| The number one problem I see with investors today is their unrealistic expectations of how real estate really functions. They are unfamiliar with the real estate market especially when it decreases in value and does not appreciate at the tremendous rates that have been seen recently in some parts of the country.
People react to what they have most recently experienced. For the past several years, Southern California has experienced incredible market increases, sometimes 25% gains in property values in one year. It can not be emphasized enough how this is not standard and is not how long-term investors should be calculating their numbers.
Long-term investors need to be realistic and conservative in how they approach maintaining and sustaining their investment portfolios in the good times, as well as the bad times. Real estate gains will be experienced for a period of time and then immediately followed by times of losses up to 20-30%. These gains have historically outperformed the losses, but investors who keep and sustain their properties during these cycles are those who win in the long run. When you are a long time investor, you will experience some of the wins in the market and some of the losses.
Smart investors want to be able to learn to sustain the property in both markets. Here a few tips to help investors stay in the real estate during the changing markets:
1. Rental Rates will drop: Be prepared to sustain your properties with a rental rate decrease of about 10-15%. They will typically not decrease by anymore than that amount. Ask a local property management company that has been working in the area for at least ten years about what the historical trends have been when the market is depressed.
2. Prices and Value will drop: Most of the time real estate values for single family residences and condos will decrease no more than 20% to 30% in any market adjustment. Multiple unit properties and land have historically experienced greater drops in value, sometimes up to 40% to 50% decreases. Remember, however, that rents don’t decrease much, so you should only worry if you plan to sell your investment during this downturn of the market.
3. Increased Vacancy Rates: When real estate decreases in value, usually the whole economy is going through a rough time. This means that unemployment rates have increased and people are looking for work. When people are looking for work, they do not usually move around. They are more likely to stay where they are at or move in with family or relatives (i.e. leaving an existing home vacant). It is more common for children to stay in their parents’ homes for longer periods of time than they want due to financial constraints. Young families also feel the financial pinch and tend to stay in smaller housing units than is comfortable because money is tight.
This is why vacancy rates increase during market recessions. The number of people who stay in each rental units increases during these downturns in the real estate market. Vacancy rates do not increase over 10% to 15%, even in bad markets.
4. Increase in Mortgage Interest Rates: Be prepared for interest rates increasing. Look at the terms of the note that you signed with the bank when you originated the loan. In the terms are some parameters that will tell you the maximum the loan can adjust to and the amount per year it can increase in your mortgage payment. These numbers are essential for you to know so you can plan for the worst case scenarios when markets really adjust.
How To Be Prepared For Market Drops
There are several key action steps investors can make to help sustain their investment real estate during all real estate market adjustments and conditions.
1. Take Out Equity Line on Primary Residence to help augment mortgage payments when the rental income decreases during declining markets. Set up an equity line when the market is healthy and you have a good paying job and good credit. Right now also happens to be a good time to establish low interest rates.
2. Alternatives For Profitability. These alternatives are crucial when you have either lost your job or you are experiencing a loss of rental income by higher vacancies. Take some immediate actions to make the rental units more attractive to your tenants like new paint, carpet and landscaping. These improvements mean a lot to tenants and if they feel like they are treated fairly, they are less likely to move. It is also important to attend to repair items immediately. This decreases tenant complaints and increases their willingness to stay and encourage others to move into the property with them.
3. Decrease Rental Rates Slowly When Needed. If the local rental rates are dropping then you need to pay attention and drop your rental rates as well. But drop them slowly. You don’t need to drop your rates as aggressively if you keep your tenants happy. Work hard at pleasing your current tenants so that you will not have to drop the rates to attract new tenants. Smart investors sometimes offer incentives like grocery coupons to tenants if they have a friend or family member move into the complex. These gifts go far in saving you money in the long run.