Changing Markets, Adjust or Die

Do you remember companies like: Blockbuster Video, Borders, Pier One, Sports Authority, Toys R Us, etc.? These companies essentially cease to exist, yet at one time were of substantial size, sales, and locations. What happened? Change happened.

Changes within the markets and industries that they operated took place, and they either chose not to adjust, or chose too late, and as a result, they died. Could they have survived, and perhaps even thrived if they would have only adjusted to match the demands of the market? Maybe, probably, but they didn’t adjust to the winds of change, and they broke.

The winds of change are happening now in many markets, and the real estate market is most definitely one of them. The rise in interest rates and the increase in prices of almost everything, thanks to the increase in inflation, are influencing the borrowing ability of homeowners, and the lending guidelines of lenders from Main Street to Wall Street. Rates have doubled in a short period of time. The flow of capital has slowed down drastically at a swift pace. Property values, both single family and multifamily are beginning to slide downward. Change is taking place.

However, that doesn’t necessarily mean that everything and all businesses, including yours, must die. Many businesses survived the changes that killed those listed previously, in fact some new businesses were created just to accommodate the changes taking place, while others adjusted as needed to stay alive and even grow.

The choice to adjust with the changing market is yours. So, how can you adjust? It depends on the business that you conduct within the market. Let’s take a look at a few.

Multifamily investing

Multifamily operators find themselves having to adjust their underwriting with hopes of getting their projects to “pencil out”. In other words, to make numeric sense and be profitable. Previously they may have had an exit plan of selling the performing asset after 24-36 months of stabilized performance, when now they are adjusting to plan for 48-60 months (or longer in some cases) of stabilization before selling to be able to gain the returns that are sought for the overall project.

This means that they have to educate their LP’s (limited partners) that invest in their properties/projects that their investment will be tied up longer than they had originally planned.

Additionally, the operator may need to raise more capital than they were used to if the capital that is normally borrowed as part of the capital stack can’t be accessed as before, or at an interest rate that can make sense in the projections. If lenders lower their leverage (hence lowering the loan amounts in reference to the collateral’s value), then the operator might need to adjust to have the missing capital replaced by LP invested capital. This could be a challenge for some operators that aren’t already set up to raise additional capital.

Finally, the operator may need to adjust the methods that they locate new projects in hopes of gaining the assets (target off market properties, as opposed to listed ones) at a lower cost to make the numbers work in their proforma. Or perhaps even be forced to consider other alternative asset types to invest in such as mobile home parks (MHP’s), RV parks (RVP’s), self-storage, or other commercial style properties.

Flipping Properties

Flippers will absolutely have to adjust in order for their business to survive as the market changes. Why? Well, one reason why is because the rise in interest rates have lowered the number of homebuyers buying properties. This means that the average flipper might flip less properties per year, have their properties sit on the market longer for sale before gaining a qualified buyer, or both.

If the flipper is selling less properties, then they are earning less revenue, so in order to maintain the income goals, or close to it, they will have to make some adjustments. These adjustments might consist of: Stronger purchase price negotiations to gain the inventory at a lower cost per property; be creative in locating off-market properties with hopes of once more gaining the inventory at a reduced cost; sharpen their contractor and supplies pricing negotiating skills in attempts to gain the material and labor at lower costs in order to gain back some of the lost revenue of fewer flips or reduced property values.

Another adjustment that the flipper could consider is selling the rehabbed properties to landlords as opposed to homeowners. If the need for rentals continues to grow, as more renters flood the rental market in search for a home since they either cannot qualify to own, or choose not to, a supply of turnkey rental properties (single family or small multifamily) may be appealing to landlords looking to add to, or begin building, their property portfolio.

Wholesaling Properties

Wholesalers most often sell the properties to real estate investors that are either landlords, or flippers. Although they can sell to homebuyers, the greater amount of property purchasers buying from wholesalers are other real estate investors, as the property often may need updates that a homebuyer may not care to deal with. If the volume of homebuyers buying from flippers slows down as the rise in interest rates continue, the flipper may be buying less often from a wholesaler.

The wholesaler may have to adjust their potential buyers list to include more landlords than flippers and may have to adjust the condition of the average property to require less rehab if a landlord is searching for a faster time to rentable ready condition. Additionally, the wholesaler may need to adjust their property search methods to target potential pre-foreclosures if the job loss numbers increase as the economy surges closer to recessionary styling, and homeowners fall behind in payments due to loss of income.

Single Family to 4 Unit Landlords

The drop in the number of homebuyers will likely increase the number of potential renters in certain markets. This could result in increased rents since they are driven by supply and demand. The landlord may need to consider rental rate increases when leases are maturing and will have to keep their pulse on the local market average rental rates that align with the property type or unit size that they are offering.

The opportunity for potential rent-to-own or lease option considerations may become more plentiful as wannabe homeowners may see an opportunity to lock in pricing of a property that they are renting and would consider buying while property values may be lower in a down market and that they can capitalize on when the market values rise once more.

There may be more opportunities to buy additional properties at reduced costs if property values continue to lower as inventory continues to climb, so landlords may need to position themselves to be more cash rich, as well as lender friendly so that they can take advantage of buying opportunities as they reveal themselves.

Change is Happening – are you ready?

Without question the changes that occur in the market will require the real estate investor businesses operating in those markets to adjust. Some businesses may find the changes and the adjustments that they make to be favorable and more appealing, while other real estate investor businesses may find the changes & adjustments to be difficult and painful while necessary to be able to simply survive.

None of us have the ability to foresee the future, or posses the crystal ball that we wish was locatable, so the best we can do is try our best to keep an eye, and ear on what is taking place and plan for adjustments accordingly that align with our style of real estate investing.