Navigating a Cooling Market
Updated: Mar 14, 2019
Many top investors are positioning themselves for an upcoming correction in the market. Here are some rules to follow to mitigate risk if buying at this point in the cycle:
Buy for Cash Flow
Make sure your asset is spinning off plenty of cash to the point that you can experience a year at double the average vacancy rate and still be cash flow positive. Know your break even occupancy, compare it to the average occupancy rate from the last recession in your market, and be sure you feel comfortable with it
Long Term Permanent Debt
Look for Financing from the likes or Freddie/Fannie who offer 30 year amortization with 10 year terms. Be very careful with bridge loans at this time. I repeat: Be very careful with bridge loans at this time. Refinancing in a soft market can leave you in a very bad spot if you are not careful. If you do go that route, refinance into long term debt as quickly as possible.
Liquidity wins when things get tricky. Raise plenty of capital up front and have reserves for any of your current properties.
Do Not Over Leverage
Some experienced investors are purchasing at 65-70% LTV (Loan-to-Value) instead of the normal 75-80% to give them the extra cushion. What this means is that they are leaving in more equity in their investments to mitigate the risk of being upside down if it becomes necessary to refi/sell in a down market. This also means that with a larger down payment, the monthly debt service is less, thus increasing cash flow. Finally, from a lender's perspective, lowering the LTV percentage increases the DSCR (Debt-Service Coverage Ratio).
If things get scary, do NOT stop implementing your preventive maintenance plan, as that can lead to a downward spiral. Maintain the property and begin implementing strategies that promote tenant retention before you need it.
Buy in Fundamentally Strong Markets
The temptation is to chase yield in speculative areas without a strong local economy, but don’t fall for it! These types of properties typically only trade when the market is nearing the top, making it a challenge if forced to sell. In addition, these are the areas and demographics that are typically hurt the worst during a downturn. Economic occupancy will suffer, and the asset can be very difficult to sell if forced.