by Tod Snodgrass
Those who cannot remember the past are condemned to repeat it.
Whether you are a relatively experienced real estate investor (REIer), or provide services/products to the investor-related real estate trade, let’s face it: we are all in the same boat. When the larger REI universe prospers or falters, our individual boats rise or fall on the same financial tide. And right now, the REI tides over the next couple of years do not look that favorable. Many financial indicators are showing that the real estate market is slowly turning south. The next downturn will hopefully not be as draconian as what we all went through in 2007-2010, but it is always wise to prepare for the worst, wish for the best, and hopefully we all come out of this in fairly decent shape.
Some of the hallmarks of the RE downturn of a decade ago was the access to easy money; that tended to inflate housing prices. Many REIers leveraged themselves to the point of being overextended. Then when the market turned down, they found themselves in a very vulnerable financial position. Rehabbers often wound up stuck with properties they couldn’t sell (for lack of buyers). Landlords suffered because when tenants lose their jobs, they often cannot afford to pay rent. Flippers were afraid to make offers because they didn’t know if the prices were going to keep dropping over time—and they often did.
This doesn’t mean you should stop doing what you like to do best: REIing. Far from it. What this is about is reducing risk as much as possible, while still engaging the market as an active investor. What follows are some strategic concepts and tactical ideas for weathering the gathering storm. Accept the best, reject the rest.
1. OPM. Decrease how much of your own money you can/will commit to deals, and increase the use of OPM (Other People’s Money). As the old saying goes, Cash is King. Start thinking about holding your own cash back as a rainy day reserve, i.e. for emergencies. OPM can include: private debt or private equity; Joint Venture deals; “Subject to” funding; seller financing; seek out investor-friendly sources who will provide 100% of your flip funding needs.
2. Deleverage. During normal times, it is wise to leverage as much as you can to maximize ROI yields. However, if and when the market does turn, you might want to give serious consideration to reducing or even eliminating (most or all of your) investment-related debt. Deleveraging can include: selling off assets for cash; bringing in an equity partner to pay off any debt. Another idea: Consolidate from multiple properties with debt on each one, to fewer properties with no debt on any of them. In this way, you will wind up with no debt that the bank can hold over your head. If needed, when you have no bank debt, you can even temporarily reduce your rental rates, in order to keep good tenants, then raise them down the road when the economy improves.
3. Pursue lower LTVs. Shift from 65%-75% vs. 30%-35% LTVs. Put greater bid emphasis on properties where the owner is DMF: Distressed, Motivated and Flexible. These are usually off-market (not on the MLS) properties where the owner is facing obvious and serious problems such as: in pre-foreclosure, clouded title (tax liens, law suit/lis pendens, probate, etc.), divorce, job loss, disability, etc. Find lower LTV/DMF properties using: bird dogs/property scouts; “driving for dollars” looking for run down properties; “dialing for dollars” (answer ads that use wording such as “fixer upper: or “needs TLC”), etc.; seek out investor-friendly realtors who send you their “back pocket”, low-LTV property listings.
4. Offer an equity incentive. If you need to sweeten the pot to get say, a DMF homeowner to sell you their property, offer them some of your future (backside) profit (once you have successfully sold their property), in exchange for a “front side” discount now. FYI: This of course assumes the homeowner still has enough equity remaining in their property to make it worth your while to invest in their property in the first place.
5. Switch from fix/flip to straight wholesale contract flips. They take less time, you make your profit faster, they reduce your risk, and you can do more deals in a shorter period of time.
6. Reverse flipping. Instead of putting a property under contract, and then trying to find a buyer for same, the process is reversed: First you find the end buyer, then fill their request with a property that you go out and find, and put under contract. Think of it as pre-selling.
During a looming real estate downturn, the key is risk management. In this case, you may want to consider trading some potential upside profit in order to reduce downside risk. Each deal is unique. While it is obviously impossible to remove all risk, it is possible to reduce it substantially via calculated and well thought out strategic and tactical techniques. Good Hunting!
What We Do: Quickly provide short-term, first position, private capital funding, in smaller amounts, on a cash-on-cash investment basis, to real estate investors.
Contact info: Tod Snodgrass, email@example.com, 310-408-7015