Navigating a Cooling Market

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. 

Adequate Reserves

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). 

Manage Well

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.

Rehab Almost Finished on First Purchase

It's been almost 6 weeks from my purchase, and as planned, the renovations are set to be complete today.  I've chosen to go with a local property management group and secured insurance for the property.  

For the insurance, I am getting a 500k umbrella policy with a housing value of 150k (about 15k above what I expect my appraisal will come out to be) for about $900/year.  This is a bit more expensive than I initially budgeted for in my calculations, and is almost identical price to the property that fell through previously (duplex in Pittsburgh).

Here are some update photos. It is coming along nicely!

In regard to next steps.

Near term:

We will get all utilities accounts set up and I'll be having an inspection done on the final product (regular, termites, and radon inspections). Once those are complete and any issues addressed, the property management group will begin finding tenants for the property and I'll begin cash flowing!

Longer term:

I have been investigating various ways to get my money back out of this deal as quickly as possible, ideally before the seasoning period (generally 6 months after purchase). There are some interesting options, such as delayed financing. Most of them look like they'll be much more expensive than they'll be worth and also are a bit more risk. With today's cooling off market, I'd like to stay as risk adverse as possible. I will make a separate blog post on the options available in the future. 

Most likely, I'll just cash flow without any mortgage payment (i.e. double the monthly cash in my case) until the 6 months are up, at which point I'll finance the property.  I'm already a few months into the seasoning, and it takes a while to establish a relationship with a banker and setup the finance anyway, so at the end of the day I won't be waiting much longer than I originally anticipated.