Cash reserves, good cash flow and moderate leverage
Originally posted by @Michael Szypulinski :
I’m New to BiggerPockets community. I have an interest in getting involved with real estate investing in the near future, specifically rental properties. I was wondering if anybody knows of any good strategies to survive another market crash? I know this may be a general question but any specifics would help. For example, how much cash flow would a property need. Worst case scenario, how low would rent get? -50%? -60%? How much down payment would be required? 30 yr or 15yr loan? Recommending to sell before a crash or riding it out? Etc. Any examples would be greatly appreciated.
how much cash flow would a property need
- Depends on you, the number has to be over your PITI + vacancies + CAPEX + repairs + other potential costs you can project
Worst case scenario, how low would rent get? -50%? -60%?
- No one can predict. Only the market can tell you. What you can control are your costs mentioned previously. That's where reserves come in play.
How much down payment would be required?
- As little as possible. OPM is the best.
30 yr or 15yr loan?
- Personally, I go for the 30 yr loan. Gives you more flexibility, and better cash flow. You can always pay more monthly towards principal on a 30 year loan, but you cannot pay less on a higher 15 year mortgage.
Recommending to sell before a crash or riding it out?
- No one can predict. But there is always money to be made regardless of the cycle.
Honestly, if you need to ask these questions, rather than investing in the top of a market you'll probably be better off waiting for the coming correction. Investing then is much simpler. It's coming, Zillow sent me an email today saying one of my properties went up 5% last month! I don't believe it, but it's indicative of the froth in the market. Look at the implied GRM of 39! When RE looks like Bitcoin, be very wary.
The Zestimate for this house is $939,904, which has increased by $50,369 in the last 30 days. The Rent Zestimate for this home is $1,995/mo, which has decreased by $205/mo in the last 30 days.
@Caleb Heimsoth hit the nail right on the head. The long and short of it is to remember that bears lose money, bulls make money, and pigs always get slaughtered. So long as you don't chase the market right to the top like a million dopes did in 2007, over lever, and have substantial short term financing in place, you are ahead of the game. Stockpile as much cash as possible to weather a storm, be vigilant on the acquisition, and get your systems organized now while there is still stability. If you buy right, a downturn won't make you even skip a beat.
Only buy solid, sound deals and don't over leverage!
Don't buy properties that go 100% vacant during recessions.
Hard to believe this happened but I guess it did in PhoeniX.
- Good locations
- Add value
- Cash flow
- Long term debt
A good recipe with any market conditions.
See below for a post on overcoming fear of the market.
To add to @Brandon Ingegneri I’d also say avoid ARMs. That’s what also screwed people in 2008-09. They overleveraged and they were all arms which then tripled payments at once as the teaser rates expired, and then poof they go under
If you are someone that is just starting to learn, take your time and learn the different strategies of investing. After you understand RE investing, pick one strategy and focus on that. Find mentors and others in that strategy and shadow them, work for them, invest with them, partner, etc. Now is a great time to learn and build your network. Be patient in this market. It may be several years, but eventually the market will make an adjustment, so be ready to pounce when others are running the opposite way.
For riding out a crash, position yourself properly with solid cash flow, 8-12 month of P&I reserves, desirable properties, low leverage properties and solid financing. Also, understand historic rental rates and property values based on income. Tenants can afford 30% or so of their income for rent. If your rents are 40% of the median income, then when a recession hits your rents could go down. That is ok, as long as you can still cash flow
Booms are followed by busts! We are enjoying a massive boom. There is no way to tell when a recession will happen.
My theory is to follow Warren Buffet, who preaches to make money when you buy the asset, have the financial wherewithal to hold on to it forever if you could and always keep a margin of safety.
I’d personally make sure to buy well. That is a deal or steal vs comps in the area you are buying vs simply buying because you want to buy or because the price looks affordable!! That requires maximum work and then run your numbers assuming a 20% drop in rents or 20% drop in values and see if you can still sustain. Do a stress test at 30% as well. If you pass this test, buy.
Sorry for the late reply. A lot of exciting things have been happening recently. Just completed my masters degree! Should start seeing some income coming in very shortly and then I will get started with investing. Appreciate all the responses!
Caleb Heimsoth: Short, sweet, and to the point. Thank you for your wisdom.
Chris T: Great info! How do you go about estimating for some of those values (repairs, CAPEX, etc.? I just bumped into a crowdfunding website called Fundrise. Sounds like an interesting way in investing money as well as getting money for deals.
Brandon Ingegneri: What would you define as over-leveraged? I understand the concept but don't have a number to relate it to. <10%? <5%?. Also, how much reserve would you recommend. I noticed someone say 8-12 months, but I don't know of a value they have in mind. Do you calculate it based on how much extra cash you need per unit? Say extra $500 per unit to last for 12 months?
Brian Garret: Same question. What would you consider over-leveraged?
Mike Dymski: My polish friend. Thank you. Your last name is much easier than mine haha. What brings you so far away from the capital of Poland (Chicago haha)? I will utilize your recipe to the T and will read that post you provided shortly.
Todd Dexheimer: I've read around 15 books on RE in the last couple of months during my free time. Looks like buy and hold and/or BRRRR strategy are my calling. Working on my network as we speak. Have been attending some local REI clubs. P & I = principal and interest? How would you quantify/determine 8-12 months of reserves? Where do you get your information of history rental rates and property values? Thank you!!
Sam Josh: I like this stress test concept!! will definitely utilize the idea. Thank you
Don’t do like half the dopes do on here .. brag about cashing in your 401k to buy a 250,000$ single family home that cash flows $73 a month ... then a month later post in the landlording section about how the tenant trashed the place is selling crack and won’t leave so now your broke .
Buy conservatively, and make sure you have cash flow. Equity is nice too. Luckily in the lower priced house ranges around Chicagoland the rents don't really go down. They're pretty flat.
Try to keep your cash reserves high and don't overleverage. (I would try to stay under a 2:1 debt/equity ratio, although this might be tough for new investors). Focus on getting your portfolio performing too so you have very high occupancy. Also, try to build a stable of private lenders.
Recessions can be tough, but they can also provide enormous opportunities.