With each passing month, it’s becoming abundantly clear that the real estate market is changing. Home buying activity is cooling rapidly across the country, thanks to a lack of affordability. When inflation is at decades high and home prices are at record levels, a rising interest rate environment means fewer people can afford a home.
While more homes are hitting the market as homebuilding backlogs clear and sellers try to capture maximum prices, demand seems to have already peaked. With fewer sales taking place, home prices have actually begun to fall.
To be clear, we’re not in a real estate bear market yet, but these indicators could be signs that one is coming. If you’re a real estate investor owning real estate investment trusts (REITs) or rental properties and feel bleak about where the real estate market is headed, here are three changes you should make to your portfolio.
Solidify your income
Savvy real estate investors always realize that growth is a bonus while investing in rental real estate or REITs. First and foremost, they are income opportunities.
Asset values plummet in a bear market. Real estate investment demand often falters due to decreased confidence in the market’s health. But rental or dividend income should keep coming. By investing in income first, you eliminate much of the risk exposure in relying solely on values, and it helps you ride out bear markets or downtime.
If a recession accompanies the bear market, there is a chance rental income and demand could take a hit, leading to declining rental revenues or higher vacancy rates. That’s why it’s a good idea to analyze your portfolio, looking for investments at risk of negative impacts of a bear market.
If you have a property prone to high rental turnover, lowered demand, or tenant challenges, it might be a good idea to sell while the market is still up. Likewise, if a REIT has shown poor performance lately and its debt ratios are getting out of hand, putting it at risk for a dividend cut, it might be time to sell its stock.
Reviewing your portfolio will help you make informed decisions about how best to solidify your income and reduce your risk exposure.
Reduce leverage exposure
Selling certain stocks or properties may not make sense given the income or return they’re producing, or simply because you know what goes down will eventually come back up. However, if you’re carrying a high amount of debt, it’s a good idea to consider cashing out to reduce your leverage exposure.
Recession impacts could also lead to higher delinquencies and decreased revenues, which means the REIT or you, the landlord, will need cash to float operations and maintain debt obligations. If you don’t have a lot of money, you could be forced to sell when the market is down to prevent mortgage default.
If you own rental properties, look at how much cash you have on hand today and how long you could maintain your current operations, assuming 30% to 50% of your tenants stop paying. This range is very liberal, so if your cash on hand can float you for five to six months or longer, then you’re likely in a safe leverage position. On the other hand, if you have three months or less on hand, it’s likely a good idea to add some cash to your savings.
If you invest in REITs, taking a look at each of your investment’s operations and balance sheets would be a good idea. You want to see healthy payout ratios for dividends around 75% or below. In addition, you want to see that they have enough cash to cover their near-term debt obligations and have steady income coming in. If you see things out of kilter, that could be a sign to sell, which ultimately reduces your leverage exposure.
Recessions don’t always accompany bear markets, but there’s reason to believe the coming real estate bear market would coincide with a recessionary period. In such an event, values plummet, consumer spending would slow, and unemployment would likely increase. This can result in tenants defaulting.
In recessionary times and bear markets — cash is king. Extra money can help you float any losses incurred from a lack of rental revenue. But it can also help you buy more investments when values are down. Loads of REITs and even rental properties will be on sale, making it a tremendous buying opportunity. Getting cash-heavy as the market turns means you’ll be in the right financial position when the bear market hits.
Bear markets aren’t a signal to sell everything. Many stocks and most properties will not only survive but eventually rebound from the fall. Always take a long-term outlook to invest and consider the property’s current performance and the industry or market’s growth opportunities over the next decade. This will help you determine if selling is the best method for getting cash-heavy or if simply saving extra is the route to take.
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