Coronavirus Updates

Caught Off-Guard by COVID-19? Prepare Yourself for the Next Black Swan—Here’s How

Expertise: Mortgages & Creative Financing, Personal Development, Landlording & Rental Properties, Personal Finance, Real Estate News & Commentary, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management, Commercial Real Estate
175 Articles Written
Black swan swimming

A black swan is an event that is so far outside of the norm that it cannot be reasonably anticipated by markets and investors. I think it’s fair to characterize the COVID-19 pandemic as such an event.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

I have my thoughts on what the outcomes may be, but I need more data on the ground before I consider approaching any prognosticating. For now, let’s say that while the type and timing of a black swan event cannot be anticipated, the notion of such an event occurring at some point in the future can certainly be rationalized and should be prepared for.

In other words, while we do not know what black swan will emerge, where, or when, we can assume that it will happen, and we should make an effort to be prepared.

In today’s article, I’d like to address what it means to be prepared for a black swan event.

How to Prepare for Unforeseen Events as a Real Estate Investor

Realistically, there are many moving parts to this, but at the bottom of this pile is a cold, hard reality that everything comes down to a super simple acronym—LLBP.

Preparedness for a black swan event includes three hurdles:

  • L (Liquidity): This helps you survive the black swan.
  • L (Location): This helps you recover from the black swan.
  • BP (Business Plan): This helps you protect from the downside and achieve long-term prosperity.

I’m not sure how everyone else tackles this, but I’ll share with you what my team and I do for each and every acquisition so as to prepare us to survive, recover, and prosper following a black swan event.

Why The Fibonacci Sequence Is Your Key To Stock Market Success

Liquidity—Immediate Survival

9 Months of Debt Service Reserve

Automatic to our underwriting model is a nine-month debt service reserve. Important to note here is the fact that most of the time, the lender requires some amount of reserve. However, up until a month ago, lenders were happy with one to three months’ worth of reserve.

From what I’m hearing, Fannie Mae is now requiring up to 18 months of debt service reserve for the deals in the pipeline to offset the risk of the eviction moratorium, with an average requirement of 12 months.

This new requirement was one of the primary reasons deals have fallen out of escrow in the last week.

Say you were a syndicator prepared to escrow two months of debt service, and the lender just changed their terms—you now have to escrow 12 months of debt service. Even if you could raise more money in time to close, your projections for returns took an insurmountable hit. Many had to walk away from deals.

An interesting side note on this situation is that because my company always has nine months of debt service in reserves, we are taking a minimal hit to our underwriting. This helps us be competitive in a market where 75 percent of buyers have been sidelined.

General Reserve

In addition to the debt service reserve, automatic to our underwriting is a $1,000 per unit general reserve.

Construction Floats

On larger repositioning projects with more moving parts, we also like an additional construction float. This is also liquid, and if the black swan necessitates adjusting our construction plans to tap this liquidity, we have this bullet in the chamber.

To give you a sense of these numbers, our last acquisition of Sun Crest Apartments required a total equity raise of $4.2 million. The reserve items I mentioned above totaled almost $600,000, while the debt service on the deal is under $40,000 per month.

Some other reserves we typically have included:

  • Replacement dollars for 25-50 percent of the HVAC units, depending on the DD.
  • Replacement dollars for 25-35 percent of the hot water heaters, depending on the DD.
  • Plumbing reserve of $50,000-$200,000, depending on the DD and mechanical layout.
  • Cost overruns for all of the CapEx projects.

Perspective on Liquidity—It’s Not Easy

There are a couple of points here, one of which is something you’d expect, while the other may be quite surprising.


As you would expect, all of these reserves are certainly a strain on the underwriting, which frankly, is the reason so many syndicators are quick to drop the reserves in order to prop up the forecasted returns. Lots—and I mean lots—of value-add is necessary in order to accommodate such reserves. But you knew that.

Something surprising, on the other hand, is how often I get pushback from investors for insisting on this level of the reserve. Specifically, new investors who haven’t had experience with us complain that having this much equity sit idle impacts investment returns too much.

Sam and I typically report to our partners on a monthly basis, but since the outbreak of COVID-19, we’ve sent out weekly updates.

I haven’t heard anyone complain about the excessive reserves lately—go figure.

Ladies and gents, I don’t sleep very well in general. This is because I am an old neurotic Jew who worries about everything. But, I take some comfort from knowing that all of our assets carry “too much idle equity which negatively impacts projections of return…”

Related: The Essential Importance of Cash Reserves in a Crisis

Location—Short-Term Recovery

CBRE’s most recent Weekly Market Update projects the following for multifamily:

  • The average vacancy in Q4 to rise from 4.1 percent to 5.7 percent.
  • The sharpest drop in rents is forecast in Q3 at 3.4 percent.
  • Early-stage new construction has stalled.
  • Rent increases are currently 0 percent.

The reality right now is that the economy is taking a hit, and the only questions are how bad and for how long. Where liquidity facilitates our staying power for the duration of the downturn, your location likely has more to do with how long it takes you to recover.

Let’s not overcomplicate things—all of this is rather logical. There is reason to think that a city that was growing its employment base by 3 percent per year prior to the pandemic is likely to recover sooner than a city that was growing its employment base by 1 percent.

Similarly, if rents take a hit as an outcome of the pandemic, a city that was growing rents at 8.5 percent prior to the downturn is more likely to return to positive rent growth sooner than a city where rents grew by 2 percent.

WhiteHaven invests in Phoenix. Below are some stats for Phoenix MSA, according to Colliers International:

  • MSA Population: 5 million
  • Population Growth: County has been the No. 1 growth county in the U.S. for three years running. Phoenix is the fastest growing city. Population expected to double in 10 years.
  • Job Growth: 3.2 percent, which places Phoenix in the top five employment markets
  • Rent Growth: 9 percent year over year
  • Occupancy Rates: 95.2 percent
  • Average Rent: $1,185
  • Inventory Under Construction: 16,200. According to the report, “Despite sustained new construction, Phoenix’s apartment deficit is still expected to hit 32,000 by 2020/2021.”

There are more unknowns than knowns at the moment, but I feel pretty good about our chances of recovery at a faster pace than many other municipalities. So much so that we are aggressively making offers while so many buyers are sidelined!

Related: How to Reduce Vacancy During an Economic Downturn

Business Plan—Long-Term Competitive Advantage

The purpose of a business plan is to drive risk-adjusted returns. In order to do this, the business plan needs to synergize (a) that which will drive growth, with (b) that which will minimize risk exposure.

The thing to understand here is that in times of economic downturn, there is always a flight to quality. This is true in any market. As this relates to multifamily properties, when rents deflate and concessions escalate, tenants find themselves able to afford to scale up on the quality of their apartment.

So, when Class A begins to take a hit and starts discounting rents, this results in two things. First, those tenants who could only afford Class B yesterday, now all of a sudden can afford Class A, and they relocate. And, secondly, this competition from Class A in-turn forces Class B to discount their rents as well in an effort to keep occupancy up, which forces Class C to discount theirs, etc. It’s a race to the bottom.

So, how do we address that in the business plan?

Value-add for so many apartment syndicators has become something I call “lipstick on a pig,” consisting of painting the cabinets, refinishing the countertops, flooring, paint, and fixtures. In total, costing anywhere from $4,500 to $6,000.

We made the decision early on to go well beyond that. We replace cabinets, install granite countertops, install washers and dryers, build new offices and gyms, etc. We can only afford to do this because we focus on extreme value-add repositioning opportunities, where we can pencil lifting rents by $200-$400 per month. But the end result is that we end up owning uncommon quality rentals in the submarket. In fact, when our Class-C tenants go looking at Class B because they think it'll be nicer, they realize that it's not.

So, our business plan facilitates higher rents than the competition because our product is something no one else is offering. But, even more importantly, our business model essentially creates a subclass of property. These are Class-C transitional locations but Class-B units with Class-A finishing surfaces, which serves as sort of an insurance policy for the downturn when there is a flight to quality.

It is now too late to prepare for this black swan—it’s already here. But, if this helps any of you in the future, remember LLBP—liquidity, location, business plan.

Blog ad for Wealth magazine

How are you preparing to weather the financial storm caused by the COVID-19 pandemic?

Join the conversation in the comments below.

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the BiggerPockets Podcast. He was also featured on the cover of REI Wealth Monthly and is a public speaker at events across the country. Ben is the creator of Cash Flow Freedom University, the author of House Hacking, and a noted Multifamily Underwriting coach. Through his company, Source Capital LLC, Ben currently operates $40M of multifamily real estate. Learn more about him at
    Nicholas Lohr Investor from San Francisco, CA
    Replied 10 months ago
    Hey Ben, With you being in Phoenix, do you do any planning for the potential global warming black swan? Or is that still seemingly too far out? That's the one major thing that personally scares me about Phoenix. I've dealt with value add deals in Sacramento in the summer heat and it's rough. I can only imagine what it's like out there and and what it could be like out there in 10-20 years. What if it gets so bad that those figures you presented go in reverse as people flee the heat?
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Nicholas, global warming is a known, as such it is not a black swan. Are we planning for it? No, we are not. Thanks :)
    Genna Golden Rental Property Investor from Portland, OR
    Replied 10 months ago
    Global Warming is not a black swan, but a massive and long lasting power outage in a region that is 115 degrees would be.
    Matt Rachow Investor
    Replied 10 months ago
    Interesting concept; class C areas given B or A improvements and finishes. The value of the building will ultimately be limited by the location and cost of land, but the idea makes sense.
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Thanks, Matt. The value of any building is in part sociological and in part economic. The economic component is a function of the availability of land and construction cost. The sociological component resides in the fact not everyone wants to move to another part of town... I'll write a few articles in the coming weeks, and likely will touch on this. Thanks for reading!
    Alex Bekeza Lender from Los Angeles, CA
    Replied 10 months ago
    Great article Ben. I know of quite a few deals that just fell through because of these increased reserve requirements but they're certainly warranted as time will tell and many non agency loans of similar structure/asset types go into foreclosure in the next few months. In a "normal" environment, I'd love to service the agency fall out with private/commercial alternatives but this Black Swan has brought those to a temporary pause. Hopefully some of these will come back in some capacity early to mid summer.
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Thanks indeed for reading, Alex!
    Steve Vaughan Rental Property Investor from East Wenatchee, WA
    Replied 10 months ago
    Thanks for this, Ben. Know your market, know your plan amd have reserves. Excellent advice in any environment 👍
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Steve, thank you :)
    Phil McAlister Specialist from Chicago, IL
    Replied 10 months ago
    Nicely done
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Thanks, Phil!
    Scott Trench President of BiggerPockets from Denver, CO
    Replied 10 months ago
    Ben - excellent article. Your aggression -- your returns -- derive from your low cap rate market, with great appreciation prospects, and your operations/value add. You offset this risk with a large capital reserve. I agree completely with your approach, and structure my own personal investments that I control in much the same way. I think I know the answer, but I'd love to hear you explain it -- why do you collect the liquidity upfront and reserve it, rather than simply do a capital call or looking to restructure your debt when/if you believe you'll end up needing it? Would this increase your returns on paper yet give you effectively the same buffer? Lastly, I love that "BP" is one of your three keys to a black swan event! Ha!
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Oops, responded in the window below on accident :)
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 10 months ago
    Scott, thanks! To answer your question, the syllogism is quite simple: If the main objective is not to lose partner capital, and If timely access to reserves is key to not losing partner capital, Then collect the reserves up-front. Most private placements provide for but do not mandate participation in capital calls. Meaning that if necessary I could ask for additional equity, but partners do not necessarily have to agree. That said, I don't want any ambiguity relative to "timely access to reserve capital". An interesting additional side-effect of collecting the reserves upfront is another syllogism: If idle equity reserves compress projected returns, and If investors need to see a certain level of project returns in order to deploy, Then the two options are to either lower reserves or find a better deal that pencils inspite of higher reserves. Since we are totally unwilling to lower the reserves, we are forced to find better deals. In this way, pro-forming reserves not only makes us safer investors, but also better investors. At least this is our perspective on the matter. I should write an article on this, shouldn't I.
    Wenda Kennedy JD from Nikiski, Alaska
    Replied 10 months ago
    Ben, I really agree with you. I've been preparing for this moment, or a similar one, for years. I believe in huge equities rather than leverage. I believe that cash is king when the bottom falls out of life. After 44 years in the real estate business, I know that bad things happen... at the worst moments... and to good people. Good intentions are just that -- a moment that never really comes around. They are only a fleeting thought. I've watched people come and then abruptly go. Real estate is a revolving door that spits people out quickly after they lay down their money. It's a very unforgiving business.
    Ben Leybovich Rental Property Investor from Chandler/Lima, Arizona/OH
    Replied 9 months ago
    Thank you, Wenda!
    Account Closed from Anchorage, Alaska
    Replied 9 months ago
    Great article Ben. I was prepared for an event like this despite many others I know in multifamily investing who are about to lose their properties. I made a rule for myself early on to have a year's worth of building expenses in the bank for each property before I would continue to scale. Many people in the local real estate circle thought I was crazy for not deploying the capital I had "laying around" into more leveraged properties. "Scale scale scale!" is what everyone has been chanting for the last 10 years. As Warren Buffet said, "Its only when the tide goes out that you learn who's been swimming naked"... well there are plenty of naked investors right now. I know a few personally who are reporting 4 out of 6 tenants in one building aren't paying, some of which worked for businesses that are actually going bankrupt and closing permanently. These same investors overpaid for properties with little value add potential, and were leaning on rents to stay stable or grow... they invested for "long term equity", lol. My buildings were all mismanaged and very dated properties in prime locations, that I purchased at a discount, then re positioned after extensive remodeling. I'm a contractor, so my expenses were all materials. I put recessed can lighting, custom walk in tile showers, granite counter tops, removed baseboard heating and installed in-floor, washer/dryer in each unit etc. One of my properties for example was a pre-foreclosure 4-unit I purchased for $365,000 after a $490,000 appraisal, that I converted to a 6-unit. The building originally generated $3200/month in gross rents. After the conversion and renovations I did all by myself in about three months, the property now generates $7200/month... yet the bank note is only $2200. If rent prices plummet around here, and they mostly will because Alaska is so dependent on oil ($14/barrel) and tourism (Coronavirus), my A class property will survive this market easily. I'm getting $1400/month for 2br units, and I could float the property and expenses with $700/unit. I'm glad to hear you're navigating your cruise ships through this storm successfully! I'm keeping my little boats afloat too. Cheers!