Read this post if you are currently saying things like this to yourself:
“I’m waiting for a market correction to take action.”
“I’m just building my investor list right now so it’s ready when the market drops.”
These can be perfectly fine thoughts if you have experience in real estate, currently own plenty of assets, and you have established an excellent reputation of success in investing. However, if you are just getting started, you may be disguising your fear as practicality. If you are using the current market condition (which is overwhelmingly positive by most all metrics) as an excuse not to take action, then I’d advise you to look inwardly and seek out the root of this fear starting by reading this post and reflecting.
There is no perfect way to time the market. The only people who can be wrong all the time and keep their jobs is weathermen and economists. There is no crystal ball. You cannot know, with any certainty, that you will be correct about when the market will rise or fall.
I see quite a bit of people trying to be the smartest in the room, but they’re the most scared to take action. I often hear the excuse that a person isn’t buying anything right now because “They’re just building an investor list until the market crashes,” then they’ll go look for deals.
The 2 major issues with this logic:
- The market could be good for another 3 years (or any amount of time, the point is you don’t know) and you’ll have wasted valuable time that you could have been taking action and acquiring assets. Acquiring deals is how you truly build a loyal investor list that has actual substance. Not just a group of people who say they will invest with you. The truth is, that when it’s time to put pen to paper there’s often a stark contrast between a person’s actions and prior words. Investing In multifamily syndications to the tune of several tens or hundreds of thousands of dollars is a big ask. The conversion rate from soft to hard commitments is about 50%. So, do not take your ‘mock raise’ amount at face value.
- The way you protect form a downturn is not putting your head in the sand, its taking action and buying with proper assumptions and conservative metrics in place that will protect you even when there is a significant rise in vacancy/concessions and/or a softening in rents. For example:
- Buy for cash flow, not appreciation. Appreciation should be viewed as a cherry on top, not the sole focus of the investment. The reason for this is because appreciation is something in which you have no control. Its dictated by the market’s growth and also the macro perception of its growth. Cashflow, on the other hand, is the amount of cash you’ll have after the debt, expenses, and reserves are paid. If your cash flow is high on day 1 then you will have a buffer from unforeseen circumstances. Your cash flow should be high enough that even if there is a 30% drop in the income you’ll still be able to pay your debt service and maintain the property until the market recovers. Real estate has never lost value over any 10-year period in history. If you bought at the worst possible time in 2008 but were able to ride out the storm till 2018 you would have recouped your losses and even made money in most cases.
- Pay attention to DSCR. Be conservative with your year 1 DSCR. Being very conservative would mean having a DSCR that is above 1.3; this means that you’ll have a 30% buffer between your debt service and your net operating income. You want your worst case to be: that if there is a massive drop in the market, you won’t make all that much in the way of returns, but you will not lose the property. Rather than you’re your worst-case being: foreclosure, several capital calls and eventual loss of the property. As I said earlier if you can weather the storm you will historically come out on top.
- Get long term financing. If you secure financing with a term of 7 years or greater (ideally 10) then you greatly reduce your risk of having a loan come due in an inopportune time. There is plenty of loans currently being offered with longer-term loans. Banks are inclined to give you a longer-term loan in today’s current market conditions. The market has been up for so long that people are worried about a drop, the banks understand this fear and at the end of the day want you to be able to pay them back. Their goal is not to foreclose, they don’t want that headache, they just want you to responsibly pay on time. Interest-only loans are being offered at a higher frequency right now as well, because the bank makes their money on the interest and again, wants to receive their money first and foremost. An example of a loan with these elements being offered right now is the CMBS loan. The current interest rate is 3.9% with a 10-year term, 30-year Amortization, and IO for the full length of the term 120 months. There are also downsides to this loan such as large prepayment penalties in the way of yield maintenance, but the point is a loan of this type will allow you to ride out a drop in the market.
You don’t have to sit idle and not take action until a market correction. You can acquire assets right now. I assure you sitting on your hands at this time is not being practical, its fear disguised as practicality. The answer is to work harder, learn more and take action. Not sit back and “play it safe.” You don’t know when the market will crash. Also, you prevent a loss from unpredictable market conditions by buying correctly and assuming things ‘will’ get worse; not things ‘may’ get worse. The natural state of things declines unless you actively do something to prevent this. For example, leave your house unattended for a year and see if it’s in better shape than when you left. I assure you it will not be. There will be dust, the potential damage from break-ins, pests, lights that have burned out if left on, etc. You have to take care of the downside, not the upside. The upside will take care of itself.