Nervous about passive investing in an uncertain market? Read on for 5 strategies to protect yourself from a downturn and grow your wealth with multifamily!
There’s no way to predict what’s going to happen in the real estate market.
With the ongoing threat of tariffs and an upcoming election, many passive investors are skittish about putting their money in multifamily.
But there are things you can do to protect yourself from a recession while you continue to grow your wealth with apartment building investing!
In this week’s video blog, I share 5 strategies for passive investors to protect yourself from a market downturn.
I explain the importance of choosing deals that cash flow from Day 1, taking on debt that matches your business plan, and building reserves in case of emergency.
You’ll understand how to choose an experienced team and learn to identify conservative underwriting for a multifamily deal!
Watch the video below (or keep reading).
Invest with an Experienced Team
The most important thing you can do to protect yourself from a market downturn is to choose an operating team with a track record of success. When the General Partners (GPs) on a deal know what they’re doing, you can rest assured that they will pick the right kind of property in the right market.
Does that mean you should run from a syndicator who’s only done one or two multifamily deals? Not necessarily. Look at the team they have built and consider their background in apartment building investing. Does the operator have experienced team members, mentors or advisors? Look at their professional track record outside of real estate. Has the operator set and achieved noteworthy goals?
Cash Flow from Day 1
Another way to keep your investment safe from the possibility of a market downturn is to put your money in deals that cash flow from Day 1. If the property is bringing in money when you buy it, you can ride out any economic storm.
This is a big part of the reason why we stay away from ground-up development. There is no cash flow to service your debt should the economy go south. But if you invest in a stable value-add deal, for example, the rental income you’re getting from the very beginning will pay the bills.
Plenty of Reserves at Close
A smart syndicator will have plenty of money in the bank at closing to cover unexpected expenses regardless of market conditions. But it is especially crucial to have reserves in an uncertain market.
Unforeseen circumstances (e.g.: roof repair, flood damage, etc.) will arise–that’s just part of the process. So, to protect yourself from a market downturn, be sure that your operator has a good chunk of change in escrow to handle emergencies. They should also be taking money out of cash flow regularly to add to those reserves. ($250 per unit per year is a good rule of thumb.)
Debt to Match Your Business Plan
How does debt structure affect a multifamily investment in a market downturn? Bottom line, your debt needs to align with the business plan for the property.
If you’re planning a cash-out refinance in Year 2 of a value-add deal, a 10-year loan is not appropriate. You’ll be stuck with a prepayment penalty! On the flip side, a bridge loan or short-term note is a bad choice for a stable value-add deal you plan to hold long-term (five to seven years). Instead, you’d want to use long-term debt to lock in the current interest rate–which is at an all-time low of 3.48%!
That way, if you’re planning to sell in Year 5, but a market downturn hits in Year 4, you’re not forced to put the property on the market at a bad time. You have the option to hold and a three-year runway for things to turn around.
Last but not least, you can protect yourself from a market downturn by investing in deals with conservative underwriting. Operators who make projections based on best-case scenarios are asking for trouble. So, what should a passive investor keep an eye out for?
- Rental Increases
- Vacancy Rates
- Exit Cap Rate
Projections of rental increases of $150 per unit per month in Year 1 are unreasonable. It takes at least two to three years to raise rents by that much. Use extreme caution if your syndicator is promising crazy-high numbers like that.
When it comes to vacancy rates, consider both physical and economic vacancy. In a heavy value-add deal, for example, vacancy rates of 5% or even 8% are NOT conservative numbers, especially if you’re facing a market downturn. You may have to deal with tenants who don’t pay their rent. Other units will be empty while you renovate. To be on the safe side, look for projected vacancy rates of at least 10%.
The last number you should consider carefully is the operator’s projected exit cap rate (the multiplier we use to gauge the value of commercial real estate). The current market cap rate is between 6% and 7%–which is pretty low. This means that the cap rate is unlikely to go down. Do the projections take that into consideration? At Nighthawk, we assume that the cap rate will be 0.5% higher at sale, and our underwriting reflects that.
In uncertain times, there are a number of things you can do as a passive investor to keep your money safe and protect yourself from a market downturn:
- Invest with an experienced team
- Choose deals that cash flow from jump
- Ask about the amount in reserves at close
- Check for debt to match the business plan
- Make sure the underwriting is conservative
If you’re looking for an experienced syndicator who will keep your money safe in an uncertain real estate market, join the Nighthawk Equity Investor Club!