The stock market has officially entered Bear Market territory and now analysts are wondering how far down it’s going to go. Thankfully, real estate remains a smart investment in 2020 and beyond.
Why Real Estate Is Still a Good Investment
As absurd as cap rates have gotten in real estate—and they are absurd—our space is definitely the “cleanest dirty shirt.”
You can find good deals and create value, rather than remaining subject to the whims of market forces beyond your control.
Would you rather own a 4 percent cap high-quality apartment that has potential for growth (it may be a 6 percent cap in five years) or invest in a corporate bond that has a yield to maturity of 2.8 percent. Plus, if interest rates rise, the value of the bond will be slashed.
How about some stock in the S&P 500, with a dividend yield under 2 percent and valued at levels last seen in the dot-com era?
Despite ultra-low cap rates, a case could be made that, as long as capital markets continue to demand yield and have a risk-on mentality, cap rates could compress further.
There are certainly ways for you to get your face ripped off in the real estate game. Generally, here is how to avoid that gruesome outcome.
Make no mistake, I do feel that the real estate market is frothy. I think a lot of the easy money has already been made, and good deals are hard to find. There are plenty of ways to lose money in this market.
An important but often under-appreciated point to make here is that risk preference means everything. Regardless of the fundamentals, with cap rates this low, if for any reason investors begin to put a higher risk premium on assets, cap rates can suffer. You don’t necessarily need declining rents or oversupply for this to happen.
Simply, the broader capital markets perceiving and pricing risk differently would be sufficient to impact real estate prices negatively. Deep pessimism in the stock and bond markets, or the broader economy, can spill into real estate, even if rents are on the rise and the supply-demand balance looks strong.
How to Not Lose Money in Real Estate
Moderate, Long-Term Leverage
Putting high leverage on a deal is the fastest way to lose your money. In a situation where market values are impaired and you have an otherwise appealing asset, your main risk will come when refinancing the loan.
If you start at an 80 percent LTV, it doesn’t take much in the way of rent declines or cap rate increases to put you in a position where you’ll soon be giving the keys to the bank. Resist the urge to use short-term debt at high leverage points.
A widow-maker is a real estate deal where there is a component of the deal that can completely wipe you out. An example here would be a high-cap rate, retail net lease deal. It may provide great cash flow for a few years, but if you lose the tenant, the likelihood that you can replace the rents, especially without paying through the nose for tenant improvement (TI), is very low.
This kind of deal can wipe you out. You’re counting on one event—a lease renewal—to make or break the investment.
Source – Bigger Pockets
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