This is a chapter taken from the upcoming comprehensive guide titled, Market Cycles: How Investors Can Survive (+ Thrive) in a Turbulent Economy. If you would like to sign up for early bird access to this comprehensive guide, please sign up here.
Being a real estate investor for all economic seasons can be a superpower. Up market, flat market, or down market, we all need the best tools to operate our businesses in good and bad times. Trust me, there are opportunities in all markets; investors just need to get more creative.
What follows is an overview of the different tactics and strategies real estate investors can deploy to protect themselves and thrive in a downturn. Instead of closing the hatches and hunkering down, real estate investors can find significant opportunities in difficult economic times.
If you haven’t already, check out these other resources that will also help you become a better real estate investor in any market cycle:
- Real estate investing lessons from the Great Recession applied to 2020
- Defensive financial modeling for your real estate portfolio in a crisis
- 10 things real estate investors should do during economic downturns
Market cycles: Be liquid, and patient
During down markets, real estate holders who have thin margins are squeezed even tighter. Many of those didn’t perform the initial due diligence and proforma properly, leaving them with an expensive asset and tight income streams. These types of properties become available, typically at a discount, and can be an interesting portfolio addition for investors.
Patrick Carlisle, Chief Market Analyst at Compass notes that:
“Financial and real estate markets have always run in cycles. The savvy investor knows this and incorporates it into their business plans. They do NOT assume the up-cycle will last forever, so they prepare for recessions. And they know that down cycles don’t last forever either – and in fact, down cycles can be huge buying opportunities. Over time, the long-term investor in residential income real estate has reaped tremendous returns because of the extraordinary advantages currently built into tax law and because of trends in interest rates, demographics and rent appreciation. Barring extraordinary circumstances, the long-term investor simply needs to plan for the long term to see incredible financial returns.”
This is why liquidity during a downturn is critical. Not only to mitigate the risk of reduced cash flow, but to set yourself for potential acquisitions when the opportunity arises. This doesn’t mean sell everything and just be in cash, but it means that all things being equal, you should favor any model or strategy that keeps cash in your bank account.
How to locate opportunities: Network
Your network is your net worth. The wider your network, the more likely that off-market deals will flow your way. Giving your network the framework of the types of properties you want to acquire will keep you top-of-mind if they hear of any deals, or want to sell assets themselves.
On your real estate team, having your broker and realtor informed of your acquisition criteria is also critical during a downturn. They may see off-market deals or be able to give you advance notice before something is about to be put up for sale. These types of opportunities can be particularly lucrative as a seller may be looking for a quick sell over potentially getting a better price if the sale goes on a public listing site.
Deal making in a downturn: VTBs
Vendor take-back (VTB) mortgages are a great tool for real estate investors. A VTB mortgage typically works as follows, but can on take many different structures:
- Seller agrees to ‘take back’ a portion of a mortgage.
- Seller registers a mortgage on the property for the VTB amount in second position to the first mortgage.
- Buyer makes monthly payments to both the first and second mortgages.
The buyer agrees to a seller’s price of $500,000 for a 6-unit apartment building. The buyer then gets a first mortgage from a traditional bank for 80% of the purchase price. In this case, the first mortgage will be for $400,000, with the buyer having to come up with $100,000 down payment.
The buyer and seller agree to a VTB of $80,000, where the seller agrees to lend the buyer (from the proceeds of the sale) $80,000 with a certain repayment period and interest rate. Now, the buyer only has to ultimately come up with $20,000 to purchase the 6-unit building. Everyone wins.
This model works assuming the revenue from the rent will cover both mortgages.
Tough economic times leave some properties and investors in distress. They need to sell, or go into some form of foreclosure or power of sale. Under these circumstances, an investor is typically purchasing the property ‘as-is’, meaning anything wrong with the property will be your problem. This isn’t necessarily a bad thing, particularly given you’re getting a steep discount, but it’s worth keeping in mind for due diligence.
There are a number of ways to research and uncover distressed sales, here are a few:
- Look at tax sale websites in your state using google searches
- Ask at city hall where to find tax sale information
- Review foreclosure listing sites
- Talk to your agent and network about the best ways to find distressed deals
- Search online for “foreclosures” or “REO property”
- Search bank websites, such as Bank of America
- Check out paid foreclosure listing sites like RealtyTrac
- Reach out to local estate agents, or search for estate sales in your area
Although down markets do present challenges for real estate investors, for savvy ones they can be a wealth of opportunity as well. These are some strategies to consider during a market downturn to be opportunistic and add income-producing assets to your portfolio at a discount.
- Keep your network growing and informed of your deal criteria
- Nurture your relationship with your agent and broker so they know you’re open for business
- Understand the ins and outs of VTBs
- Keep an eye out for foreclosure and power of sale opportunities