Should you buy real estate when stocks are plunging?
The year has not been good for stock market investors. Of course, for those with a long-term penchant for stock picking, that’s a good thing: it’s easier to find bargains when other investors head for the hills. Single-tier shares are now value shares.
Is it the same for real estate?
Property prices have yet to take the same hit as equities, but there are signs that it is coming. That said, I think now may still be a good time to buy real estate, as long as the following three things are true: you find values, you have plenty of reserves, and you keep a long-term perspective. Here is an overview of each factor.
1. How to find value
Value is key in equity and real estate investments. You might find the best multi-family building ever, but if you overpay and can’t even pay off your debts with the cash flow, you might suffer a loss. And after a few years of gangbuster comebacks in real estate, there aren’t many values left.
Examine the cash returns of potential investments. Calculate what your cash flow from the property would be and divide it by the down payment. Cash-on-cash yields are similar to cap rates but factor in funding, so your cash-on-cash yield should be higher than the cap rate. You can compare this yield to the dividend yield of a real estate investment trust (REIT).
Set a cap rate threshold and don’t buy if you can’t hit that hurdle. You can get creative – if a property hasn’t performed as well as it could, figure out what the market rent would be and use that in your analysis. Also remember that any deferred repairs or maintenance you take care of must be added to the down payment amount, as this is an investment you are making.
2. Maintain sufficient cash reserves
A decline in stocks doesn’t necessarily mean a recession will follow, but it’s good to be prepared just in case. If the stock market, inflation, supply chain issues, and labor shortages cause some level of economic recession, you could be stuck with long periods of vacation.
If this happens, you must have reservations. All real estate investments have fixed and variable costs. Fixed costs are things like property taxes and mortgage payments, and variable costs are things like property management fees and utilities. If no one is occupying your property, you will not have to pay the variable costs, but you will still be responsible for the fixed costs.
Reserves are the commercial equivalent of a rainy day fund. Most of the time, they sit idle in a bank account and don’t earn much interest, but when you need them, they’re a lifesaver. A good rule of thumb is to keep around six months supply at all times. Calculate your monthly fixed costs and multiply them by six. If you’re very worried about the economy, keep a full year. It may also be a good idea to determine if there is any deferred maintenance (like a furnace that will need to be replaced soon) and start saving specifically for that.
3. Invest for the long term
In the stock market, it is difficult to have a long-term vision. Every minute, the market shouts a price at you. If the price of a stock has fallen by 60% or even 80% in the last year, it becomes very difficult to stay the course.
Real estate investing just isn’t as active. Maybe your neighbor who has a similar house will sell, and it’s 10% less than what you paid, but who cares? As long as you have good funding, if any, it doesn’t matter. Keep the place rented to continue generating cash flow and paying off debts. If you’re making payments, the bank usually doesn’t care if the price goes down.
In real estate investing, building equity and generating cash flow is what matters. You are not buying a rental property with the intention of selling it. You buy it to collect rent and use it to pay off debt. If you can do it consistently, the market price just doesn’t matter.