plan and got him to his goal in three and a half years. He was able to retire early. However, not only did he keep receiving the cash flow each month, now he has tangible assets that he can sell off if he ever needed to and can pass on to his children and grandchildren,” Dani Lynn Robison, Co-Founder of Freedom Real Estate Group stated.
Something else to consider is how you are using the power of inflation to your advantage. Most 401k plans aren’t able to keep up with inflation. With the small returns and high managements fees, unless you are able to invest a lot in those funds, you may not even be able to keep up with the rate of inflation. However, with rental property, you are working with inflation to win in two ways. First, your mortgage payment doesn’t change. Let’s say when you purchased the property it was a $500 per month payment. If the market tanks, it’s still a $500 payment on a fixed rate loan. If the market is great, same payment. When the market is doing well, your asset, if all goes as planned, is increasing in value. You’re actually earning value on the asset while effectively reducing the value of the money you’re paying due to inflation. Second, you will likely be able to increase the rental amount between 1%-5% per year. That’s additional cash flow and value you will be receiving yearly.
Finally, it’s important to note that this is an investment and with any investment, there is inherent risk. No investment is guaranteed. However, real estate is one of the most proven, asset-based investment classes in history. Most millionaires were either made through investing in real estate or find large value in investing in real estate. As you explore this investment opportunity, look for markets that do not have super highs or super lows in market crashes (like 2008). States affected greatly were Florida, California and Arizona. One of the cities most notorious for being hit hard in the crash was Las Vegas. These may be markets to steer clear of. If a market crash occurs again, it may cause migration out of those areas resulting in rent losses. “Consider markets that may seem ‘boring’ like many in the Midwest including our market – Cincinnati and Dayton, Ohio. These have proven to weather a down economy and not have big drops in real estate values or population. These are the markets where you truly win.” Eric said.
Diversification is the key to weathering a down turn in the market. More specifically, investing in buy and hold rental properties not only is a proven strategy to survive and even thrive in a down market, but one that holds many positive attributes such as consistent cash flow, numerous tax benefits, and true wealth building.