I was prepared for an unexpected downturn. Were you?
Every few years, something happens in the real estate market that throws it out of whack and devastates a lot of unprepared real estate investors. This usually happens during downturns when unemployment rises to high levels, like from the periodic recessions that are simply inevitable or a rare depression or an even more rare pandemic.
Unemployment hits hardest at the lower and medium income segments of the population, since they rarely have sufficient money cushion (or none at all) to absorb loss of income.
If you own rentals, many of these lower and medium income households are your tenants and when sheepdip happens, they may have enough cushion to pay for food, but maybe not the rent. If your tenants can’t pay full rent, you still have to pay your mortgage loan, property taxes and other expenses.
We all know that you need to leverage OPM (other people’s money) to create wealth and passive income through rental real estate. This works absolutely great in good times. Many of you newer investors who started investing after the last real estate crash in 2008, experienced up to a decade of good times for rentals with positive cash flow and appreciation.
Then a 100-year pandemic hit and the government instituted a moratorium on evictions that looks like it will last about a year. At the same time, you still need to pay your mortgage, property taxes and other expenses.
Many of you are experiencing negative cash flow and it hurts.
The pandemic was certainly unexpected. But periodic recessions are not unexpected.
Since recessions and high unemployment are expected, you must be prepared to cope with these situations since they are inevitable. The timing of recessions is not predictable but their occurrence is guaranteed to be predictable. They happen on average every 11 years and most landlords keep their rentals longer than that.
In my lecture “Leverage of OPM: The Good, The Bad and The Ugly in Real Estate Investing”, I talk about how much leverage is good leverage and how much leverage is bad leverage. I talk about the fact that good leverage generates wealth and income. Good leverage has a third crucial characteristic and that is that it weathers downturns.
I also talk about the main characteristic of bad leverage.
Bad leverage looks like GREAT leverage until a downturn and then it can be devastating. I know quite a few investors who were overleveraged in 2008 who LOST EVERYTHING by 2011.
I will share here one of the practical guidelines I teach in my lecture “Leverage of OPM: The Good, The Bad and The Ugly in Real Estate Investing.”
The following mental exercise takes 5 minutes and may save you from Chapter 7!
As you read this mental exercise, be aware that I started teaching this publicly in 2015 when times were great, unemployment was low, mortgage rates were low and distressed properties could be easily bought at a discount. In other words, it was a great time to be a landlord and no one wanted to waste 5 minutes thinking about anything negative. I am sad to say that not enough investors listened to this lecture and did not perform this 5-minute mental exercise.
Here goes.
When you first by a rental property, you do your calculations to figure out your positive cash flow and cash-on-cash return. You know t