How can you profit from a downturn in the economy?

Question

I am new to the world of real estate investment and am trying to build a solid foundation of knowledge before I start making any deals.  My interest is broad and I could really go in any direction as far as "choosing a niche" goes.

My question is this:  How can you protect yourself from a downturn or even crash in the economy? Is there anything in the world of real estate that is equivalent to shorting stocks?

It's been my experience in life that there is always someone making a profit when everyone else seems to be losing, it's just a matter of being clever enough to figure out how to be that person.  Are there any investors on BP that somehow profited from the crash of 2008, or is there any advice from someone who learned the hard way?

Kyle Nelson · Answer

a downturn in the economy equals a sale on real estate. That's the time to gobble up as many properties as you can. If you were buying houses in 2010 you were getting them at a significantly lower price than someone would pay for the same home 5 years later. Same with stock.

Michael Henry · Answer

@Kris Klark  you need a lot of cash to profit for a downturn mainly so you can hold long enough for the market to recover. I remember when AIG stock price dropped to $2 a share, now if you have the cash to wait, I lot of money would have been made.

James C. · Answer

Kris,

Let's deal with the concept of a short in the stock market, and then apply to the real estate market.

First a definition: Fungible - one is exactly like another e.g a $20 bill, or a stock certificate.

Short process in stock market:

Borrow the stock, sell borrowed stock, wait for price to drop, buy replacement stock and give back. The concept here is that the stock is fungible, that is every share of stock is the same as every other.

Simple word replacement (stock for property)

Borrow the property, sell borrowed property, wait for price to drop, buy replacement property and give back.

Now, this is going to have heads scratching, because SFR is not really fungible. Commercial is a bit more fungible, but still not really. That is to say, one property isn't like another in the owner's eyes. This makes the swap of a bit more difficult. It's like having to return the ORIGINAL STOCK that you borrowed, not a replacement. BTW, mortgages are fungible, but again, only to a certain point.

Still, in concept, it's doable(ish)... to wit:

You "buy" from original owner agreeing to close at the market value at some point in the future. (borrowed). You then sell to a new buyer at market rate (selling borrowed property). At the point in the future, you pay the original owner for the property.

In our case, the original seller and new buyer are "long" real estate, you are "short" real estate. The original owner and new buyer think the property is going to go up in value, you think it's going to go down.

Typically, in real estate this is done with lease/option/purchase agreements, and/or a sale with a wrap/subject to, along with a Deed In Lieu. Not a straight short, but has the same effect, namely, the profit is the arbitrage between the two lease or property prices. It's done this way, because of the conservative nature of real estate transactions, i.e. limited downside and maximum upside. By their very nature, REI are optimists. That is why "everyone" is in a panic when property values go down. RE is a tough hedge, I don't know of a direct hedge for RE, most are in some sort of RE derivative, like interest rate swaps.

If you really think RE is going to go down, then hoard cash and have lots of financing lined up. When it tanks, buy distressed stuff (mortgages, MFR properties, etc.). Of course, you could do a bunch of options and clean up between now and then ;)

FWIW, I found two other ideas out there. One involves mortgaging as much as possible and buying T-bills. The other is a CME futures/options product based on the Case-Schiller Home Price Index. Those both seem rather big gambles as opposed to hedges... but hey, each unto their own.

Good Luck!

Jim