For my first article on BiggerPockets, I’d like to address what seems to be the most contentious issue in real estate right now: the coming crash.
Let me start by saying that I don’t know when or how the next recession will unfold, how severe it will be, or what will be impacted most—and neither do you. That is largely irrelevant. Whether a correction occurs in three months or three years, most investors would agree we’re near the top of the cycle.
That said, it would be a mistake to sit on your hands, hoping for some horrendous crash that allows you to swoop in and pick up properties at pennies on the dollar while the rest of us make money. There are ways that you can continue to grow your portfolio now while protecting yourself and your investors from a lot of the downside risk that will come with the next cycle.
Before I get in to the details, let me quickly hit you the highlights of where we are in the cycle and why a correction is looming in the shadows like a TMZ reporter in Justin Bieber’s trash can. Then I’ll hit you with a little advice.
The Federal Reserve
This guy is writing about the Federal Reserve?! Yawn. I get it. But understanding what the Fed has been doing is probably the most important factor to grasp if you want to know what is happening in real estate.
It would take an entire book to really get into the weeds on the Fed, but here is the short version:
Interest rates are like the one ring that controls them all when it comes to investing. Lord of the Rings reference? Does this guy know how to party or what?!
When the Fed keeps interest rates artificially low, investors start to make bad decisions based on faulty information. They start taking on excess risk. Why? Because yields on traditionally “safe” assets are too low. The market is distorted. So they stretch themselves, and everyone shifts out on the risk curve, buying riskier assets and chasing yield. Speculating.
This is what caused the housing boom and bust. The other stuff everyone blames it on—greedy banks, no doc liar loans, ratings agencies, hedge funds, etc.—were symptoms of the greater disease, which is free money sloshing around capital markets, desperate for a home.
Like me in college when it came to tequila, the wise overlords at the Fed have had a hard time learning any lessons from the past. For the better part of a decade, we’ve had basically 0% interest rates and QE out the wazoo. Holding treasuries won’t get you anywhere, so everyone has been pushed into yield seeking speculation, chasing higher returns anywhere they can find it. That includes real estate.
Investors are indiscriminate in their choices today. They see little need to obtain much premium for investing in riskier assets. A 1980 value-add deal with eight-foot ceilings is trading very near the cap rate of a 1995 value-add deal with nine-foot ceilings. If you’re an active investor out there, I don’t have to tell you how crazy people are getting when bidding on deals. It’s ridiculous.
The good news is, even in a pretty severe downturn, solid multifamily properties tend to hold up well. It is usually not a catastrophic decline in income that will kill you; it is overpaying and poorly structuring. If underwritten and structured properly, you can make it out on the other side relatively unscathed, should the market turn.
So, what should you do? I don’t know, I’m just a guy on the internet. But here’s what I would do:
If you are new to investing, keep your day job. Keep working, enjoy your stable income, and build up some valuable experience so you can get aggressive when there is blood in the streets. But maybe don’t jump in with both feet and risk everything. Partner up and do a couple deals structured as described below. If you try to buy a large deal from a reputable broker, you will overpay. Seriously. The only way they will ever award some new guy a deal in this market is if you…