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Real Estate Investors: As Markets Roil, Keep Calm and Carry On

Expertise: Real Estate News & Commentary
13 Articles Written
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The financial markets have seen a whirlwind of activity these past several days. As news of coronavirus quarantines and speculation on trade roils the markets, I’ve heard every opinion from, “Sell everything and buy gold and canned goods,” to, “This is a tremendous buying opportunity.”

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I’m here to tell you that for real estate investors, the best thing you can do is calmly follow a disciplined approach.

I do put money to work occasionally in other assets, like stocks, options, REITs, commodities, and ETFs. However, I continue to believe that real estate is far and away the best investment in today’s climate.

Here’s why.

Real Estate Returns Trump All

Real estate has the most attractive risk-adjusted return profile.

Even with the recent pullback, the broader stock market is priced to provide dismal returns over the next decade or so, in my humble opinion.

Bonds may be even worse. You’d have to go extremely far down the risk curve into junk bonds before you could find anything approaching the yield on a real estate investment.

Not that the average person can invest in private equity, but in that space, acquisition multiples are through the roof and there is a significant amount of operating risk that just isn’t present in real estate.

Related: Real Estate vs. Stocks: Which Has Been the Better Investment Over 145 Years?

Why The Fibonacci Sequence Is Your Key To Stock Market Success

Why Real Estate Is Still a Good Investment

As absurd as cap rates have gotten in real estate—and they are absurd—our space is definitely the “cleanest dirty shirt.”

You can find good deals and create value, rather than remaining subject to the whims of market forces beyond your control.

Would you rather own a 4 percent cap high-quality apartment that has potential for growth (it may be a 6 percent cap in five years) or invest in a corporate bond that has a yield to maturity of 2.8 percent. Plus, if interest rates rise, the value of the bond will be slashed.

How about some stock in the S&P 500, with a dividend yield under 2 percent and valued at levels last seen in the dot-com era?

Despite ultra-low cap rates, a case could be made that, as long as capital markets continue to demand yield and have a risk-on mentality, cap rates could compress further.

Important Caveats

There are certainly ways for you to get your face ripped off in the real estate game. Generally, here is how to avoid that gruesome outcome.

Make no mistake, I do feel that the real estate market is frothy. I think a lot of the easy money has already been made, and good deals are hard to find. There are plenty of ways to lose money in this market.

An important but often under-appreciated point to make here is that risk preference means everything. Regardless of the fundamentals, with cap rates this low, if for any reason investors begin to put a higher risk premium on assets, cap rates can suffer. You don’t necessarily need declining rents or oversupply for this to happen.

Simply, the broader capital markets perceiving and pricing risk differently would be sufficient to impact real estate prices negatively. Deep pessimism in the stock and bond markets, or the broader economy, can spill into real estate, even if rents are on the rise and the supply-demand balance looks strong.

How to Not Lose Money in Real Estate

Moderate, Long-Term Leverage

Putting high leverage on a deal is the fastest way to lose your money. In a situation where market values are impaired and you have an otherwise appealing asset, your main risk will come when refinancing the loan.

If you start at an 80 percent LTV, it doesn’t take much in the way of rent declines or cap rate increases to put you in a position where you’ll soon be giving the keys to the bank. Resist the urge to use short-term debt at high leverage points.

Avoid Widow-Makers

A widow-maker is a real estate deal where there is a component of the deal that can completely wipe you out. An example here would be a high-cap rate, retail net lease deal. It may provide great cash flow for a few years, but if you lose the tenant, the likelihood that you can replace the rents, especially without paying through the nose for tenant improvement (TI), is very low.

This kind of deal can wipe you out. You’re counting on one event—a lease renewal—to make or break the investment.

first_commercial_property

Quality Counts

Investing in high-quality residential or commercial real estate locations with a bright future is even more important than usual right now. Any buildings that feel an outsized negative impact will be the marginal ones.

A well-located apartment building near employment centers, transportation networks, and entertainment options will likely suffer far less than their less optimal competitors.

Related: Which Real Estate Investments Provide True Passive Income & Financial Freedom?

But What About a Recession?

Before the coronavirus scare, my opinion on the matter was that the economy seemed vulnerable to a recession, but my base case was that 2020 would continue to show modest growth.

Now it looks like there is a high probability that we slip into a recession.

The question becomes, how good will the containment efforts be, and how quickly will people regain their confidence to go to work, shop, and attend events?

I’m not an epidemiologist. There seems to be conflicting projections and beliefs even among experts. The important thing is how people react and the economic decisions they make. On that front, it looks likely that an already fragile economy is going to tip into recession.

At this point, there are simply more questions than answers on that front. I certainly hope that this is short-lived.

As Always, the Economy Will Bounce Back

Recessions are a necessary component to a functioning economy to clear out malinvestment and reallocate resources to more productive uses.

I certainly don’t mean to sound flippant. Anyone who loses their job or faces tough times deserves our sympathy and help. However, if unemployment reaches the level it hit during the last recession, about nine in 10 people will have jobs. Businesses get formed in recessions. Bills get paid, and people persevere. The economy will bounce back.

This recession won’t be like the last recession—no two are the same. If you’re sitting around waiting for 2010 prices on real estate, you may be waiting a long time. On the other hand, you may be right—in which case, kudos to you. I can’t tell you how to handle your investments.

I, for one, feel confident in my ability to manage risk appropriately, use leverage wisely, and continue to grow my wealth and cash flow streams, even in a recessionary environment.

In conclusion, my advice would be don’t panic, stick to a disciplined approach, manage your risk, and continue to pursue your investment goals. Good luck out there.

Recession-Proof Real Estate book blog ad

What do you think about current activity in the financial markets?

Join the conversation in the comments below!

Phil McAlister is a Chicago-area native and real estate investor. With a career that has spanned investment banking, commercial lending, and real estate, he has extensive transaction experience fro...
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    Terry Lowe
    Replied 27 days ago
    We believe that having all our eggs in one basket can be dangerous. Luckily we have both stocks and real estate. We have a running joke about which is best.... this week, I win!
    Scott McElhaney Investor from Mount Pleasant, SC
    Replied 27 days ago
    Great article, lots of good insight. Thanks for your time spent writing Phil. Best Regards, Scott
    Mike Hawk
    Replied 27 days ago
    Im hoping for 2010 home prices in ventura county area. With 100k I could finally afford a home!
    Troy Pedigo
    Replied 26 days ago
    Grew up in Simi. Would love to own some real estate back in SoCal. I'm missing the beach really badly!
    Wenda Kennedy JD from Nikiski, Alaska
    Replied 27 days ago
    I totally agree with your article. This is my 5th business cycle in real estate and you're right. Steady, conservative decisions win the race over time. Over the years I have come under a lot of criticism for being too conservative in my real estate investments. You could of... You should of... If only... I know I'd rather sleep at night rather than worrying about how I'm going to pay a pile of mortgages on properties that are bleeding red ink. Real Estate is something that I understand, unlike the stock market. I can manage my properties and make sure that they turn a profit. I especially like the part about "Avoid Widow-Makers". Over the years, I have seen a lot of people lose everything on that one aggressive investment in their portfolio -- that is dependent on one or two national anchor tenants. They bet the farm on that one property, thinking it's their ticket to the good life. Then that lynchpin tenant fails to renew... which makes the smaller tenants fail or move away... the cash stops... the bank wants its money back... and that one asset takes the investor down. The party is over. Even the big boys go bankrupt!
    Phil McAlister Specialist from Chicago, IL
    Replied 27 days ago
    This thing is moving quickly in real time. I submitted this article a few days ago. Since then we've seen NBA, NHL, NCAA and multiple event venues cancelled or postponed. I would raise the odds of a recession pretty substantially at this point. I also think I may have erred in my assumption on how dangerous the disease is. Because this is more contagious and people can be infectious long before symptoms, I do believe this disease can be substantially more dangerous than the common flu. Wanted to update as soon as I could.
    Susan MacLaren
    Replied 27 days ago
    Thank you for updating yourself on the coronavirus based on how it - and the likelihood of a recession- are evolving. It makes your story even more compelling seeing that you have no problem coming out and telling us how your perspective has changed.
    Ed Brancheau New to Real Estate from San Diego, CA
    Replied 27 days ago
    Do you think you could update the article to reflect that? I'm checking a lot of other forum posts and I don't see people really paying attention to what happened and is happening in other countries. Parts of China were on lock-down. Then Vietnam and South Korea. Then Italy. Today it's Norway. And for the past two weeks, Seattle has been a ghost town. Look, if people are physically banned from moving, how can people even check out houses to buy? Much less fix up and sell? If people are quarantined, landlords could have much less rent coming in and they can't evict. But they will still have loans to pay back. And the medical experts are saying that this shares many commonalities that the Spanish flu had which did subside over the summer of 1918 before it came roaring back ten times worse that fall. Sure, the market was probably due for a correction but that's regular market forces. And some of this selloff is panic induced. But the majority of it logical. If people can't go to work, they can't make money. If they can't make money, they can't buy products. Which causes layoffs. And it causes a spiral so investors bail out before they lose more. I'm not talking about you but it blows my mind how many people are ignoring completely unheard of actions. Countries shut off? Travel bans from Europe? Sports owner (they greediest MFers around) talking about not having fans at games or completely postponing games? People like this don't make panic decisions.
    Edward Seid Real Estate Agent from Seattle, WA
    Replied 27 days ago
    Thanks, I was about to chime in and say our local hospitals won't have enough beds for those infected and requiring hospitalization in a few weeks if the spread worsens. Because real estate is a slow transaction industry, the effects of the stock market wont be felt in the real estate industry for a while. For me, it gives me more time to adjust my strategy for buy and holds.
    Andrew DeWeerd Rental Property Investor from Sarasota, Fl
    Replied 27 days ago
    My real curiosity will be with the flipping/retail market, opposed to the rental market. I'm putting my first flip on the market this week, and was going to look at another today... buying it at 70 of ARV is still a nice hedge, but not if we thought the retail housing space is going to weaken.
    Terry Lowe
    Replied 27 days ago
    I just heard a lot of people are canceling listings because they don’t want the virus in their homes. Like I said, my husband is the stock guy and I’m the landlord. We are not overly worried about either sector. It’s no fun watching the stock market crash, but it’s certainly not a time to sell either. Yes, we are all beginning to understand the social distancing and that is so important. We will survive all this. As usual, we just have to use our smarts! And we wish all who are sick a speedy recovery.
    Frank Boet from Miami, Fl
    Replied 27 days ago
    The Corona virus is going to impact real estate big time. The advantage of owning stocks is that one can get out of the market in a matter of a second, or actually short the stock market and profit as the market drops. It can take months to get out of a property. Many stock dividend payers are returning over 5% yield which is just slightly less than the average cap rate. I think many workers are going to lose their jobs which will impact the economy and the real estate market. Just like the stock market has dropped 20% from its all time high, the real estate market is due a big correction.
    Alan M. Rental Property Investor from San Francisco Bay Area
    Replied 27 days ago
    "It would be a shame if a bug that looks to be only slightly more dangerous and far less common than the seasonal flu caused a recession, but we should allow for the possibility for now." This is an ignorant and dangerous statement to make. But the number of "real estate is the best thing ever, this can only help" posts on this thread is downright scary. Drinking the Kool Aid is strong with this one. I own a few million in real estate investments and another few hundred k in syndication deals, but I'd still consider myself an amateur in this space. That being said, I feel like those in this thread are being WAY too optimistic and I'm not going anywhere near the industry in the near future. Maybe wrong, but here's why I'm thinking this way: First - this is going to hit every single person in the US within 1-2 years. At this point, it's not a question of IF but a question of WHEN.https://www.cbsnews.com/live-updates/coronavirus-outbreak-death-toll-infections-latest-news-updates-2020-02-25/ The goal of the quarantines, travel restrictions, school closings, WFH policies, etc. is simply to slow down the spread of the virus so as to not overwhelm our hospitals. Here's a good graphic to explain why this would be a problem: Every sick person is expected to infected 2-3 additional people. That's exponential "community" spreading and means that once it's out like it is, it'll be impossible to keep it from spreading everywhere. We can try cutting back on travel, WFH, and school closings but it's far too communicable to shut down the spread. The analogies to the common flu are completely naive at best - the common flu doesn't spread nearly as easily and has a mortality rate of about 1/4 of this virus (more on that later). The only reason there aren't more cases in the US is that we have tested far fewer people. We have tested 5 people per million of population. That's 80x fewer people per million than Israel, 160x fewer people per million than Italy, and 720x fewer people per million than South Korea. There are far more cases of Covid 19 here than we know and the rate of infection will continue to double every week for the foreseeable future. Schools are closing, businesses are WFH, airline bookings are down 70%. 2 weeks for school closing is fine, but this won't stop in 2 weeks. 2 weeks is just what we know about now. I doubt Seattle downtown opens in the next 3 months. All the businesses in Amazonia in South Lake Union are going to bleed red with no one coming into work. Many will go under. Short term rentals? How long can someone float their mortgage with bookings reduced by 70%? How skinny have the margins on those short term rentals gotten as more and more people got into that space? Good luck refinancing to lower your rate when you can't get your place booked at anything close to the going rate. Hourly workers will be let go. Open positions won't be filled. Then it'll move to the businesses that support those industries most affected. This will trickle to all part of the economy. Yes, some parts will prosper (it's a good time to own stock in hand sanitizer companies!) but reduced spending, reduced consumer confidence, lower profits, reduced wealth effect - these will all have impacts on the economy. This will be slow, until it's not - and then it will be fast and long. Also, if the infectivity rates and mortality rates are what they look like, this will kill a few million people in the US. A FEW MILLION PEOPLE. Furthermore, this hit the elderly much harder while cases in children are much less fatal. An older population passing away affects far more than if this was concentrated with children. Older people own homes, have money, spend money. The mortality rate for those 60 and older is 10%. There are 47 million elderly Americans. Even if the mortality rate is only 1%, that's 470,000 elderly Americans that this disease will claim. If it's 10% (God forbid), that's 4.7 million people, and that's just the elderly. For comparison, 405,000 Americans died fighting in WWII. That's going to completely decimate housing stocks in retirement areas like Florida, Palm Springs, Phoenix, etc. Yes, younger people will back fill the vacant homes, but the trickle down effect will mean this will ease demand for housing, lowering prices, lowering rents, etc. Why? The population growth rate is already lower than it has been in 50 years. https://www.nytimes.com/2019/12/30/us/usa-population-growth-decline-census.html. With immigration down, birth rates down, and a virus that might kill 1% of the population, we're looking at an inevitable population decline. Population decline, especially among housing-aged populations, means demand for housing will inevitably drop. Just like when population growth is going like gang busters, housing and rents go up. When populations decline, housing doesn't do well (see Japan's housing crisis https://www.standard.co.uk/news/world/japan-is-giving-away-homes-in-bid-to-tackle-countrys-unique-housing-crisis-a4010601.html) Again, I'm presuming that the experts are right and that 1) everyone gets this in 1-2 years, 2) the mortality rates stay consistent 3) the government isn't able to mitigate the effects completely. I could be wrong, I hope I'm wrong, and would love to hear how I'm wrong.
    NJ Ram
    Replied 27 days ago
    I agree that it will hit the elderly harder than the rest of the population. But nature has a way of balancing out, and housing will bounce back to normal pricing ranges. No question it will affect all of us... as humans have done after numerous other disasters in our history
    Phil McAlister Specialist from Chicago, IL
    Replied 27 days ago
    I agree with a lot of what you said. Especially on the way that the disease is likely to spread. I assumed that the headlines on the disease were true, but they aren't. I'm working on getting an edit into the post. It takes several days from when I submit a post for it to hit the website. In that time frame a whole lot has changed. I think recession probability is quite high at this point.
    Sean Wallace
    Replied 27 days ago
    Good for you for working to answer comments and revise the article rather than trying to defend old comments made when we had limited data. #respect.
    Christopher Smith Investor from brentwood, california
    Replied 27 days ago
    Is the statement really ignorant and dangerous? I'm certainly no fortune teller so won't opine on something outside of my. expertise, but I spoke with a person who just today that has two daughters that are both MD's one Harvard one Stanford and they are saying exactly the same thing. I guess they could also be ignorant and dangerous, I guess only time will tell.
    Nathan G. Real Estate Broker from Cody, WY
    Replied 27 days ago
    It is not ignorant and stupid. The swine flu had I er 1 million known infections in the USA two months before Obama declared an emergency. This round is a major exaggeration resulting is mass panic. Will it affect the economy? Yes. But it will affect the economy because of fear, not science.
    Jon Muldoon from Berlin, Massachusetts
    Replied 27 days ago
    I just responded to this in another thread: The comparison to the swine flu well optimistic, is not accurate. Swine flu had an R0 (essential calculation for how easily the disease spreads) 1.4 and 1.6. The coronavirus is about 2.2. For comparison, the Spanish flu was estimated between 1.8 and 2.6. Meaning, the coronavirus is more contagious the the Swine flu. Some other math: Swine Flu hospitalization rate: 300,000/60,000,000=.5% Coronavirus hospitalization rate: 15% with 5% in ICU (https://www.statnews.com/2020/03/10/simple-math-alarming-answers-covid-19/) Because the hospitalization rate is so high, hospitals will likely become overwhelmed leading to a higher death rate. Speaking of... Swine Flu Death Rate: 18,000/60,000,000= .03% (the flu is about to be .1%) Coronavirus death rate: 3.4% with the gigantic caveat that many cases are asymptomatic creating the illusion of a higher death rate. There are estimates the actual death rate will settle around 1%. This is not my opinion. It is the math. However, these numbers can change with effective management (which the US has not had). If you were looking for something optimistic, we should follow South Korea and Singapore's example which can be read here: https://www.cnn.com/2020/03/09/asia/south-korea-coronavirus-intl-hnk/index.html and https://www.mprnews.org/story/2020/03/12/npr-singapore-wins-praise-for-its-covid-19-strategy-the-u-s-does-not And the Obama thing making the rounds is false: https://www.snopes.com/fact-check/obama-wait-swine-flu-n1h1/
    Jenna Cavadas Realtor from Belmar, NJ
    Replied 27 days ago
    Agree with everything you said Alan M and couldn't have explained it better - thanks for backing your comments with facts - which are all true, unfortunately. Thanks for sharing and everyone should take this seriously because the facts are clear and the US is seriously behind in responding. Even if we are wrong, which I would love for that to be the case, the US should still be responding faster and more efficiently than we are in order to get ahead of it. Be safe everyone.
    NJ Ram
    Replied 27 days ago
    I think the real danger is a spiral effect - it affects not just the stock market but also jobs, and if tenants lose their jobs, they will stop paying rent for us investors. So don't panic but all of us may need to cut rents to give affected tenants a break to get over the hump. Tough when you are overleveraged which is why you should always have capex/emergency funds for each rental
    Ron Pfeifer
    Replied 27 days ago
    Overall a good article. I did find the capitalization example seriously flawed
    Todd Goedeke from Sheboygan, Wisconsin
    Replied 27 days ago
    With all due respect the author is not a doctor or health expert. For him to say the corona virus is more dangerous than past flu outbreaks is completely unsubstantiated, disagreed upon widely by leading doctors and only contributes to ongoing hysteria.
    Bill Thoreson from Woodinville, Washington
    Replied 26 days ago
    Good article Phil, let's be careful not to overreact either as the news media would love to perpetuate any bad news for all it's worth. Spread the good news, nearly 70,000 people infected with the virus have already recovered. https://thehill.com/changing-america/well-being/prevention-cures/487280-nearly-70000-people-have-recovered-from
    John Murray from Portland, Oregon
    Replied 26 days ago
    I survived the measles, rubella, chicken pox, mumps and a verity of 200 colds or so (the real diseases). Perhaps many cases of flu. During the 1st swine flue epidemic ( Gerald Ford Administration) I was in the army and the inoculation made my entire company sick, not the disease (thanks CDC). I was inoculated for polio, thanks Mom and Dad! This Corona Virus is a political hammer that is being used for political gain. The strong will survive and there are over 7 billion of us to testify to that fact. I think I lost hundreds of thousands this week but still have my health and millions. Don't buy into the hype.
    Vaughn K. from Seattle, WA
    Replied 24 days ago
    I think you and a lot of other people are mistaking "This is going to be a major problem in the short to mid term." for "OMG!!! IT'S THE END OF THE WORLD!!! WE'RE ALL GOING TO DIE!!!" Nobody I know of is saying it's the end of the world... Because it's not. But millions of people more than average dying in a short span of time is indeed "a thing." It is not nothing. And if we get swamped quickly, which it is looking like we will be, then even younger people may die at far higher rates than needed because hospitals have run out of fancy 21st century medical equipment that could have saved their lives. I say this as somebody who is sick with Covid-19 symptoms, under isolation orders in Seattle AS I TYPE THIS. I'm fine. But if I have this stuff, I may well have passed it to an earlier person who will die now because of it. That person might have lived, and worked, another 10-20 years had this thing not come around. Not the end of the world, but potentially a big, fat, mess.
    Phil McAlister Specialist from Chicago, IL
    Replied 23 days ago
    Well said
    David Abbate
    Replied 24 days ago
    Ya, just put your head in the sand. This is Real Estate. It never goes down.
    Phil McAlister Specialist from Chicago, IL
    Replied 23 days ago
    If that's the takeaway you got from the article, I'd suggest re-reading it.