Waiting for the Downturn

I grabbed coffee with a guy last week who is a high-income earner and has significant amounts of cash sitting on the sideline.

He had been saving for several years and looking for the right investment to jump into. Real estate intrigued him, but he was wanting to wait until the next big downturn before jumping in. He asked for my opinion and I was candid in telling him that I think timing the market is rarely advised and almost always a horrible idea. Here is why.

Learn From Downturns

Listen to enough pundits and podcasts and you will eventually here people fixate on the imminent downturn that will destroy everyone. Predicting a downturn is like a broken clock predicting 6:00. Eventually you get it right but that does not mean you get to profit from it.

Knowing how assets function in a downturn, what protects you from loss, and learning how to mitigate those losses is an important component to any investing strategy. Protection against a downturn is important, but this knowledge also helps you protect against the unexpected. There are a lot of other elements that can go wrong in an investment. Making sure the numbers line up means that you can weather all sorts of storms.

Instead of waiting for the downturn, learn what happens and how to protect yourself from a downturn.

Longer-Term Financing Protects You

When I invest I want to see long-term financing. Anything less than five years is a risk, and seven years is my personal limit. I prefer to see opportunities with financing terms that are +10 years.

I do this for two reasons. A longer term on financing means that if a downturn occurs within the next 24-36 months, the economy will have plenty of time to turnaround before my investment needs another financing solution. Most commercial loans last between three and 20 years. They often include an interest only period, and then they move to an amortization schedule that is usually 15 or 20 years. A seven-year balloon loan might be structured so that the first two years are interest only, the next five years are interest and principal on a 20-year amortization schedule, with the remaining balance being owed at the end of the seven-year term.

More years equals more security.

The second benefit to a longer-term loan is more equity. I naturally pay back more principal on a ten-year note verse a five-year note. If I am caught in the middle of a downturn when it comes time to refinance, the more equity I have the safer bet I am for the bank to loan me money.

Be Picky in Your Investment

It is getting harder and harder to find great deals in this market. Set your investing threshold and stick to it. I want to see +5% cash flow starting in month number one, and I want to see a rate of return (IRR) to be well above 15% (preferably above 20%).

I make more money in any market by being selective. I also sleep better at night knowing that my stronger investment can take more stressors than an investment with an IRR of 10% or 14%.

I think this is the intelligent investor’s version of staying on the sidelines and waiting for the downturn. Maintaining high standards means that you will naturally have fewer opportunities as the market reaches its high because fewer and fewer opportunities are going to meet your standards.

Be Careful at the Top of the Class

Apartment complexes are usually rated as A, B, C, or D class properties, and inside each class properties can be rated with a plus or minus.

Do not get caught up in the details around the ratings. There is a lot of debate around what these mean and what does or does not qualify as an A-class verse B-class property.

What is important is knowing generally where you feel comfortable investing.

Personally, I would rather avoid investing in A+ level properties simply because if a downturn occurs and households begin to downsize, A+ properties will be the first properties to feel the strain. This is not an absolute rule that I follow. Any investment can make sense at the right price point. I just need an extraordinary price point to jump into higher-end properties.

Being on the Sideline Comes at a Cost

For over half a decade the pundits have been expecting a downturn. I have invested in over ten syndications in that time, and they are all performing. Being on the sideline would have cost me thousands of dollars in income.

There is a cost in investing that economists call opportunity costs. When a business or individual selects between multiple investments (and keeping cash in the bank is an investment), the cost associated with missing out on profit is called the opportunity cost. An investor needs to factor in the opportunity cost for sitting on the sideline.

Circle back to keeping investment standards high. If I refuse to compromise on my standards for an investment, then I should keep my opportunity cost low regardless of the market. Passing on a low IRR investment means that I have no opportunity cost when a better investment comes along. Deploying my cash when a great investment comes along means that I do not suffer the opportunity cost by not investing. This works in any market.

Deploying Capital Gives Knowledge

Most of the lessons that I have learned in investing have come from investing. I would have missed out on an extraordinary amount of wealth and knowledge if I had sat on the sidelines for the past five years.

I can read all sorts of books, read blogs, and listen to hundreds of podcasts to fill my head with knowledge, and doing this is valuable.

However, nothing matches the application of that knowledge. Nothing matches applying that knowledge when emotions are involved.

I have been able to refine my investing strategy in ways that never would have happened had I waited for a downturn.

Now, when the downturn comes, I have the tools and skills to crush it.

Maintain Perspective

I have never had a massive amount of money invested in the stock market, but there have been many days where I have lost thousands of dollars in a single day.

I rarely got upset because I knew that the market would, eventually, make it up. I also never invested more than what I could afford to lose in a single investment.

Real estate and every other asset work the same. If you are worried about losing too much money in a single investment, you are probably investing too much.

You also need to consider your investment compared to your net worth. Never invest more than you can afford to lose.

Consider Syndicated Real Estate to Protect Against the Downturn

Buying my own rental property may take well over $50,000 and now I am on the hook for making a bank payment each month even if the property is unoccupied. I am required to know my local tenant/landlord laws so that I do not get caught up in a lawsuit. I am required to expeditiously fix anything that breaks. This can open me up to some big financial risks if I am not careful.

Compare this to syndicated real estate investments. There are a lot of syndicated opportunities that I have invested in for as low as $25,000, and I get the upside of investing in property where if someone moves out I still make cash that month because there are +90 units bringing in rent to cover the one vacancy. If something breaks, the sponsor has maintained capital reserves to make those repairs. If for some reason the investment falls apart, the bank will not be able to come after me to make up the difference.

Syndicated investments allow me to invest less and take on less risk while experiencing similar upside and tax benefits to doing it myself. Syndicated real estate investments allow me to continue investing passively while launching more active real estate ventures.