Episode 5 Recession-Proof Real Estate Investing Flashcards
The goal of this book is to help you prepare for the imminent changes that will occur throughout the next economic cycle and future cycles.
3 Economic Cycles:
The Business Cycle:
1.-The business cycle is driven by the interaction between two main forces: inflation and interest rates.
2.-The Long-Term Debt Cycle
3.-The Real Estate Cycle
Occurs about every 18 years.
When the downturn from two or more of these cycles hits at the same time, we tend to see a much larger recession than is typical. This is likely what happened in 2008.
we should expect to see another dip in the real estate cycle sometime around 2026.
Stagflation is an economic situation characterized by simultaneous inflation and recession. Stagflation can destroy the economy for years or decades. This is because all the tools the Fed has available to curb inflation will risk deepening the recession, and vice versa.
4 Phases of the Business Cycle:
-The Expansion Phase
-The Peak Phase
-The Recession Phase
-The Recovery Phase
I like to use three major analysis tools when I’m considering where we may be in the cycle: observation, timing, and data.
Yield Curve: represents the change in interest rates for government bonds of different expiration dates.
It turns out that the yield curve is one of the best predictors of an impending top inflection point in the economic curve. Right before a recession, we will typically see the yield curve go from flat to inverted, with the left and right ends of the curve higher than the middle.
An inverted yield curve has been one of the most reliable predictors of a recession for the past century, and typically occurs between six and 18 months before the downturn is evident.
Full Employment has historically been a signal that a downturn, or full-fledged recession, is right around the corner.
If the market has been steadily climbing for a long period of time, it’s probably an indication that we’re either nearing the end of an Expansion Phase or in the Peak Phase.
The Buffett Indicator: suggests that the stock market’s total value is directly related to the nation’s GDP. We should be able to compare the value of the stock market to the GDP to determine whether the equities market (basically, the stock market) is correctly valued, undervalued, or overvalued.
-The Buffett Indicator has only been above 100 percent four times in the past 50 years, and all four times were followed by a recession within a couple years.
GDP is the total value of economic activity within a country and indicates overall economic health.
-When GDP is decreasing, the economy is contracting.
-Growth that is below this 3 to 4 percent rate is often a sign of a weak economy.
In general, if GDP is negative for two or more quarters in a row, the economy is considered to be in a recession.
Housing supply is sometimes referred to as housing inventory or days on market (DOM), and is the average amount of time it takes to sell a house in a particular market.
-On average, housing supply across the country is around six months.
-Notice that there tends to be a dramatic drop in housing starts immediately preceding each of the past eight recessions.
Foreclosure Rate is a powerful indicator of the strength of the real estate market and the economy in general. During an economic expansion, total foreclosures drop,
-But toward the peak of the cycle, as unemployment ticks up and inflation starts to impact how far paychecks will go, foreclosures start increasing. They continue to increase through the downturn, where they peak.
The capitalization rate (or just “cap rate”) is one preferred measure of financial return used to evaluate an income-producing property,
-In simple terms, the cap rate is the income generated by the property divided by the value of the property.
-Cap rates tend to be consistent across similar properties in a geographic area.
-Cap rates tend to move in cycles.
-There are 3 external forces that can push cap rates up or down: 1-Interest rates, 2-Vacancy rates, and 3-Availability of money.
If you’re interested in buying investments that generate cash flow, buying during times of higher cap rates will position you to make more profit, both from increased cash flow and from an increase property values when cap rates drop. These higher cap rate environments typically occur during the recession and recovery phases.
Margins are simply the percentage amount that a business’s profits exceed its expenses.
-We often see margins increase during phases of the cycle when property values are increasing, which includes the recovery and expansion phases, and early in the Peak Phase.
Market Risk is the risk associated with a deal based on current market conditions.
Deal Risk is determined by the borrower’s creditworthiness and the risks associated with the specific deal they want to finance.
I’m not a big fan of investing for appreciation over long periods of time because, historically, in many areas of the country, real estate values don’t tend to increase much more than the inflation rate.
Conventional Lenders: A conventional lender is typically a big bank or mortgage broker that facilitates loans insured by government agencies or quasi-government agencies like Fannie Mae, Freddie Mac, FHA, or VA
During the expansion part of the cycle, interest rates are low, the economy is strong, and the government will loosen up conventional lending requirements.
As we get over the peak and toward the Recession Phase, credit becomes tighter.
Portfolio Lenders: Portfolio lenders tend to be small banks that loan their own funds—the money of their depositors—instead of loaning government-secured funds
-Because portfolio lenders typically don’t have a limit on the number of units they’ll lend against for an individual landlord, these loans are more flexible than conventional loans for landlords who want to acquire a large portfolio of properties.
-During the expansion, small banks love to lend to investors. They’re lending on flips and rentals, and their interest rates and terms are competitive with conventional lenders.
-Unlike conventional lenders who start to require larger down payments and better credit, portfolio lenders just stop lending altogether.
-Late in the recovery, small banks will get their appetite for rental financing back, but many of them won’t start lending to house flippers again until the next Expansion Phase.
Hard-money Lenders are individuals and companies who specialize in lending to real estate investors. These lenders may be lending their own money or they may be raising money and then lending that money out for a higher rate than they’re paying, keeping the difference as their profit.
-Hard money lenders typically have much higher interest rates and less favorable terms than conventional or portfolio lenders,
-Hard-money lenders have it better throughout the cycle than flippers and landlords. Hard-money lending can work at any point throughout the cycle, presuming the lender has access to funds.
Private Lenders are people we know—friends, family, and professional acquaintances. These are generally people who have extra funds in a savings or retirement account and are looking for a better return than what they’re currently getting.
-Private money is going to flow freely throughout the Expansion Phase, and maybe even into the Peak Phase.
Passive Investors are those who invest in syndicated and group-funded deals.
Crowdfunding is a relatively new form of financing that’s come along with the internet—it’s where investors raise money from ordinary people who are looking to invest small sums of money into real estate deals with lots of other people.
Chapter 8: Investing Strategies
Strategies are plans of action. These are the high-level things we do in our business to generate income. In real estate, strategies are things like flipping houses, wholesaling, buy and hold, and lending.
Flipping is the process of buying property below market value, adding value through renovation and/ or repair, and then reselling it for a profit at or above market value.
-Because flipping requires you to buy low and sell high, the best times to use this strategy are when property values are increasing, which typically occurs during the recovery and expansion phases.
-House flippers have a tremendous opportunity during the Recovery Phase, shortly after a downturn ends.
-Of all the strategies we’ll discuss, flipping is the one that’s most affected by the market cycle, which is why it’s important for flippers to understand other strategies and either:
-Transition to another strategy when the market doesn’t support flipping; Sit on the sidelines when the market is declining;
-Be ultra-conservative if you continue to flip near the cycle peak or during the Recession Phase.
Wholesaling: is the process of finding and/ or negotiating the purchase of property below market value and immediately reselling it or the contract to another investor for a profit.
-If you want to implement wholesaling as a strategy, you have to be good at marketing and acquiring property at great prices.
-Great negotiation skills are a major asset for wholesalers.
-When trying to wholesale during suboptimal parts of the cycle, it’s crucial that you have a large network of buyers.
Buy-and-Hold Rentals: Buy and hold involves purchasing a property and renting or leasing it to a tenant who pays for the use of that property.
-A buy-and-hold strategy is often best during the recession and recovery phases
During these two phases, prices tend to be low. Oftentimes, homeowners (and even investors) want to get rid of their properties and are willing to sell at a discount.
Multifamily - When we talk about multifamily investing, we’re typically referring to the purchase of properties with over five units.
-In the multifamily world, it is cap rates that determine property values, and it’s the times when cap rates are high that prices for buyers will be low. This is common when interest rates are high and when sellers are getting desperate to get rid of their properties. Like with single-family, this is going to occur during the Recession Phase (especially the end of the Recession Phase) and during the Recovery Phase.
Development & New Construction - Development involves purchasing land, improving it, and either selling it or holding it to generate consistent cash flow. New construction is the process of taking developed land and building on it, or taking a previously developed piece of land, tearing down an existing home, and building on the lot.
-Development and new construction can be very lucrative, but these strategies hold the highest risk and are impacted by the market cycle more than other strategies for several reasons:
-The most successful developers work throughout all phases of the cycle, other than perhaps during the Recession Phase. They buy cheap land and distressed property while the economy is in turmoil (recession and recovery phases) and prices are down. Then they hold their land until values increase and builders are ready to build or homeowners are willing to pay for new construction (expansion and early peak phases).
Private and Hard-Money Lending: Private lenders are those who don’t lend professionally but who lend to investors.
-Lending can work in any part of the market cycle, especially for those lenders who can underwrite a wide variety of deals.
Note Investing - A note is simply a promise to repay a loan (the mortgage agreement you sign is a note), and there are many different strategies around buying, selling, and holding notes.
Commercial - Commercial investors invest in various types of real estate other than small residential properties or land. Examples: Multifamily (apartments) Retail space Mobile homes Office space Warehouse space Self-storage
-Nearly all commercial investing relies on income from regular lease payments,
-In general, though, I recommend focusing on the purchase of traditional commercial investments during the recovery and expansion phases. Especially early in the Expansion Phase. And then focus on the purchase of recession-resistant commercial assets as we get closer to the downturn, during the peak and recession phases.
Buying Land - Buying land involves purchasing undeveloped or partially developed parcels with one of several potential exit strategies, the most common being:
-Development.
-Land banking.
-Land flipping/ wholesaling.
Peak Business: cycle phase in which prices hit a plateau and demand starts to soften.
The Recession Phase of the cycle starts when the economy begins to contract, and many common economic metrics begin to decline. It’s characterized by economic turmoil, which frequently includes rising unemployment, higher interest rates, reduced wages, and tightening credit.
-Subject to involves taking over the payments for a homeowner. The buyer agrees to continue paying the loan as scheduled, and in return, gets the deed from the seller.
-A wrap is similar to a Subject to, except in this case, the buyer and seller execute a new mortgage agreement that “wraps” the original. This allows the seller to collect additional monthly payments in addition to the loan payments the buyer agreed to take over.
Recovery Phase: The business cycle phase where the economy starts to recover after hitting bottom.
Expansion Phase: The business cycle phase in which buyer demand for housing increases as other economic factors such as wage and job growth are strong.
Appreciation: The increase in the value of an asset over time.
Bonds: Debt (often provided by the government) that pays a fixed interest to the investor.
Business Cycle: The cyclical expansion (strong economy) and contraction (weak economy) that we see about once a decade or so, and what we typically think of as basic economic fluctuations.
4 Phases of the Business Cycle:
The Expansion Phase
The Peak Phase
The Recession Phase
The Recovery Phase
