Imagine that you have $100,000 in wealth that you are ready to invest in real estate. You have accumulated this $100,000 over the course of about 10 years, and it amounts to the sum total of your worldly wealth outside of your home equity and/or retirement accounts.
Ready for a bad plan?
Invest all of that money into a $400,000 property producing a modest cash flow in a solid location and resume saving at $10,000 per year.
Why is that a bad plan, in spite of you getting some cash flow and reasonable prospects? Well, it’s a bad plan because you only win if the market goes up. You’ll survive in a flat market. But you are up a creek without a paddle if the market goes south.
You can replace the phrase “accumulated this $100,000 over the course of about 10 years” with “inherited” or “won” or “came into.” The point is that it is quite perilous to invest an amount of wealth so large that you cannot rebuild it in a year or two all at once.
Contrast yourself to the guy that starts with nothing but sustains a savings rate of $25,000 per year. This guy can invest $20,000-$25,000 in an $80,000-$100,000 property each and every year. Or he can purchase a $200,000 property every two years. This guy isn’t screwed if the market goes down—he can buy more property for a better price in the event of a downturn! He has a system of wealth creation that will help him work through the next downturn, benefit from appreciation, and cash flow throughout.
The difference between these two cases is that the guy with the huge lump sum but slow accumulation rate is at the mercy of the market, while the market is at the mercy of the guy who is sustaining a strong accumulation rate.
As usual, this article is written for the full-time earner that makes their living in something besides real estate but is looking to build wealth semi-passively or passively through real estate on the side. The full-time real estate entrepreneur might approach their strategy completely differently and be correct in doing so.
How to Win in an Up Market
Fundamental to your decision to invest should be the assumption that your property value and/or rents will increase with or in excess of inflation. I’d argue that if you do not believe your property will increase in value at least at the rate of inflation over a long time period that your money would be better invested elsewhere.
Related: How to Make Money in Real Estate — Whether You’re in an Up OR Down Market
Why would you invest in something that you thought was going to decrease in value over time?
Assuming that you agree with this premise, you know then that you must be invested in real estate in order to benefit from market appreciation or even just good old inflation. You lose if the market appreciates and you own nothing, as you could have made money by owning property.
OK, so that’s how you win in an up market. Makes sense—this should be obvious information. Benefit from appreciation, and benefit from the increase in cash flow that comes with rising rents.
How to Win in a Flat Market
There are many markets around the country that remain relatively flat over the years. Many Midwestern towns, for example, experience little to no appreciation over long time periods, and rents and home values increase at or at a slower rate than the pace of national inflation over time.
Still, the owners of property in a flat market can win if they are able to generate significant cash flow from their investments. If you can generate a 8-12% cash-on-cash return (after accounting for ALL operating, financing, and CapEx expenses!) on your investment AND pay down the mortgage, you’re probably going to do alright, even if you don’t experience a bit of appreciation. At the end of 15 or 30 years, you’ll be left with a fully paid-off rental that can generate a substantial investment, and that rental will have been paid for with other people’s money (the tenants’ money).
Again, you can’t win in a flat market if you don’t invest, so staying out of the game is not an option here.
How to Win in a Down Market
This is the part I’m sure you’ve been waiting for. Keep in mind that I have NOT yet survived a market downturn, so this is purely my philosophy. I hope that you see the merits of this approach and are able to parallel it in your own investing life.
I believe that the way to thrive (not just survive) in a down market is to be prepared to buy more real estate. See, in a down market, you will likely be able to purchase more property with fewer dollars and likely generate more rent per dollar invested than in a booming market.
There are two ways to put yourself in position to purchase more real estate.
First, your purchasing power is dictated by your personal financial position—the holistic position that you maintain across your other assets, the income from your job, and your cash position. If you are able to save thousands of dollars per month and have tens of thousands (or hundreds of thousands) of dollars in wealth outside of your current real estate investments, you are likely to be setting yourself up in a strong position in the event of a market downturn.
Second, your purchasing power is dictated by your reputation. If you are known as the real estate expert in your circle, among your friends, family, and colleagues, you stand a good shot at being able to raise money in the event of a market crash. Notice that you cannot develop a reputation in real estate if you do not own any property. I am not going to give someone tens of thousands, hundreds of thousands, or millions of dollars to invest in real estate if they have never owned property before!
I believe that all of this stuff is interrelated. I believe that if you want to be successful in real estate investing over the long-term, regardless of whether you think that the market is going to go up, down, or sideways, you must first buy property, manage your property conservatively and reasonably, maintain a strong holistic financial position, and network to consistently build your reputation.
This is how I manage my business and my life. I keep a large cash reserve, work hard to make sure that I am able to earn a steady income, spend as little as necessary to live a happy lifestyle, and gather as many intelligent perspectives about real estate investing as I possibly can.
My properties will provide economic benefit to me in the form of cash flow and loan amortization in a flat market, will continue to offer me a shot at appreciation, and are training me to take advantage of the next market crash.
In the event of a market downturn, I plan to purchase exponentially more property by harnessing my personal financial position. And should I deem the situation to be appropriate, I will attempt to use my reputation amongst my friends, family, colleagues, and elsewhere to attempt to raise capital to buy as much property at an excellent price as I can.
Notice that I am not investing, at the moment, more than about one to two years of wealth accumulation at a time. I believe doing otherwise needlessly exposes me to the market and that I will be dependent on my first or next investment going well.
My fate would be outside of my control.
Related: How to Survive in All Market Phases (It’s About More Than Just Ensuring Cash Flow)
Maintaining a Strong Financial Position
I choose instead to take a slightly longer but more steady approach toward early significant wealth through real estate investing, and I believe that I will continue to reap the rewards of this strategy regardless of what the future may bring.
Notice that most of the approach here comes down to your position outside of real estate. I believe that the majority of real estate investors out there invest in real estate part-time, on the side, while working full-time jobs. If that’s you, then your success through your first 5-7 years of real estate investing is likely to be just as impacted by how you run your finances across your entire life as it is by the properties you buy and how you manage them. Are you able to sustain a strong financial position outside of real estate investing during the initial years of portfolio building? If so, you may find real estate to be slow, steady, and rewarding. If not, you may find yourself on a roller coaster ride. Let’s just hope that you don’t run out of track.
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Do you have a plan to win if the market goes down? Or do you only win if the market stays flat or goes up?
Let us know in the comments below!