Over the past couple of years you may have noticed everyone has become a real estate investor! Real estate investing is not a new concept. People have been investing in real estate since the Louisiana Purchase! So why the sudden influx of people wanting to quit their jobs, purchase real estate, and travel the world?
In short, Q4 of 2019 the federal reserve lowered their interest rates to 0%. The federal funds rate is the rate a bank pays to the government in order to loan you money they borrow from them. A strong economy coupled with these low interest rates meant that many people could qualify to purchase real estate in addition to their primary residence. This created an extreme amount of demand and for nearly 2 years if you bought or built a property you could sell it for substantially more than what you paid for it. Over that 2 year period the equity in people’s homes more than doubled!
Check out the chart below to get an idea of just how much cabins in the Smokies have appreciated over the past 4 years.
|1 Bedroom Cabins||2 Bedroom Cabins||3 Bedroom Cabins||4 Bedroom Cabins||5+ bedroom Cabins|
If you are still having a hard time understanding what that means; let me say it like this. For the past two years the odds of investing in real estate and making a return would be similar to going to Vegas and playing Black Jack while having the odds over the house! Not the case anymore…Starting in January the federal reserve has taken an aggressive approach to fighting inflation by raising interest rates over 3% in the first 3 quarters of 2022. In short, the house just took the odds back!
So, in this shifting real estate market with a recession looming how can you make sure that you will make money if you choose to invest?
Control your expenses – The fastest way to profitability is to control your expenses!
When investing in Real Estate during a recession there are going to be a lot of things you cannot control. One of the things you can control is your expenses. As an investor it is your job to know your numbers inside and out and use the resources and relationships you have to drive down cost, and create better profit margins. Controlling your expenses will make you more money, mitigate risk, and give you more options/pathways to profitability no matter if you hold the property or sell it. Here is a quick list I made on things every investor should be doing to better control their experiences.
- Have and keep a budget – This is the first step to success and it doesn’t matter if you are flipping houses or holding them for the long run. You should know how much money your properties will produce and how you will be spending the income to maintain and improve the property. Obviously this can be a little more challenging on properties that do not have a fixed income but the most important principle is knowing the cost associated with your property and having the best plan in place to address those cost. Also, for those who are brand new to investing. If you have never budgeted before the best place to start is with your personal finances. You should not expect to have the ability to be disciplined with your real estate finances if you are not disciplined with your personal finances. To start budgeting I would suggest checking out YNAB(You Need A Budget) and getting started today!
- Shop your rates – You control your rates…well sort of. You don’t really control the rates but most people do not realize that there are thousands of dollars difference between companies. In that sense you control if you are getting the most affordable mortgage and insurance rates available. I do not want to lead you astray so it is worth mentioning that not all companies & policies are created equal. You should also do your own due diligence in understanding who you are working with and what you are being offered. There are several places you can start your search for better rates. One quick google search and you will be well on your way to gaining a little control over this area of your expenses. If you still do not know where to begin we would suggest Bankrate.com. Bankrate will allow you to search both mortgage and insurance rates and they provide a lot of great information about average rates and the overall trustworthiness of certain companies.
- Find the right property manager and self manage your short term rentals – Like rates property managers are not created equal and certainly do not charge equal amounts. While long term rental property managers typically charge 10-15% of the gross income while STR property managers charge anywhere from 15% to 40% of your gross income! For long term rental properties we always suggest a property manager and can guarantee they will be an asset to your business. That is unless you enjoy cleaning up a strangers sewage after they clogged up the master bathroom toilet and swore it was a septic issue. STR’s are a different story. In the world of Airbnb, VRBO, and incredible technology platforms almost all of the processes for short term rentals can be automated. Most of your time will be spent communicating with cleaners and the occasional handyman. For that reason it is incredibly difficult to suggest giving someone 25% or 35% of your gross income! Keep in mind that while self managing a short term rental is our suggestion and can open up the opportunity for increased property; mismanaged short term rentals will perform poorly, often times have a lot of deferred maintenance, and will cost you money. Self managing means that you are responsible for marketing the property, maintaining the property, and providing an exceptional service for your guest. It can be a lot of fun and very profitable but is not for everyone.
- Reduce your taxes – Deductions, Depreciation & Cost Segregation Studies, and Capital Gains – Taxes are the biggest expense investors face. Most investors work with an accountant who will make sure they pay their taxes in full and on time. Every investor needs a good investor on their team but they also need a good tax strategist who will help them understand all the tools available to them. Having a good tax strategy is all about building your portfolio while decreasing your tax burden. I like to think about this as learning how to use your money in the most efficient way possible. Fore more information about some of these strategies we have listed to good articles below. Also make sure to talk to a licensed tax professional to determine the best strategy for your specific situation.
- Property Maintenance Planning – This is one of the areas we have started to pack our proforma as we appear to heading into a recession. The best way to think about property maintenance is in relation to your health. If you know you have a health issue and you keep ignoring it, it doesn’t go away. It continues to grow, causing more issues, putting you more at risk, and in the end costing you much more money to fix it. Allowing room in your preforms for property maintenance will allow you to keep your cash flow projections in tact while charging at the top of the market rate because your property is in good condition. Also, ignoring needed maintenance and deciding to sell will cost you as well. Future investors are not going to pay you for value they are going to have to add. In our properties we withhold anywhere between 5-10% for property maintenance. To date, we have not encountered a problem with any property that this withholding could not cover. Simply put it your business account, let the money continue to build up, and don’t sweet it when your property needs maintenance, right the check and move on.
- Monitor and adjust your rates to keep up with the market – There are a number of things a investor should review on a yearly basis; property values, insurance rates and value adjustments, and future cost projections are just a few. One of the most important things a investor should review is the current market rates. If you are not updating your rental numbers to reflect the current market rate then you are losing money. In the current climate there has been a lot of talk about sharky landlords taking advantage of inflation to charge higher amounts. One thing that is rarely discussed in the increased risk of investing in the current market. You should not feel guilty or be guilted for charging the market rate for your property. You took the risk, you are responsible for all the cost associated with your investment. At the end of the day, if someone cannot afford the market rate for a property then they cannot afford the property. Quit giving up your profit margins because of pressure you receive from people who do not invest and do not have your best interest in mind.
- Consider a partner – When I first started investing I was determined never to have a partner. Why? I saw them as a risk. A uncontrollable. Another variable I had to consider. So what changed? Well, I quickly realized that I can get a lot more done by working with people gifted in areas I am not. I still believe partnerships are a risk and you should be very careful who you partner with. To date I only have 2 partners and both of those partners bring value that I could not otherwise bring and by working together we mitigate a large number of expenses to produce better cash flow. Those increased profit margins mitigate a large amount of risk and allow us to continue investing through uncertain times. Think of it this way. By bringing certain people in as an equity partner on a project I can decrease my up front expenses in exchange for equity. This greatly decreases the cost of a project and those increased profit margins gives us the option to decrease the price if necessary or even hold a property we were planning on selling.
Much like the pandemic exposed the health of our relationships, the looming recession will expose the health of our financial strategies. Those who are disciplined, control their expenses, and give themselves a variety of options will have the best chance at success. Those who continue forward like they have in the past couple of years assuming that it will all work out will be sadly mistaken. The house has taken the odds back. It doesn’t mean you can’t win. It does mean that disciplined investors will have the best chance at winning.