• Mon. Nov 28th, 2022

Why a bear market shouldn’t scare off real estate investors at all

ByWillie M. Evans

Sep 2, 2022

One of The Motley Fool’s main investing principles is to focus on the long term. Don’t speculate on short-term moves and don’t let dips during bear markets scare you away from a stock that still has good long-term prospects. These same arguments, plus a few others, apply to real estate investing.

Let’s see why a bear market shouldn’t scare real estate investors away from business as usual.

Image source: Getty Images.

The price doesn’t really matter

It takes a long time to invest in stocks because new prices are constantly flashing you, to train you not to pull the trigger and sell when the price drops. Real estate investing is different – there are no flashing prices and pulling the trigger can take months. However, the argument is the same for both types of investment: if the economics of the company are still strong, the current price does not matter.

As long as you have a good loan-to-value ratio, can keep the property occupied, and can keep paying off the mortgage, short-term declines in house prices don’t matter much. The bank won’t worry unless the price drops an incredible amount and usually falling house prices follow an increase in rental demand so rents probably won’t drop as much .

The key is that you don’t have to sell the property. You can hold onto it through changes in the market price (and you wouldn’t even know exactly what’s happening to the price without getting a valuation) and still collect cash flow until prices recover, which they will in almost all cases. Case.

That said, consider increasing your reserves so you can withstand vacations or rent cuts. Keeping your mortgage current and being able to pay your taxes and insurance are essential for long-term investors.

You are not here for capital appreciation

Another twist on the argument that prices don’t matter is that you shouldn’t invest in real estate for capital appreciation in the first place. There are four ways to make money investing in real estate: capital appreciation, rental income, debt repayment and tax avoidance. Of these four, capital appreciation may have the least impact on your returns.

Real estate prices simply don’t rise as much as stocks over the long term. When you buy a rental property, most of your gain comes from using leverage and paying off debt by someone else, and then possibly generating a fair amount. cash flow from the property. Let’s say you buy a house for $500,000 with a 20% down payment and over time the tenants pay off the mortgage for you. That’s an initial investment of $100,000 and a gain of $400,000 from debt repayment, plus any change in property value.

It can be an opportunity

In most places, real estate has had good years before 2022. Where I live in Utah, prices have increased by more than 150% from 2015 to 2021 in some areas. This makes it difficult to find values.

For example, the popular BRRRR (Buy, Rehab, Rent, Refinance, Repeat) method only recommends buying properties that have a cap rate of 8% or higher. The capitalization rate is calculated by dividing the cash flow generated by the property by the price of the property. For comparison, if properties were valued at a 4% cap rate – which was typical last year – that means they would either have to sell for half as much or generate double the cash flow to operate. with this investment strategy.

The BRRRR method is, admittedly, a distressed real estate strategy, but a cap rate rule is good to follow. If you make sure to only buy properties with a 6% cap rate, for example, you will ensure that you always have enough cash to pay the mortgage and other fixed expenses. It’s hard to find properties that can meet this hurdle if cap rates are low for the overall market.

If prices start falling now, valuable properties could finally hit the market.