How to protect equity from next crash?

Question

I thought commercial properties would do it since they are valued by their NOI/cap rate, but I hear that's not the case since the cap rate fluctuates as the economy expands and contracts, thus also affecting commercial property values.

So what is one to do? Pay hundreds of thousands in taxes to the feds and repurchase after a down turn (years from now, not talking about current economy) or watch their property values decline by a million or two by holding onto them? One is the lesser of the two evils, but there has to be a better way...

Cash out refinance and hold onto the cash until a down turn and dollar cost average as the market goes back up? DST?

Key thing is I want to protect all the equity that I've built up, and have the ability to get cash out or use existing cash on hand to repurchase when there is another crash.

Another option is to cash it all out into a 100 unit apartment complex which I also move into, retire, live off the cash flow and wait for the market to recover again. FI and long term wealth...

Thing is I'm sitting at a cool million right now and am looking at 2 in 4 years or less. I want to turn that 2 million into 4, then 4 into 8, etc.

David Faulkner · Answer

If you are a long term buy and hold real estate investor, and you invest in quality properties in quality locations where you are confident that the prices would bounce back after a recession, and you buy in such a way that you can afford to hold through a downturn, then short term market fluctuations in prices should be of no consequence to you at all. If any of those above ifs are not true, then you should reassess your strategy carefully and adjust until they are all yes's or pick another strategy. Risks can be mitigated and avoided to a large degree, but never fully eliminated ... so there is no investment vehicle in the world that will allow you to multiply your money 2-8x in 2-4 years with zero risk ... you should run away from anyone telling you otherwise. 4 things will keep you out of trouble and safe in a downturn, and you need all 4 (not just one):

• Equity: From a down payment and/or forced and/or market appreciation
• Quality Cash Flow: Not just any cash flow, but low maintenance, low volatility, stable, high quality cash flow that comes from high quality tenants who want to live in high quality property in high quality location. Quality matters just as much (and more) than quantity of cash flows.
• Cash Reserves
• Skill and flexibility to adapt your investment plan as needed. The 3 elements above will go a long way to getting you this, but you will still need the vision and skills to spot trouble and execute to avoid it.

If you are unable and/or unwilling to find a deal that meets the above requirements, then do not force a deal that gives you none or only a few ... in that case you are better off sitting on cash or looking at another strategy or asset class to invest in, but those other investments should also have similar such requirements to give you the margin of safety to make it through a downturn when (not if) it happens.

Andy D. · Answer

@Jack B. I'm a firm believer that equity (in a property) should be put to work and make itself profitable. This is not the case if it "sits" in the property.

While you obviously want to have a decent equity-cushion (@David Faulkner's point #1) the only way that I can think of to protect any equity that exceeds this "cushion" (in my opinion the percentage is to be defined by each investor individually based on their situation) is to pull it out and invest in something that creates value.

This can be another (cash flowing) property. Or maybe the stock market with a decent yield on investment (diversification!). Then again, both of these are currently somewhat toppish. While one will find real estate markets in the US that are less toppish than others, one might not be able to or not want to invest there for various reasons. I'm in that boat. And in "my" markets I'm having trouble finding good deals when trying to follow the usual "number crunching".

So now I have a bunch of cash sitting in my account that costs me serious money in interest payments. Yes, I can deduct that from my tax bill (important thing for my situation) but ultimately it currently costs me money. Period. Then again, I did this to be ready to pull the trigger if a good deal shows up. And there will always be good deals at some point. Just got to be patient.

So now I'm looking into possibly using these funds for hard money loans to others, playing the interest rate spread game. This is usually short term and therefore, say over a period of 6 months, I should have covered my (annual) cost and possibly even made some money in the end while also having a half year gone by to see what the market has done, with new developments (liitterally) having surfaced.

One other thing that just now occured to me: what about investing that money into an empty lot. Lot's seem to increase more quickly in my area than some properties with structures on them. Go figure. But to a certain degree it makes sense: a building requires upkeep (= costs money), a lot does not (leaving aside some minor costs for e.g. infrequently checking on it). These lots are sought after (obviously depending on the location - as always), so selling it fairly quickly should not be an issue if the money is needed for a good deal. Maybe something to look into in more detail.

Otherwise I fully agree with what David Faulkner wrote.

Adam M. · Answer

At the end of the day cash on the balance sheet is the biggest protection. As long as you can afford the financing the bank will not foreclose. Ride it out. Had a family member take a $300k hit on their appraisal which amazed the banker as well as my brother who has 15yrs experience as a commercial real estate appraiser.

Jack B. · Answer

Retire and become a full time investor.

Barry H. · Answer

JACK - Very interesting muse - one I have myself from time to time.  The fact you have made it already is great news and reflects that you don't really need anyone else's input on attaining growth.  Every one of the options you describe will protect your equity/cash.

I would be more interested in understanding what you plan to do with 2, 4 or 8MIL?

How to protect equity from next crash?

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