I’ve heard a lot of talk lately about an impending market crash that is coming in the next couple of years. Consequently, I’ve heard a lot of people asking, “What impact will a crash have on me as an investor and/or what can I do in preparation for a crash?”
I can only speak and educate in regard to rental properties because those are all I have working knowledge of. Answers to those same questions may vary for flipping and other types of real estate investments.
In no particular order, I’m going to bring up several different aspects involved with a market crash and address how each may be impacted—and possible ways you can help mitigate risk with each, as applicable.
Here goes! Again, these responses are specific to rental properties. They may also apply to other investment strategies, but you will have to assess that for yourself.
6 Property Factors Associated with a Real Estate Market Crash
1. Property Value
I cannot say this enough—property values only matter if you are buying or selling a property! This would include refinancing as well. But let me say that again—property values only matter if you are buying or selling a property (or refinancing)! The most common thing I heard during our last crash was how many people were freaking out and selling their properties just because. This was more often primary home buyers than investors, but it’s still worth putting out there. People were panicking when their houses went “underwater” and felt more comfortable selling the house in order to—I’m actually not sure what. There were some cases, of course, where people lost their jobs to such a severe degree that financially, they were forced to short sell their house or sell it while it was underwater. This is not the case I’m referring to. I’m referring to the case where people were selling simply out of pre-emptive panic.
I feel like I should say this, again, one more time—property values only matter if you are buying or selling a property! Since buying a property isn’t so much of a threat, I can focus primarily on the owning and selling aspect. If you own a property and the market crashes, the crashed value of your property does not matter unless you try to sell or refinance the property. So, an easy solution would to not sell or refinance your property during a crash. There are a couple factors that I will get to in a minute that can affect whether or not you might be forced to sell your property, but outside of those, just know that there really is way less reason to worry about the value of your property than most people seem to think. First step—don’t panic.
2. Debt and Loans
Just as I say “don’t panic,” people immediately think of leveraging and panic. Leverage is quite often the major player in the panic game during a crash. Being leveraged means you have a loan, likely a mortgage, on the property. Unfortunately, loan payment requirements don’t stop or change with the market, so it makes sense that this is a primary source of panic because regardless of anything on your property, you owe the bank (or whoever) money every month. If you don’t pay it, you can lose the property. Whereas if you own a property outright, meaning you don’t owe a bank or anyone a loan payment every month, you may have a lot more room to maneuver without major financial implications.
Related: 3 Important Points to Remember When Considering a Potential Real Estate Crash
One common thought during an impending crash surrounds how much someone should be leveraged—maybe 65% loan-to-value (LTV) or 75% LTV or something. Personally, I don’t think any particular number is better than the other because no one can say for sure what the implications of the crash will be (see upcoming note about speculation). I think the only rule that should absolutely hold true is to hold to whatever LTV you are personally comfortable with. Some people aren’t comfortable with any debt (0% LTV), and people like me are comfortable with maximum debt. I will address later some ways to help you survive having debt, should you need it, but there really is no right or wrong answer—you just have to be where you are comfortable.
With that said, there is one major precaution about debt and loans that everyone should be extremely clear on when it comes to fixed-rate loans versus adjustable-rate loans. I don’t know that I have ever heard of any major problems during a crash with a fixed-rate loan. I have, however, heard of a tremendous number of financially devastating problems with adjustable-rate loans, also known as “ARMs.”
Here’s a scenario—you buy a property with an ARM with a 6% interest rate. The property cash flows decently. The market crashes. Then your ARM jumps to a 10% interest rate. Now you are suddenly stuck with negative cash flow each month. Because of the crash, the value of your property has tanked, so you can’t refinance to help make up for the monthly cash flow loss, and you can’t sell unless you are willing to take a significant loss. You are now paying out-of-pocket on the property every month, and depending on your job and/or savings situation, that may only be feasible for so long. You eventually can’t make the payments, and you end up short selling or foreclosing because you have no other choice. Now, how would all of that have been different with a fixed-rate loan? Assuming the rents didn’t decrease dramatically with the crash, your interest rate never changes on the loan, and the rents continue to cover your expenses. The difference between 6% and 10% doesn’t sound like a lot, but trust me, it can mean the difference between profit and loss when it comes to cash flow. There are some factors we could still discuss related to this, but for now, understand the significant risk you are taking on if you go the ARM route. Remember, ARM rates don’t care if there’s a crash or not, and they can be ruthless on interest rate changes with no second thought given.
Now, assuming you’ve handled the other crash factors appropriately, this is the only one that can really cause you problems. While the value of your property decreasing doesn’t really matter, if rents decrease during a crash, that can matter. If you own a property outright, you can probably get away with a significant decrease on rents. If you have a mortgage on the property, a decrease in rents may very quickly put you into the same scenario as I mentioned above about the ARMs—you may suddenly not be able to cover the mortgage and expenses of the property, and you could end up in a position of having to short sale or foreclose.
The good news is that if you buy smart and utilize risk mitigation on the rent standpoint (see next bullet), rents quite often don’t crash as hard as property values do, if at all. A lot of people speculate that it’s unlikely to see a major decrease in rents during a crash because of the current supply-and-demand of housing. That is possible, but pretty quickly, we are going to get into pure speculation about what may or may not happen on the rents standpoint. But one of your primary focuses when you are looking at potential rental properties to invest in is to consider properties with a lesser likelihood of rents decreasing. What would constitute that? Ooh, ooh, I know! Location!
One of the best things you can do is own property somewhere that has a significant demand for housing and where it’s suggested that demand will continue to increase. This would include cities with a steady increase of jobs, industry, and population—and general demand for people wanting or needing to live there. Cities or markets fitting this bill would be considered “growth” markets. This would be in comparison to “declining markets.” For information on these two types of markets and what leads to each designation and the risk involved with each, check out “How to Know if Any Given Real Estate Market is Wise to Invest In (With Real Life Examples!).”
I think the market you choose to invest in is the number one factor in whether or not you will experience a dramatic decrease in rents on your property. As I said, assuming you have managed the other factors right, it’s that rent decrease that is most likely to affect you in a crash.
Take Atlanta for example. While I am not supportive of Atlanta as a market to buy in right now, just because of where it is in its market cycle, Atlanta also has built up so much and brought in so much industry over the past few years that I would be shocked if, even during a crash, any rent decreases were experienced there. In contrast, let’s look at Las Vegas. Vegas for the most part has one main industry, which is entertainment. Guess what one of the top industries to be affected by an economic crash is? Entertainment. So if Vegas’s one industry crashes for some amount of time, and the general demand for the city goes down, wouldn’t be be more likely that rent decreases may start occurring? Or think about the Michigan cities that crashed alongside Detroit when the automobile industry tanked. Rents went down in those cities because there was no longer industry there and therefore no jobs, and not only did people stop moving there because of it, but people had to move out of those cities! That is where the criticality of the market comes into play. If there was only one reason to invest in growth markets over declining markets, it would be for the direct attempt at avoiding rent decreases on your property either during a crash or at all. Thinking back to the most recent crash, rent decreases most definitely did not happen everywhere. So, remember that.
5. Buying vs Selling
I think I made it abundantly clear in talking about the property values that unnecessarily selling a property during a crash is unwise. It should only happen if there truly is no other option. Why? Because the value of your property is tanked! But where do tanked property values come in handy? Buying! See where I’m going with this? Everyone has always heard “buy low, sell high,” but often people can’t bring themselves to follow that. Again, I may be talking more about primary homebuyers in this case, but if you are really wanting to make it as an investor, you especially need to be jiving with this idea. If you aren’t, your investing career is going to be tougher than it needs to be.
Buy all the properties you can during a crash! This is where the money is! To give you some perspective—at the bottom of the recent crash, I bought quite a few properties in Atlanta. They were all turnkey properties, so I made market value for them at the time. However, since I bought at the beginning of the impending boom, all of those properties have more than doubled in value from what I paid for them in only 5-6 years. Anyone buying in Atlanta right now is paying top-dollar for properties because we are no longer in a crash, and that is why I don’t necessarily recommend Atlanta any longer for buying. For more information on how markets can change over time, check out “Warning: The Market You Should Be Buying in Has CHANGED!”
So in my opinion, the minute a crash occurs, your sole focus should be on buying. Don’t buy just anything—do it with some smarts—but buy as much as you can. Then, once the market has bounced back, you are welcome to consider selling.
At the end of the day, anticipating a crash or planning for a crash is all speculation. Forecasting when a crash might happen speculation, and so is planning for the specific dynamics of a crash. None of us has any idea exactly how a crash will play out and exactly what it will affect. Yes, we know generally that housing prices will probably go down and rents may or may not be affected, but we don’t know to what degree, for how long, or to what level of impact. So if you are planning for anything even related to a crash or trying to plan your investing around a potential crash, just know there is no foolproof way to plan for it because there’s no way to know every dynamic that might be involved or when exactly, or if, the crash itself might happen.
The 5-Point Real Estate Market Crash Survival Guide
Again, at best, you are going off speculation and there’s no way to know exactly every component of a crash. So don’t stress yourself out too much over your planning. However, for rental properties, there are some simple things you can take into account as you shop around for and buy rental properties that will help lessen potential blows should a crash happen.
If you do each of these things, you are positioning yourself as best as you possible can for a market crash.
- Buy in a solid growth market. Do NOT buy in a declining market! You read details on these types of markets in the article I provided earlier, but in short, whether a market is a growth market or declining market is going to be wholly dependent on jobs and industry affecting population. There must be a solid reason that people want or need to move to a city. There shouldn’t be one main industry; there should be at least a few unrelated industries if you want reduced risk of an industry crash.
- Buy a property with solid cash flow. The more cash flow you earn from a property each month, the more room you have to maneuver on rent decreases if those happen. The less cash flow you earn each month, the greater your risk of not being able to cover your payments and expenses, especially if the property is mortgaged.
- Only buy with fixed-rate loans. Avoid the adjustable-rate loans at all costs (pun intended). Always get as low of an interest rate as you can, and be sure it’s fixed and can’t change. If you combine a fixed-rate loan and minimal chance of rent decreases, how much debt you are in doesn’t matter as much.
- Don’t sell for no reason during a crash. Unless you have to sell for some reason during the crash, just don’t do it. You are only going to lose more money. If your cash flow continues during the crash—because you bought in a good market with a fixed-rate loan and have solid cash flow margins on it—then that income may actually help you should you experience job loss issues or anything else that may come. Even if your property is underwater in that scenario, who cares?
- Always have a nest egg. It is crazy for any real estate investor to not keep some level of a nest egg. If you buy a cash-flowing rental property, maybe you save your cash flow each month until you have a solid savings that you can use should any emergencies on the property come up or should a crash have you having to pay your mortgage out-of-pocket. How much this nest egg should be is up to each investor. Take into consideration your mortgage payments, property expenses, and your own sanity, and you can surely come up with a number that feels comfortable to you. If you’ve been debating about whether to leverage a property or pay cash for one, meet in the middle and leverage the property while you put the money you would have used to pay cash into a savings account and use it only for any unexpected issues with your property. Then you are reaping the financial benefits of leveraging while also having the protection of owning a property for cash. Make sense?
Have I left anything out?
Experienced investors—how did you survive the last crash with your properties? Any extra tips for readers to consider?