There are a number of reasons why people are still buying, some good, some not so good.
1) Funds with cash - they are incentivized to deploy cash since holding cash will drag down overall returns
3) People who have access to deals whether they are just very good at finding off-market deals or they have already done so many deals that they are getting better deals from brokers
4) Whilst some markets are very hot, others are less so. If you are local you likely have an advantage and this can help you to find good deals
5) People who haven’t been through a real estate cycle and are less risk averse than others that have
At the end of the day it is impossible to time the market, I know this because I used to trade financial derivatives for a living, I spent my life on a trading floor and I have worked with numerous hedge funds. Even the best of the best are unable to consistently predict market cycles. It is also very expensive staying out of the market in the hope that your timing will be perfect enough to get a deal that offsets the lost returns. In my opinion it’s better to deploy a defensive strategy if you believe that the market is overvalued so that you can stay invested but with lower risk.
Here is a 12 step program to reduce your risk
1. Focus on the right asset – multifamily real estate is popular during times of uncertainty because people have a preference for renting during these times and because it is valued intrinsically it is less prone to large swings in sentiment which can impact the value of single family homes.
2. Invest in real estate - it represents diversity in your overall portfolio so if you are taking cash out of equities to invest in real estate then you are potentially building yourself a portfolio that is positioned for excess returns with lower volatility. For a real life example take a look at the Yale Endowment portfolio.
3. Pick the right market – not all housing markets were impacted in the same way during the last recession. If you select a market with population growth, jobs and wage growth, a balance between supply and demand and a diverse range of employers you will do just fine. If you invest in a stagnant market with just one big employer then you will be exposed
4. Buy for cashflow, not appreciation – this is a cardinal rule of real estate investing. If you have a cash flowing asset you can hold onto it indefinitely, if you have negative cashflow and are hoping for appreciation you will end up being a forced seller in a down market. We can create equity in multifamily real estate by investing in our assets to grow rent, improve vacancies and by cutting expenses
5. Avoid high end real estate – high end real estate always gets hit first in any downturn as people migrate from more expensive to less expensive homes. By focusing on class B/C properties we expect to see an increase in demand and in rental rates during any downturn
6. Lock in long term financing – lack of available credit was the downfall of many homeowners and investors during the last recession. By locking in our funding we can eliminate one source of potential distress and we can also 'fix' one of our major expenses by locking in the financing rate
7. Increase your cash position – there will be opportunities to buy distressed assets from people who were not prepared, but you will need cash
8. Reduce Leverage – leverage can be used to provide higher cash on cash returns however along with leverage comes greater sensitivity to any loss of income. If we reduce leverage we may get lower cash returns however we do increase our ability to 'stay in the game' and not be forced sellers should rental rates decrease or vacancies rise. Being a distressed seller during a downturn is not where you want to be
9. Be more conservative underwriting – multifamily properties are priced based off their current financial performance only. When we are underwriting deals we can plan for a downturn in our assumptions e.g. increase expected vacancy and decrease rents to avoid overpaying
10. Dispose of weakest assets – this is simple portfolio management, it's key to let go of underperforming assets to free up cash and credit required to buy better performing assets. Don't wait until the recession arrives to sell underperforming assets
11. Increase cash reserves – whilst this can decrease returns it is all about being able to weather the storm, cash is king!
12. Have a range of exit strategies – If it isn't a good time to sell then you do have other options with multifamily real estate, provided that it is cash flowing. You could, for example refinance to get your cash out.
Good luck!
