The 5-Point Real Estate Market Crash Survival Guide

by | BiggerPockets.com

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.

potential-market-crash

3. Rents

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!

4. Markets

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.

6. Speculation

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.

housing-market

Related: 4 Ways to Survive Future Real Estate Market Crashes

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.

  1. 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.
  2. 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.
  3. 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.
  4. 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?
  5. 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?

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

22 Comments

  1. Christopher Smith

    Very interesting and a lot of good points made. I did exactly what you did except I bought most of my properties in Silicon Valley bedroom communities during the last crash. All have more than doubled in the 4 to 6 years since acquisition, with solid if not stellar cash flow.

    I bought newer properties (2 to 4 years old) in nice middle and upper middle class neighborhoods. Rents held up nicely as those folks who lost their homes often turned right around and rented them back frequently in the same neighborhoods.

    I hope a crash doesn’t happen, but for those willing to guy it out it can often be a stellar buying opportunity. But you are right, most people will be running naked in the streets screaming that the world is coming to an end and won’t even consider buying, at least not until prices have doubled again. Which makes finding deals for those willing to take the risk like shooting fish in a barrel.

      • Christopher Smith

        That is precisely what gave them the extraordinary value they turned out to be. There was so much fear that people were throwing in their chips left and right, and the remaining folks were so totally paralyzed they could not act at all, which made real estate prices drop to incredibly low values. Of course values can drop further, and you will likely never catch the absolute bottom, but if you play it right you will have many winners to offset any “falling knifes”. This goes equally well for stocks and real estate.

        Don’t need to take my word for it, read Peter Lynch’s (the Magellan Fund Guy) books on investor psychology, this is exactly the time to act, and not to be consumed or paralyzed by the fear pervading the market. Warren Buffet says the very same thing, be greedy when others are fearful and fearful when others are greedy. The two most successful investors in many generations – they don’t fear the “falling knife” or the “dead cat bounce” they understand its a possibility and exploit the situation anyway and when done properly over a portfolio of investments you will nearly always come out on top.

        In my own personal case, I had a few gut check moments for sure dealing with the fear, and some values did drop slightly after some of my purchases, but over a 150% return in about 5 years (2M in total profit and still going strong) is something I could never have achieved if I had feared the “falling knife”. Don’t fear the reaper, use his scythe to your own advantage.

        • Graeme Ford

          Awesome information Christopher, it must have took a lot within you to look at the situation and go after it. Reading this makes me wonder how you reassured yourself that your path was true and that you were using a valid strategy. Basically I think of the gumption it must have took to have an objective view of the market to see opportunity in what others saw as the end of the world.

          I think of all the times I hear Josh on the podcasts talking about Detroit and just because a property is cheap does not mean you should buy it. Did you have a strong focus on cash flow and refrained from speculation and if so how were you able to have a feel for what rents would be in the virtually newly developed market?

        • Christopher Smith

          Graeme

          I think very rarely (if ever) you have absolute assurance that what you are doing is going to work out as mine did, and as I indicated I had momentary lapses of anxiety during the first 2 years as prices in some instances got even more depressed. However, I felt longer term I had a number of things that would ultimately play out to my advantage as follows:

          1) Prices in my area were off well over 50% and in some cases almost 2/3 which means you could if your timing was good pick things up at 35% of their pre crash selling prices – new middle class homes 2 to 4 years old in very nice neighborhoods.
          2) My market is a bedroom community of Silicon Valley which is an anchor for the entire nation’s (if not world’s) economy. If anything was going to come back strong it was California property in the Silicon Valley region.
          3) Rents actually remained surprisingly strong even at the depth of the crises. Logic was the vast majority of the folks who lost their homes would turn right around and rent a comparable home often in the very same neighborhood – and this turned out to be totally valid.
          4) While rents in CA can be difficult normally to cash flow strongly, when you pay 35% on the dollar for your CA property acquisition it makes cash flowing (even a CA property) a whole lot easier. So I was cash flow positive from day 1 which helped keep the boat afloat until better times came along.
          5) I would say my planned approach was based upon realizing solid if not spectacular cash flow and of course given the hugely depressed pricing that I bought in at, significant underlying appreciation, both of which have been realized far beyond my expectations.

          I see what I did as very different than Detroit, that is a very different kettle of fish. My areas were not depressed by any means, yes there were a number of vacant homes, but they were in excellent condition all of them recently built in middle to upper middle class neighborhoods with reasonably good schools and solid city infrastructure. In fact the city that I bought into (even despite the crash) was actually ranked as the number 1 locale within California for young couples attempting to build an affordable new home. I personally think that was an exaggeration, but its a great area by almost any CA measure nonetheless.

          Having said that, I’ve worked fairly diligently since my acquisitions in continually improving my properties’ cash flow year by year. Its never going to be as good as you can get say for instance in the Midwest (where I have recently acquired some properties), but its respectable giving me about 100k a year net cash flow. Kind of like having a great growth stock with that pays a very healthy dividend on top of it.

          The only thing I have to complain about now is that California pricing is currently way way too high for any additional acquisitions, and even the Midwest is starting to move out of reach, so my pace of acquisitions has been reduced to a crawl, if that. But that’s OK, real estate was never my primary activity (I am much more of a securities guy) so I consider my foray in to rental real estate to have been a big success, especially since its something I never thought I would get into in the first place.

  2. Rob Cook

    Ali,

    Good post, and summary. You are right to warn that anticipating/predicting such crash events is impossible, at least in such a way that you can capitalize on them without a lot of luck. I have lived thru a bunch of such markets and cycles, and while they were all different, there were usually similarities between them too. This time, however, things are all so upside down and different, systemically, that it is all the more risky to consider and try to plan for. Your basic risk management concepts, of course, are all correct and should be helpful in any case.

    I particularly liked your advice about, what I call, “catching a falling Knife” in stock trading. I.e., don’t try to pick a bottom, buying just because prices are down. They could CONTINUE down a lot more for all we know! And once the turnaround occurs, it could be a “dead cat bounce” sucking in buyers only to soon resume the decline. (short covering analogy).

    The main point I would take away from all of this is, being a long term holder of rental properties is usually (always has been?) a safe proposition, IF you make your money going in. (Good price, good location, good rent demand and cash-flow, etc). Depending or counting on natural appreciation, in any form, ever, is speculation (i.e. gambling). Appreciation is a bonus, IF it occurs (and long term, it almost always does/has).

    We are in a great business! So many of the benefits of owning rental real estate are actually HEDGES against larger economic downturns. For example, when interest rates rise, home buying is depressed, and therefore rents are supported. When high rated of appreciation in home values occurs, same thing, less buyers can participate in home ownership, and therefore are forced to rent instead. Also, when housing prices drop, it scares most would-be home-buyers out of the market, further depressing prices and continuing the price decline. Again, these people have to live somewhere, so rent, instead of buy. And even when there is a boom occurring in housing prices, many are then priced out of being able to afford to buy homes, so are relegated to remaining renters. Get the point? Not a single one of these possible scenarios depressed rents or demand for rentals. Nice space to be invested in uncertain times!

  3. karen rittenhouse

    Love this, Ali.

    Again, the message we all hear over and over (because it’s correct) You Make Your Money When You Buy.
    Buy low enough that you can lower rents when the market drops and still cover your costs.
    How do you buy lower? Negotiation and the property will probably be a bit distressed meaning the seller can’t get full retail.

    Rental properties are what got us through the 2008-2010 crash because no one could get a loan so everyone became tenants. And, we continued to buy all through the downturn because properties were getting cheaper but we knew they’d come back up again (and they have 🙂

    Thanks for your post!

    • Ali Boone

      Hey Karen! And yes, I completely agree. If another crash happens, I will be buying like crazy! I might even buy in CA….whooooaa! 😉 (despite being the out-of-state-only buyer that I have been for a few years).

  4. Abel Teklu

    This is a great summary. I never really understood why investors say they were burned in the crash because property prices dropped. Usually after some questioning, you find out the reason they sold wasn’t really because prices dropped, but because of other decisions they made like adjustable rate/short term financing, or poorly located rental markets (Detroit).

  5. jorge guadian

    Great advise. The last crash thank God did not affect me. I own 5 duplexs and have done alright for my family .Im retired Army and got in to the game in 96. I paid off 1 duplex in 12 years and the other in 16 years. Year 2019 I will have the others 3 paid off. They say it’s a cycle every 7 years or so the market goes up and down so if your in a good strong market you should not worry about the value of the property as long as your not going to sell. As long as the juicy cash flow keeps flowing you’ll be alright. I also think everyone eles comments are very interesting .we are after diffrent we all see the world in many diffrent ways.

    • Ali Boone

      I agree Jorge. Different strokes for different folks! I’m all for that, but I have never understood why people bash the ‘different strokes’ for different folks. Some things work great for other people.

      Congrats on all of your properties! Sounds like you are doing great.

  6. John Murray

    The one factor that individuals always do not discuss is the US War Machine. This is always is the deciding factor on how the pace of growth and recession effects investor confidence in all things investments. If one studies history back to the Civil War ( the first modern war in the world) the patterns are pretty evident. When quick decisive patterns occur investor confidence is high. When long drawn out botched war policy occurs investor confidence is low. The crystal ball seems to point to investor confidence as high at present. The down turn may come when the get out of Dodge cannot occur.

  7. Ashley Wilson

    Great points! So out of curiosity, what do you consider markets that grow or stay stable in crashes? The arguments, vegas and Detroit, makes sense, but was just trying to thing of something that doesn’t get impacted and couldn’t think of any off the top of my head.

    • Ali Boone

      Hey Ashley. Well it kind of depends on in which context you are asking. For property values, typically the Midwestern cities tend to experience the least amount of depreciation. In turn though, they also experience the least amount of appreciation on the upswings. If you’re talking about being able to sustain rents during a crash, you’d want the growth cities with a lot of industry and steady jobs and population increases.

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