How do investors prepare themselves for when the market goes down?

Question

Hello All,

For the last year or year and a half I have been hearing people (in person or online) saying that the housing market is bound to crash, with the inflated prices of most homes going down significantly. But then on the flip side I have heard of people saying that it's better to get started in real estate as soon as possible. It's obvious that you cannot predict every little thing, and there will be bumps in the road no matter the journey, I just don't want to buy a property just for it to lose a ton of value over the next few years.

Here's an example...

Say you were to buy a property for 250,000, and all of the sudden the market crashes and the property is worth 100,000. As an investor, what is the best way to go about this? Are there ways to prepare yourself? Is this just an irrational fear?

Any advice/insight on this matter is greatly appreciated, much love!

Nathan Gesner · Answer

First, it is unlikely to drop from $250,000 to $100,000. The more likely scenario is that you'll see property values drop back down to where they were before the market went crazy, which means a drop of closer to 50%.

Second, if you bought for the long haul, you won't care about a crash. My property values could drop to $1 and I would still continue leasing them, paying the expenses, and collecting the cash flow. The only way I get hurt is if I (a) try to sell the property, or (b) rent rates drop dramatically and I lose cash flow.

You know who will get hurt? Speculators that bought for appreciation. People that didn't crunch the numbers and bought properties that have to get maximum rent just to stay afloat. People that cashed out their equity in Property A so they could scale into other investments.

Basically, the people that will be hurt are the ones that bought using the guru techniques taught in most modern books and YouTube videos. A lot of people gained equity in 2018 - 2022 so they cashed that equity out and jumped into real estate. Many of them only have 1-2 years under their belt and have never dealt with a financial crisis, a really bad tenant, increased taxes/insurance/utilities, etc. When the going gets tough and they can't afford to keep up, they'll try to sell. If the market is bad, they'll sell for a loss.

Those that invested wisely will be fine, can ride out the storm without much effort at all, and will be poised to pick up some sweet deals after the smoke clears.

Daren H. · Answer

This sounds a lot like trying to predict/time the market. I don't even look at the real estate market as a national housing market. I focus on my market conditions (my market being the market you are buying in) which could be doing things differently from other markets. Obviously, things like U.S Government policies and economic levers they pull have an impact and ripple effect (think about interest rates as an example). I can't tell you anything about what, when, or how to predict a crash. If I could, I probably wouldn't be on BP typing right now. I will say this, don't be fearful. Study your market, the trends, economic conditions, control what you can control. Wish I had more for you.

Doug Smith · Answer

There's a cool chart I use sometimes when I do presentations that looks at housing prices over time. Don't do anything stupid, but I do agree with starting as soon as possible. From the chart below, lets take a look at the 2007/2008 crash. If you would have purchased a property at the very peak of the market and sold at the very bottom, you would be down 19%. The stock market is much more volatile than that. If, however, you would have put a renter in your property and held it for 6 years, not only would you have collected all that rent, but you would be up money. A housing crash only kills you if you liquidate when the market is down. Sure, it makes borrowing more difficult, but if you have the patience to ride it out, you'll be fine. I could go on forever on this subject, but this chart makes my point. Good luck to you!

Deanna B. · Answer

I was a real estate paralegal during the foreclosure crisis in Southwest Florida, which was the worst place in the country. We saw homes drop 70% in value at that time.

I would say the best investment is in your personal home, making sure it is homesteaded too.

I witnessed a lot of landlords take on all of the liability and have to go through bankruptcy while tenants took as much as they could from the property, even ripping the wires out of the walls. It scares me and I hope nothing like that ever happens again in our lives. The way I have prepared is by turning to syndications and funds. Typically takes less money to get in than a house, but commercial real estate funds give you a lot better diversification and also provide tax benefits. You have to choose the right ones of course. I am a big believer in diversification by location, asset type, and sponsors.

Scott Mac · Answer

How do investors prepare themselves for when the market goes down?

Some keep shoveling coal into the firebox of the locomotive as it rolls off the cliff.

If the cliff is deep enough, they are gone financially.

If the cliff is not very deep, they hold on as best then can and wait for the good times to begin again.

It depends on how deep your pockets are and how much equity you have and how "house of cards (row of dominoes) your portfolio is.

The hard stories are those who lose their own homes to bank repo due to downturns in the real estate investment market.

Like the three little pigs, build your house (investment portfolio) of straw, wood, or brick, all have differing abilities to withstand a storm.

Good Luck!

Rick Pozos · Answer

First, dont buy retail price. Buy a rehab from a distressed seller. You should have equity to begin with.

So the house is worth 250k, you should be in it for 200k MAX.

With a 200k mortgage at 5% or 6% you are probably going to pay about $1500 to 1600 per month. Rent should be at least 2k for a 250k house. If things go crazy down, it is worth 150k. BUT rent should still be at least 1k per month. This is WAY worst case scenario. Maybe you pay $500 per month for your rental property. Again this is like almost apocalypse situation.

Most likely, your 250k house that you owe 200k drops in value to 220k maybe 210k. Rent goes from 2k per month to about 1800 per month. Maybe you break even a few months here and there. No big deal. Over the next 10 years the value is going to be 500k and rents are going to be about 3500 per month. Time fixes everything. Hold on for the ride and dont sell.

Kevin Sobilo · Answer

@CJ Moulton, invest for cash-flow long term and then short term valuations affect you much less and much less immediately.

A classic C class rental has "durable income" because in times of economic turmoil with people looking to downsize people in B class rentals may downsize to C class if they need to but few C class will move to D class so demand remains strong!

If you are investing for the long term and have suitable long term financing in place even if valuations suffer you can chug along collecting cash-flow and barely notice! You only care when you need to sell or refinance but if your time horizon is fairly long then likely prices will have recovered or you will have paid down a mortgage sufficiently that you can sell no matter what the current valuations are like.

I consider market appreciation ancillary to my investing goals because I cannot control market appreciation AT ALL unlike cash-flow which I can by prudent management. In addition market appreciation as you noted can come and go quickly and also its expensive to get your hands on market appreciation because you need to refi or sell neither of which is free and selling triggers paying the tax man (unless you 1031 exchange).

Charles Carillo · Answer

@CJ Moulton

It is impossible to predict the top of the market or the bottom of the market. I would really focus on your investment strategy. If you are purchasing a small multifamily property that cashflows with fixed-rate debt, and you have a reserve fund, your risk is really minimal. Even if the property drops 60% in value (as you mentioned), it would still be cash flowing.

I purchased my first multifamily property in October 2006, then another one in October 2008, and so on. They were underwater for years but, they all cash flowed.

Eliott Elias · Answer

Holding a lot of cash.

How do investors prepare themselves for when the market goes down?

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