For many investors, a self-directed IRA makes more sense than a traditional IRA where you are limited to the types of assets you can hold in your retirement account. The potential returns are greater than with a traditional IRA, but the risks are also larger because of the nature of the investments.
Self-directed IRAs allow investors to hold baskets of alternative investments such as real estate, marketplace loans, gold, and precious metals, hedge funds, fractional investments, private mortgage bridge loans, oil and gas rights, and more. While not for everyone, a self-directed IRA provides more diversity in an investment portfolio and gives the owner more control over their investments.
While IRAs are great vehicles for retirement planning, they are vulnerable to stock market ups and downs. Self-directed IRAs, on the other hand, have built-in protections against fluctuations. Since that is true, how does the stock market affect an individual’s retirement? There have actually been some studies on that.
The Stock Market and Your Retirement
In March, the S&P 500 hit an all-time high, well ahead of the expected schedule that prognosticators predicted due to COVID-19. On August 29, the index hit its 12th all-time high. The only problem with such highs is that they tend to be followed by downturns. What goes up must come down, as they say.
COVID-19 did more than just present a public health risk. It also caused many baby boomers to leave the workforce sooner than expected. A total of 3.2 million boomers retired early as a result of the pandemic. That means whatever retirement savings they have must last longer, and if the stock market turns while they are retired, that could present a lifestyle hardship for many of them.
A study conducted by the National Bureau of Economic Research (NBER) on the relationship between stock market performance and retirement intentions concluded that there was a weak negative correlation but that factors other than stock market fluctuations caused early retirement among the wealthy class. The study was conducted in 2010 using data from 1998 to 2008, the height of the financial crisis. Researchers found that individuals more exposed to stock market risk were less likely to put off retirement and that individuals were more likely to put off retirement when the market declines as opposed to retiring early when the market gains. They explain this difference by pointing to risk aversion factors.
When it comes to retiring, what can risk-averse investors do to ensure they don’t lose the investment principle in their retirement accounts while ensuring they maintain their standard of living? One thing they can do is hedge their portfolio against stock market downturns by investing a small percentage of their assets in alternative asset classes within their IRA.
5 Alternative Asset Classes Compatible with Self-Directed IRAs
Alternative asset classes can be used to round out an investment portfolio and the perfect vehicle for doing so is a self-directed IRA. As mentioned earlier, real estate is one asset class often explored within self-directed IRAs. Below are five ways you can incorporate real estate into your self-directed IRA.
- Traditional real estate investing – Long before financial technology (fintech) and online real estate investing stole the show, real estate investors were buying and selling land, flipping houses, and investing in traditional real estate assets through their self-directed IRAs. This is still a valid investment strategy, though it is limited by geography. To invest in traditional real estate assets, you must be able to evaluate risk and get eyes on the property or trust your investment partners.
- Fractional investing – While fractional real estate investing has been around longer than the internet itself, the rise of fintech and online real estate investing platforms has expanded fractional investment opportunities and made them more available to more investors. Instead of buying properties outright, investors can own a percentage of real estate assets by pooling their money with other investors. By leveraging the capital of other real estate investors, fractional investors can earn more on their money by diversifying their real estate assets through an online portfolio.
- Marketplace lending – Marketplace lending has become a unique asset class in real estate allowing investors to choose the deals they wish to invest in through a peer-to-peer marketplace. Real estate developers, flippers, and other professionals seek a loan for project completion and investors provide that loan through a platform designated for that connection. Rather than invest in the property itself, investors lend money to the professional who must then pay back the loan with interest. All investors who participated in the lending process receive back a portion of the interest from that loan.
- Private mortgage bridge lending – A bridge loan is a specific type of loan that allows a real estate developer to complete a project already started. Private bridge loans have become very popular in marketplace lending. Investors pool their money to provide a loan to developers and pay back the loan upon project completion. Bridge loans are typically riskier than the average marketplace loan while providing significantly higher returns.
- REITs and funds – Real estate investment trusts and real estate funds also make great investments for a self-directed IRA. These assets are managed by a company that specializes in these investments, but they can be included in your basket of assets within your self-directed IRA.
While real estate makes a great self-directed IRA asset class, self-directed IRAs come with many rules. For instance, you can’t invest in a product you own. There are also rules about other disqualified persons. As long as you follow all the rules, however, investing in real estate through your IRA has the potential to triple your returns.
Coming Soon: Your Own Self-Directed IRA on Sharestates
Since February 2015, Sharestates has been committed to improving our underwriting practices, our marketplace offerings for investors, and our service to investors and real estate professionals alike. In 2019, we won the LendIt Top Real Estate Platform Award. We’ve been recognized by industry experts as of the top marketplace lending platforms or online real estate investing platforms since our earliest days. We’re proud to continue that legacy.
Sharestates is currently in the process of building out capabilities to allow investors to invest in our real estate offerings through a self-directed IRA. If you’d be interested, please let us know and we’ll keep you updated.
In May, Morningstar updated its inflation forecast for the 2021 Personal Consumption Expenditures Price Index to 2.9 percent. The analyst firm expects the core inflation rate for this year to be 2.5 percent. By 2025, they expect an average 2.3 percent inflation rate. This is a slight uptick from its previous forecast.
Kiplinger is forecasting this year’s inflation rate to be 5.5 percent.
According to Morningstar, car prices are driving this inflation. Kiplinger attributes it to a shortage of semiconductors. On another front, a labor shortage is driving up wages at a time when a push for a minimum wage increase is gaining favor. All of this is driving up the cost of real estate construction. Is this a long-term trend or a near-term adjustment? Either way, the stark reality for real estate developers are thinner margins, and that could lead to a slowdown in construction in a market already characterized by low supply.
Inflation in the Cost of Building Supplies
The cost of building supplies has been on the rise since June 2020. Lumber companies reduced output early last year expecting a decrease in demand due to mandatory business shutdowns and social distancing guidelines. What happened instead is that demand increased. The pandemic caused people to move out of cities and into the suburbs. That created a new wave of construction projects needing materials. With truncated supply lines and high demand, prices have gone up.
Prices have likely gone up more than they should have if builders were fighting inflation alone. Inflation plus high demand and low material supply have created exorbitant construction costs.
These costs, in return, will be passed on to home buyers leaving some people who won’t be able to afford the cost of a new home out of the market. In essence, we can expect the single-family rental market to be strong for the next few years while the residential real estate market will be
mixed. On the high end of the economic scale, housing inventory will move. On the lower end of the scale, probably not as fast.
How the Price of Lumber Will Impact Home Building
The bright side is that construction companies were considered essential businesses last year in many parts of the country, which meant they were allowed to c
ontinue conducting business while other businesses were shut down. That doesn’t mean they didn’t have their challenges. For starters, the pandemic delayed a lot of projects and the industry’s Commercial Construction Index health rating declined sharply early in 2020.
The price of lumber was one of the industry’s biggest news stories last year. It’s now more than 75 percent what it was before the pandemic. Initially, prices fell. But many people were out of work for much of last year and had extra income. Since many other businesses were shut down but big box lumber stores such as Lowe’s and Home Depot were left open and considered “essential,” many homeowners used the time off to work on home improvement projects. Extremely low-interest rates and a surge in construction projects also kept contractors in business. These factors created an unusually high demand for lumber and prices skyrocketed.
Now, lumber prices are coming back down. That will only benefit construction companies even more. As people are going back to work, the home improvement projects are slowing down. Demand for lumber is reaching equilibrium an
d home builders can enjoy better margins.
How the Price of Copper and Steel Will Impact Construction
Copper and steel have both increased in price, as well. With the case of copper, which is used as a conduit in electrical grids and alternative energy, demand should increase. If the president has his way, green initiatives will have a higher priority soon. His proposed infrastructure bill should give many contractors plenty to do. In an environment with lower-than-normal unemploym
ent, construction workers and subcontractors will welcome that work.
Steel’s price is going up because of supply slowdowns. Like lumber, there was an expectation of a demand slowing that didn’t happen.
The prices of construction materials are higher today all around than they were before the pandemic. And there is plenty of work to do. That means contractors’ expenses are higher and therefore will realize thinner margins on the projects they do take on. The prospect for more and bigger projects is still good in most places around the country. Therefore, there’s plenty of reason for optimism.
Are we at the Beginning of This Surge in Construction Costs?
While we’re beginning to see prices in lumber correcting, it may be some time before the price of steel comes down. Copper too. The infrastructure bill moving through the legislative process right now could determine a lot in terms of the price of materials over the next 3-5 years. Another thing is the current low supply in housing with high demand promises to keep the con
struction business operating on all cylinders until supply and demand reach equilibrium. That could be a few years.
Another factor to consider is the market-driven rise in the minimum wage. Democrats have been pushing for new minimum wage laws for several years. Failure to implement these laws is a moot point now that the pandemic has forced higher unemployment and many workers are refusing to go back to work unless they receive higher pay. To remain competitive, many companies are capitulating and offering higher wages.
If enough companies offer higher wages on their own, the net effect will be higher prices and a higher cost of living in areas where this occurs more frequently. A ripple effect of inflation will occur over the course of the next few years. That will likely affect every industry and business sector in the country including real estate construction. How much and when is the question.
One final thing to note is the looming possibility of more regulation. A Wells Fargo survey of construction industry leaders last year reveals the number one concern is the political and regulatory environment. Construction industry professionals were more worried about that than the uncertainty brought on by the pandemic.
There’s no doubt that homebuilders facing inflation and rising costs of materials will have to pass those costs on to home buyers. We can expect house prices to continue to climb.
Nevertheless, industry leaders are optimistic. While there have been ups and downs in the past year and a half, the road ahead looks mostly up. Where the dust will settle on construction costs is anyone’s guess, but there will be plenty of work to bid on, plenty of investment opportunities, and much profit for contractors ready and willing to ride the waves.
Last month, I talked about how low supply and high demand were driving the single-family housing market across the country. Millennials are in buying mode, but there isn’t enough inventory in the market to supply the demand. On top of that, the distressed housing market is down from a year ago.
According to the National Association of Realtors, distressed sales were less than 1 percent in May 2021. They were at 3 percent in May 2020. The big question is, Why? What’s driving distressed home sales?
Housing Moratoria and Stimulus Packages
On March 18, 2020, the U.S. Housing and Urban Development issued a 60-day foreclosure moratorium for FHA-insured single-family homes. Fannie Mae and Freddie Mac initiated a moratorium on the same day. The next day, the U.S. Department of Agriculture (USDA0 implemented a 60-day moratorium on USDA Single-Family Housing Guaranteed Loan Program loans. These moratoria were extended several times during the COVID-19 pandemic last year and were due to expire on June 30, 2021. Before the end of last month, the USDA extended its moratorium until the end of July 2021.
More than 7 million homeowners took advantage of the moratoria during the pandemic. According to a study conducted by Harvard University, more than 2 million homeowners are still behind on their mortgages.
First, a few quick observations:
- The moratoria have certainly impacted foreclosure rates, propping up homeowners who would have lost their homes were these not in place
- The moratoria and stimulus packages were effective in giving most homeowners facing foreclosure the financial security they needed to get current on their mortgages
- When the foreclosure moratoria do finally come to an end, we can expect to see a sharp rise in foreclosures
Big Banks have already announced when they will begin foreclosures proceedings coming out of the pandemic. Bank of America and JPMorgan Chase both expect to restart foreclosure proceedings when the moratoria are finally lifted. Wells Fargo plans to wait until next year.
During the pandemic, the U.S. spent more than $3 trillion on economic stimulus packages. Forty-three percent of recipients of government stimulus checks put the money toward housing costs. Many of them were renters, but given that the number of households facing foreclosure fell from more than 8 million to just over 2 million means that many were also mortgage holders. It’s evidence that the moratoria and the stimulus packages did what they were intended to do.
Housing Prices Are On The Rise
The pandemic didn’t hurt the real estate market much. It may have dampened a strong market to some degree, but it’s still a strong market. That’s evidenced also by the fact that home prices are on the rise, including distressed home prices. According to CoreLogic data, home prices increased year over year in May 2021, and that includes distressed home prices, by 15.4 percent. The increase month to month from April 2021 to May 2021 was 2.3 percent.
It’s pretty clear that the low supply-high demand environment in single-family housing is driving real estate prices higher. What’s unclear at this time is how an increase in foreclosures once moratoria are lifted will impact prices. It’s likely that the result will be a slow down in price increases.
Investors are poised to take advantage of the market opportunity that will develop when foreclosures do start again. However, the distressed home market is a different market than the new construction market. We’ll likely see a parallel demand curve between those two markets, but prices in the distressed market will be determined by how quickly foreclosures pick up again once the moratoria are lifted. If a large glut of homes hits the market at once, investor competition for those could drive up prices in the short term, but if investors overspend, they’ll see fewer profits on the resale.
There is also a question as to whether homebuyers will switch from the rising market in new home construction to the secondary market. If the low supply situation continues, many homebuyers could switch to buying on the secondary market, and that could impact prices in that market.
While there are a lot of unknowns due to lack of clarity on when the foreclosure moratoria will be lifted, there is plenty of room for optimism regarding the future of real estate, both for the new construction market and for the distressed housing market.
Distressed Homeowners Have a Safety Net
The moratoria and stimulus packages have proven to be a safety net for homeowners affected by business shutdowns and social distancing guidelines during the pandemic. While millions of homeowners fell behind on their mortgages, most of them have caught up. That’s a good sign for the future of the real estate market and the economy as a whole.
During the 2008-09 financial crisis, homeowners had no safety net. Lenders with loose credit standards ended up foreclosing on homes with loan terms that never should have been approved. Today, many homeowners who purchased homes during that time or immediately after are sitting on a cushion of equity in a strong market with rising prices. That means fewer distressed properties, and distressed homeowners, across the board. And the longer the foreclosure moratoria are in place, the more homeowners still behind on their mortgages are likely to catch up.
While unemployment is higher than it was pre-pandemic, the unemployment rate is down from April 2020. Unemployment remains steady at 5.9 percent. Interestingly, what’s driving most of the unemployment rate in today’s job market is voluntary. The number of people who quit their jobs in June 2021 rose from 164,000 to 942,000. Essentially, people are rethinking their relationship to work.
Don’t underestimate what that has to do with housing. People don’t generally quit their jobs unless they have one already lined up or they have enough money in savings to sustain their spending during a long tenure of unemployment. Remote work is on the rise, which means that homeowners who purchased a home due to its proximity to their office no longer feel the need to remain in the same location. While they aren’t moving far, the general trend seems to be from urban centers toward suburbia.
As jobs return and the economy recovers from the pandemic, the number of distressed homes due to financial stress will continue to decline. On the other hand, once foreclosure moratoria are lifted, we should expect to see a sharp rise in foreclosures and the emergence of a new secondary market in single-family housing.
As the economy picks up again and we begin to move into a post-pandemic environment, real estate professionals around the country are asking if we may be in a housing bubble and, if so, when will it burst?
Both Jeff Greene, a billionaire real estate investor, and Jamie Dimon, CEO of JPMorgan Chase, say yes. However, Dimon says he’s not worried about a crash like the one we had in 2008-2009.
Almost everyone else says today’s real estate market is not a bubble. So what is it?
The Factors Driving the Real Estate Market Today
When we analyze the real estate market in 2021, we’ve got to keep in mind that we are following an unusual year of very unusual activity. The COVID-19 pandemic and associated lockdowns, social distancing guidelines, and public health concerns brought the real estate market to a near halt. New construction was hampered, buying and selling were stilted, and lenders tightened their credit standards. It was an unusual year.
What happened in 2008 was a weak labor market drove foreclosures higher while banks and other lenders loosened their credit standards. Last year’s pandemic brought with it mortgage forbearances so that income earners out of work wouldn’t lose their homes. Different environment.
Another way the pandemic has impacted housing is that it caused a massive movement from urban centers to the suburbs. This is interesting because this massive move was spurred by an increase in remote work. People living close to urban centers didn’t need to be near their offices anymore, so they moved out of the city into the suburbs where they could work remotely and more at ease. This drove up demand for housing and increased housing prices since the pandemic slowed down new construction.
This is basic economics. Lower supply and higher demand cause prices to go up. And that’s what we’re seeing in 2021.
Another thing we’re seeing is an increase in homeowner equity. People who bought their homes ten years ago have seen their home’s value increase. Now they have equity, which serves as a cushion in economic downturns. It also means they are in no hurry to sell, but if they do sell, they can put that equity toward a down payment in a more valuable home.
What Causes a Housing Bubble?
Housing bubbles are generally caused by a strong economy giving people more disposable income, which they put into buying new homes. Coupled with low-interest rates and loose credit standards, the market creates opportunities for risky behaviors and new mortgage products. As a result, there is more speculative activity as investors try to invest in the next big thing or predict where the market is headed.
Housing bubbles are also often accompanied by mass moving. A lot of people migrate from one location to another at the same time.
Looking at today’s real estate climate, there are some similarities between the housing bubble of 2008 and 2009 and the 2021 housing market. However, those similarities fall short of causing worry when compared with the differences in the two markets. What are those differences?
In 2008 and 2009, there was a lot of speculation and risky behavior in the financial markets. We don’t see that today. New mortgage products are not rolling off the lending shelves every day with sophisticated sales techniques to push them.
While demand was high, as it was then, it’s coupled with low supply due to the slowdown in construction activity last year. The low supply of housing today was not created by natural market conditions. It’s artificial. As the economy picks up again, developers will begin building again and supply will catch up to demand. It may take two to five years, but it will happen. As it does, prices will stabilize.
Housing prices have gone crazy, but that’s due to the aforementioned conditions of high demand and low supply with stable interest rates. We expect to see this settle down.
One very important way today’s housing market is different is that mortgage companies and lenders have tightened their credit standards. They aren’t loaning money to just anyone. In 2008 and 2009, lenders were creating new credit products and selling them to people who couldn’t afford them. That could easily occur following a year like last year where home equity increased and remote work drove up demand for housing in the suburbs. But it didn’t. Instead, lenders tightened their credit standards, which has served to strengthen the real estate market.
Housing bubbles are caused by a lot of activity in the market due to speculation and risky behavior. We’re not seeing that in 2021. We’re seeing people shifting their priorities and adapting to a new reality, which is leading to a spike in housing demand.
Low Supply Plus High Demand Does Not Equal Housing Bubble
The biggest factor impacting the housing market today is low supply. Builders simply haven’t been able to keep up with demand because, first, it wasn’t expected. Secondly, forced social distancing guidelines and business lockdowns, especially in places like Pennsylvania and New York, meant that new construction came to a halt. We see it picking up again. As the Biden Administration continues to push for vaccines with the hope of vaccinating 70 percent of the population against COVID-19, we should see the economy open up more.
Demand will likely continue to climb, although at a lower rate, as supply struggles to catch Interest rates will likely remain stable. The housing market will remain healthy for the foreseeable future. Older Americans are continuing to downsize as they age and move into senior housing while younger Americans are showing signs of entering the homeownership market.
We should see a gradual shift in homeownership over time with younger Americans buying from older Americans. New construction will cater to the needs of younger Americans and remote workers with greater emphasis on suburbs and rural communities. When supply matches demand in the housing market, we’ll have reached a point of equilibrium that should keep the real estate market stable for a few more years.
In any investing environment, there are winners and losers. During crisis environments, the winners are often big winners while the losers are often big losers. Who is poised to come out ahead during the COVID-19 crisis, and who is poised to fall behind?
Where The Money in Distressed Debt Is Flowing Today
In recent years, several prominent real estate funds have emerged that allow investors to pool their money into mutual fund-like securities offered by public real estate companies. Unlike REITs, they typically do not pay ongoing dividends. Instead, investors seek to gain returns through the appreciating value of the underlying assets. COVID-19 is proving to be a unique opportunity for some distressed real estate fund investors, but it could prove to be a pitfall for others.
According to Business Insider, more than $10 billion is about to pour into the real estate sector through distressed debt instruments.
One of the properties responsible for this new opportunity is the Williamsburg Hotel in Brooklyn. Benefit Street Partners is seeking to sell $80 million of distressed debt tied to the hotel. This is not surprising since COVID-19 essentially killed the hospitality industry overnight. That means debt tied to hotels across the country could hit the market in the next few months simply because hoteliers and other industry service providers are seeing a major drop in business due to fewer people traveling. Even with local economies beginning to open up across the nation, the hotel industry is going to struggle to return to its 2019 glory, and it could be a couple of years before it fully recovers. That spells opportunity for investors with cash to buy up the billions of dollars in debt that hotels, as well as food and beverage, restaurant, and tourism companies, have floating around.
Kayne Anderson in Florida raised $1.3 billion in two weeks and ended up turning investors away.
There were 939 commercial real estate funds globally in early April. At that time, they were seeking to acquire almost $300 billion in debt. One estimate in early May concerning the rate of delinquent commercial mortgages was 11 percent. As the economy continues to struggle, this number could go up by the end of the year even if every state opens up its economy completely by the end of this month (which is unlikely). The commercial real estate sector will continue to struggle and we’ll see more distressed debt hit the market as lenders seek to reduce their dry powder inventory.
In essence, firms in industries where the debt-to-equity ratio is high and where COVID-19 has impacted market forces negatively are likely either looking for buyers now for their distressed debt or soon will be.
Who Is Buying Up Distressed Real Estate Debt?
Cash is king. Investors sitting on piles of it have the best opportunity to purchase distressed real estate fund debt in the short term. They not only have the cash to make purchases, but they also have the opportunity to get to that cash quickly and to close deals as struggling lenders seek to recapture liquidity.
Lenders in industries impacted negatively by COVID-19 face a high number of probable defaults. If they can’t sell loans at a discount and regain their financial strength, these lenders will likely fold. Many of these lenders are small or alternative lenders that rose up on the heels of the last financial crisis but which have not navigated through a difficult economy until now. COVID-19 is their stress test.
One industry that is seeing huge fallout from COVID-19 is the retail sector, which was struggling before the current crisis as technology firms like Amazon and Overstock ate into their market share. Neiman Marcus and J Crew are among several retailers that have already filed bankruptcy in 2020. JC Penney is preparing to file and could do so by next week. As brick-and-mortar retailers close store locations, commercial landlords and commercial new construction will suffer (one notable exception is multifamily). If store locations are tied to capital investment, much of that debt will likely find a new home by the end of the year.
It’s likely that large traditional investment firms like Blackstone and Starwood Capital Group are going to swipe up a lot of the debt (and not just in retail). According to Morningstar, they are sitting on billions of dollars in cash and cash equivalents.
Greystone & Co. set up a $400 million fund to buy distressed real estate debt, but, according to company CEO Stephen Rosenberg, the company is wary about buying up debt too soon due to prices going lower rapidly and little market liquidity. In March, Florida-based Directed Capital purchased $10 million in loans for $7.4 million. Some of the investors targeting distressed real estate debt began to look for the opportunities in December, attempting to get ahead of the game.
Preqin reported that private equity firms have been building up distressed debt funds and was holding $77 billion in dry powder in 2019.
There is no doubt that 2020 will be a year of huge capital shifts toward major investment firms, private equity companies, hedge fund managers, and financial institutions that have the cash to buy up distressed debt as smaller players crumble, fumble, and fall to the ground. This will likely trickle down to smaller firms, which will scoop up the deals the larger players take a pass on. Investors looking for a rich opportunity may begin shifting their portfolios to increase liquidity so they can grab the tail end of this opportunity at the end of the cycle.
Where Real Estate Debt is Struggling In 2020
Marriott International carries $12.2 billion in debt and saw a 92 percent decline in Q1 2020 earnings compared to Q1 2019. Struggling to manage liquidity, the hotel chain will continue to struggle as long as shut down orders and social distancing remain in place. The hospitality industry will likely be impacted by COVID-19 for a couple of years.
Related industries such as the airline and cruise industries, as well as entertainment, have been similarly impacted by COVID-19.
The events management industry has also been affected as people are not gathering in large crowds anymore. That includes business conferences, rock concerts, and venues people rent for family reunions, graduations, and weddings. The food beverage, restaurant, and retail sectors are also struggling. These industries tend to be heavily invested in real estate. Companies in these industries with low liquidity and high debt will have to fight to maintain financial health. Their lenders will likely sell at least a portion of the debt in order to manage their own financial health, and that translates into opportunity for debt investors.
Auto sales are down 47 percent in the last month.
What each of these industries has in common is a high dependency on real estate. By the same token, these seven industries with high unemployment due to COVID-19 all rely heavily on commercial real estate development. As companies in these industries restructure their debt load, some of that will likely end up in the hands of investors ready to seize upon the opportunity. You could be one of them.
States are beginning to re-open their economies, albeit some will move slower than others. The weather is warming and optimism is on the rise. While some business sectors—such as retail and tourism—are still suffering from the sudden downturn and the economic lockdown, others saw a surge as a result of the COVID-19 pandemic. Now that we are beginning to re-open the economy, will real estate return to its former state of glory? If it does, real estate professionals around the country may have opportunity zones to thank for it. Here are some ways opportunity zones could pull real estate back up again.
A Brief on Opportunity Zones
Opportunity Zones were created when Congress passed the Tax Cuts and Jobs Act of 2017. In short, these zones were designated as economically distressed zones that provide specific tax benefits to real estate developers in order to revitalize these areas and spur economic development. You can learn more about opportunity zones here.
Fix-and-flip investors have been operating in distressed neighborhoods for years, and fix-and-flip lenders have funded them. The opportunity zones legislation opened the door for alternative lenders to get in on the action. As a result, it opened the door for other real estate developers, including commercial and new construction developers, to operate with more confidence in those areas. Many of these new players were barely getting started, or were in the middle of huge projects when the coronavirus pandemic hit and the economic lockdown began to implement. It left their projects in limbo. The question is, will they, or can they, recover?
Opportunity Zone Deadline Extensions
In March, President Trump declared every state, the District of Columbia, and four U.S. territories major disaster areas. According to Polsinelli, these disaster areas will extend important deadlines for qualified opportunity zone investments.
The two deadlines affected are:
- The 31-month deadline for spending cash or other financial assets held by a qualified opportunity zone under the working capital safe harbor plan; the extension is for an additional 24 months.
- Capital received from the sale of a qualified opportunity zone fund; the extension is for 12 months to reinvest the funds in order to count them in the fund’s 90 percent asset test.
The working capital safe harbor extension can be used for qualified opportunity zones in any federally declared disaster area. That means real estate developers and investors in virtually every state could have some relief with this extension. There may be limitations, so Sharestates recommends you get your tax advice from your tax advisor and legal advice from your attorney. Nevertheless, these extensions could provide welcome relief to some opportunity zone investors.
Is Real Estate Development on the Road to Recovery?
While there are some signs of certain sectors of the economy beginning to open back up, there is still a lot of uncertainty surrounding the economy and COVID-19. For instance, researchers still are not sure how the virus will respond to warmer weather or whether it will return in the fall. Furthermore, will opening the economy cause a resurgence in cases even though many states are beginning to flatten the curve? These are some of the unknowns.
Despite the unknowns, state government is beginning to develop plans that allow people to get back to their normal lives. These include continued social distancing measures, mandatory face masks, and enhanced business practices such as reduced shopping hours, limits set on customers per square foot, and limits on how many cash registers can remain open at one time. The idea is to mitigate the effect of the virus and limit its spread while people are allowed to continue their normal routines as much as possible. The question is, will any of this allow the real estate markets to recover and, if so, how quickly?
One sector of real estate that has taken a huge hit is commercial real estate. CBRE predicts a long recovery. That’s possible since office leasing has slowed, the retail sector has slowed, and certain commercial industries such as travel and tourism have come to a halt.
The Motley Fool reports that rents were down initially, particularly right after lockdowns were implemented and in cities where shelter-in-place orders came early on. However, in April, they started going upward again. That’s likely due to the stimulus legislation that was passed as renters began to receive their direct deposits toward the end of the month. Some employers are also beginning to let at least some of their employees start work again, and unemployment insurance has some workers opting to remain at home instead of returning to work. So paying the rent isn’t as big an issue as it was.
If the virus threat continues, however, unemployment and economic stimulus packages will taper off. Some employees could find themselves out of work permanently as businesses shoulder the burden of lower profits due to limited operations. Renters may want to renegotiate rent agreement with their landlords or seek smaller rental units. Ultimately, the rental market will likely recover faster than other areas of real estate, especially if some homeowners end up losing their homes.
In Michigan, commercial developers and construction will be resume operations, with some restrictions, on May 7. Other states are beginning to open up, as well. Still, lost revenue from ceasing operations will be a factor in how quickly the construction sector can recover.
Invesco portfolio managers predict three areas of real estate that will likely recover more quickly than others. These include:
Multifamily certainly has the potential to come out of the COVID-19 crisis more quickly than other real estate sectors. With office space, leasing is more likely to recover more quickly than new construction. The logistics sector also has high potential because even online retailers and digital businesses need warehouses and transportation centers. That need is not going to go away. However, it’s possible that the sector could adapt to a new reality post-pandemic.
How Opportunity Zones Could Play a Part in Recovery
Since opportunity zones provide tax benefits for developers and real estate investors, recovery from the pandemic could lead to more real estate professionals seeking these benefits. It’s likely that new opportunity zone projects will focus on sectors that recover more quickly, and since the focus is on economic development in distressed areas, multifamily investment seems like a likely candidate for new investment.
It also seems likely that new projects could focus on smaller spaces, and new and creative ways to look at new construction and development could also arise to facilitate “the new normal.”
In terms of the total recovery, the picture is going to look different for each real estate sector and for each geographic region. Some will recover faster while others struggle. Investors will have to scrutinize every opportunity and be discriminatory in which deals they fund. Due diligence will likely require more nitpicking for a while.
Before COVID-19 made its impact on private lending, there was a new trend developing in correspondent lending. In essence, lenders sitting on too much capital and not enough deal flow were lending to other lenders. It was the fastest-growing space in private lending.
All of a sudden, mortgage refinancing surged while demand for personal lending dropped. Small business lending is soaring. Is there a new normal in lending, or will we go back to the old normal once the current crisis is over?
Business Cycles, Black Swans, and Private Lending
Businesses cycles come and go. There are boom and bust cycles in every sector. We’ve seen various cycles in mortgage lending, real estate, banking, retail, e-commerce, financial services, and more. The savvy investor learns to anticipate the business cycles and develops an investment strategy for each type of cycle. Some investors don’t change their strategies from cycle to cycle but may focus instead on priorities, the value of their investments, or their asset class mix. Private lenders would do well to pay attention to the cycles, as well. That said, there are times when an unexpected black swan event throws a wrench in the business cycle. COVID-19 is such an event.
Heading into 2020, almost every economy around the world was expanding. Many of those economies, the U.S. included, were maturing in that expansion. Since the coronavirus outbreak, however, there have been disruptions on several levels.
For instance, here are a few ways COVID-19 has disrupted the global economy:
- U.S. import and export activity has declined significantly
- Labor market concerns have risen
- Federal Reserve interest rates have been cut sharply
- U.S. Treasury yields have hit historic lows
- Volatility is the order of the day
The list of black swan events that have suddenly made big economic impacts is diverse. War, famine, terrorist attacks, nuclear reactor meltdowns, stock market crashes, and technological failures, just to name a few. The curious nature of black swan events is that they are unpredictable. These are events that no one could foresee but that pack huge financial implications across one or more economies.
What’s interesting about black swan events is that they often create opportunities as they are shutting the door on others. Famed Wall Street trader Jesse Lauriston Livermore turned short positions into $100 million during the stock market crash of 1929, while others were losing their fortunes. While COVID-19 has led to massive unemployment and short-term small business closures, many private lenders are seeing a surge in loan applications. In short, business cycles can be relied upon to an extent, but unexpected events can cause disruptions to those cycles that can benefit those keeping their eyes open for new opportunities.
How to Protect Your Investments in An Age of Volatility
Emotional selling is often the worst thing an investor can do in times of uncertainty. That doesn’t mean investors should hold onto all positions indefinitely. But if you have your investment strategy thought out before a crisis hits, you’ll fare better during the storm.
What can private investors do right now to ensure assets are protected during this turbulent time? Here are a few ideas:
- First, don’t panic.
- Look for where the market is moving right now. Private lending has picked up in some areas. Due to a rise in unemployment and the inability of many renters to pay their rent and homeowners to make their mortgage payments, federal and state governments are issuing relief packages for small businesses. Those businesses that survive through the pandemic crisis may be in the market for a private loan on the other side.
- Try to identify short-term opportunities whenever possible. Until investment markets return to normal and regain some stability, volatility will be the norm. That doesn’t mean “sitting out” is the best strategy.
- Look at previous crises and see if you can find any patterns. Commercial real estate has often done well when residential struggled, and vice-versa.
- Continue to diversify your portfolio. Now might be a good time to look at your asset class mix. Is it heavily weighted toward an asset class that is struggling amid the current crisis, or heavily weighted toward high-risk investments? You might shift some of your assets to an asset class that will serve as a hedge against potential losses in those sectors. But keep in mind that short-term volatility may not affect the long-term position of individual assets within that asset class.
- Realize that, more often than not, real estate typically fares better long-term even if it struggles during short-term crisis moments.
- Don’t be afraid to adopt a wait-and-see attitude. Every investment portfolio is different. You only lose if you sell at the wrong time. Just because an asset’s value has been affected by the current crisis, that doesn’t mean that an asset’s value will remain at its current position after the crisis has passed. There is some talk of re-opening the economy in a couple of weeks. Whether that happens or not, and, if it does, how it happens could mean another shift in market forces that could send a ripple through the economy that counteracts recent market moves.
None of this should be construed as investment advice. You should talk to your financial advisor before making decisions regarding your portfolio, but panic selling is almost always a sure losing strategy, so don’t be overrun with emotion.
How Private Lending is Poised to Change in 2020
It is likely that private lending practices, including underwriting, will change in the short term. No one can be certain how COVID-19 will impact private lending long term. A lot depends on whether or not the economy can get back to normal soon, and how quickly it gets back to normal. That, of course, depends on how soon health and infectious disease professionals can develop a vaccine for the coronavirus and how soon cases of COVID-19 decline over the next few weeks. These are unknowns.
Sharestates is continuing to monitor the private lending industry and the economy overall. Meanwhile, investors should consider that loan underwriting practices are likely to change for the foreseeable future. Lenders are already tightening credit standards. In cases where lenders have been sitting on a lot of capital, those lenders run the risk of too rapidly approving loans and placing that capital at risk. That will require additional control measures to ensure that lending too often and too quickly does not place lenders and investors at risk. That may include a cap on loan originations, loan amounts, and some restrictions on the types of borrowers allowed for such loans.
While uncertainty increases investment risk for lenders and investors, sitting out could be a greater risk. Investors may have to look harder for good deals in this environment, but they do exist.
Housing-related stocks such as Zillow and Redfin fell by more than 10 percent on Wednesday, April 1. It appears these stocks may be responding to mortgage applications falling 24 percent, well beyond expectations, from a year ago due to increased concerns over the spread of the coronavirus. Many economists are predicting that COVID-19 will lead us into a recession. We’re already seeing some fallout in the lending capital markets.
3 Ways COVID-19 Is Impacting the Home Buying Process
In the week ending March 28, 6.6 million Americans filed for unemployment. Half that many filed the week before. Globally, more than 1 million cases of coronavirus have been charted with nearly a quarter of those in the U.S. Several states have issued shelter-in-place orders or lockdowns while others have ordered mandatory quarantines for incoming visitors, and some have issued curfew orders. These restrictions are causing havoc in the real estate market in very real ways.
Here are three ways COVID-19 has impacted the home buying process and will likely continue to impact the home buying process:
- Some states have shut down nonessential businesses, or businesses that are not “life sustaining.” As a result, real estate services such as appraisals and inspections can’t be scheduled in those states. Since homes can’t sell unless those services are performed, the effect is a slowdown in home sales.
- Social distancing is affecting all areas of real estate. Agents are reluctant to schedule open houses while mortgage brokers and title companies are moving services online, facilitating digital transactions rather than in-person meetings.
- One couple in Connecticut found themselves juggling dates and working through a difficult moving process as a result of government-mandated policies.
Other real estate sectors being impacted by the coronavirus crisis include property management, commercial real estate, and new development funding.
3 Real Estate Sectors Hit Hard by COVID-19
COVID-19 is pulling at the fabric of real estate in multiple ways. Here’s how it is impacting three real estate sectors that have enjoyed a long run of prosperity since the 2008 financial crisis.
In the property management sector, millions of unemployed tenants are unable to pay rent. While many have filed for unemployment insurance, it takes a few weeks to receive the first check. Treasury Secretary Steven Mnuchin said in a press conference on April 2 that the first stimulus checks will arrive in people’s bank accounts within two weeks. Still, many people have a rent payment due this week. Some tenants are asking for rent forgiveness during the crisis while some states, including New York, have placed a moratorium on evictions.
Property management firms are caught in the middle, balancing the concerns of both tenants and landlords. Of course, if they’re not collecting rents, they aren’t collecting management fees.
Commercial Real Estate
Retail shop closures are also having an impact in several ways.
- Malls, shopping centers, and other tenant-based complexes may not collect rents from their commercial customers during this time
- Force majeure clauses are allowing commercial developers to break commitments to completeprojects by a certain deadline
- New project developments are seeing delays as many construction crews are out of work due to stay-at-home orders and nonessential business closures
New construction is being impacted in residential, commercial, and industrial sectors. That means there are many developers and project managers out of work, along with their entire employment force including contractors and subcontractors. Of course, that’s having a domino effect on mortgages, rental agreements,
and maintenance sectors.
Even in states where stay-at-home orders and business closures have not been implemented, there has been a slowdown in development.
This, of course, is impacting how and where capital is being deployed in real estate.
How COVID-19 is Impacting the Real Estate Capital Markets
While the real estate market has been impacted at the ground level, the impact may be felt the hardest in the capital markets. Deal flow in private equity and real estate has fallen at an unprecedented global level. The Motley Fool recently reported the 10-year treasury hit an all-time low of 45 basis points after rising to an all-time high of 1.226%. This short-term volatility creates uncertainty, and investors don’t like uncertainty. The fallout is being experienced in the secondary market.
Mortgage bankers often sell loan originations to be packaged into mortgage-backed securities on the secondary market, then hold onto the loans. Recently, brokers have been issuing margin calls. As a result, lenders are seeing their liquid assets evaporate.
This creates a new problem for private lenders. Without working capital, they can’t issue new loans. That, in turn, could create a ripple effect throughout the real estate markets. Developers who can’t get loans can’t build. Rehabbers who can’t fund their projects will buy fewer properties, and they’ll sell fewer properties. Less capital in real estate means fewer real estate deals in all sectors–residential, commercial, and industrial.
Private real estate lenders facing a liquidity challenge amid current and sudden volatility need a capital infusion to continue operating and service the increased demand in loans caused by the rapid unemployment and business closures. That’s why Sharestates has issued a margin call relief program.
The Importance of Capital Liquidity in Real Estate Private Lending
Lenders without capital are like boats without water. The change in environment doesn’t change their nature, but it does affect their ability to function as intended.
While the CARES Act can assist families struggling with paying their mortgages, as well as businesses struggling due to closures, it does little to address the needs of private lenders who have seen their liquid assets drain as a result of margin calls.
The Federal Reserve, in mid-March, lowered its benchmark interest rate to 0%, but that’s done more to hurt the capital markets than help. If private lenders run for too long without liquid capital, it will seriously curtail their ability to issue new loans and maintain operations. The largest operational expense for most businesses, including private lenders, is payroll. Without working capital, private lenders will have to lay off some of their staff. Not only will that hamper their ability to service existing loans, but it will also add to the already skyrocketing unemployment rate. For small lenders, any reduction in employment staff could be drastic.
Additionally, lack of liquid operating assets could cause some lenders to miss mortgage or rent payments on their office space, which would seriously diminish their ability to continue operating.
The most likely scenario would be unnecessary consolidation in the lending market. As smaller lenders struggle to survive through the temporary turbulence, they may find their only option is to merge with a larger lender, sell their loans at a discount, or sell part or all of the business to larger lenders or investor pools for less than the company is actually worth. The best option for most of these lenders is to sell some of their existing loans at a discount so they can continue to underwrite new loans and navigate through the coronavirus crisis intact.
Liquidity is the backbone of private lending. Capital is to loan originations as water is to boats. For more information on Sharestates’ margin call relief program, click the button below.
Since the Great Recession, there have been hundreds of new entrants into the alternative lending space. One of the fastest-growing areas of interest has been debt funds and real estate debt funds in particular. In fact, there were a total of 247 private real estate debt funds that closed between 2008 and January 2015. Those debt funds raised a total of $101.8 billion in institutional investor capital. To get a handle on these private lending real estate debt funds, it’s important to understand the capital stack. What makes up the capital stack, and who has the priority?
The 4 Major Tiers of the Real Estate Capital Stack
Generally speaking, there are two positions in any investment: Debt and equity.
Within these two private investment categories, there are varying degrees of capital investment. The priority of investment return is determined by where the investor sits in the capital stack. In the simplest terms, debt investments have the highest priority while equity investments have the lowest. Unfortunately, few investments are that simple.
There are generally two types of debt. Senior debt is the first lender. This position on the capital stack entitles the investor to the first right of returns. In other words, when it comes to paying off the investment, if a deal is profitable enough to begin paying off investors, the senior lender is the first to be paid back.
What it boils down to is senior debt must be paid off before equity investors see any investment returns. The pay off is, equity investors generally see higher returns due to the higher risk factor.
Junior debt is any secondary loan taken out on a real estate deal. Often called “mezzanine debt,” these loans are riskier than senior loans. They are made with higher interest, and often, stricter terms. Because of the increased risk, the return on the loan is generally higher than the return for senior debt. If a deal goes south and doesn’t earn enough to pay off the first loan, the junior lender absorbs the loss.
After all, debt has been paid off on an investment, equity investors can receive returns. The two most common forms of equity investments are preferred equity and common equity. Preferred equity has the highest priority.
Similar to the difference between senior debt and mezzanine debt, common equity is riskier and therefore is subject to higher returns, but it has the least priority on the capital stack.
To further complicate the structure of the capital stack, preferred equity and mezzanine debt are often referred to as “bridge financing.” That’s because they are often issued in the middle of a project and are often used by developers and deal sponsors to raise capital in the midst of an ongoing project. That is, when further capital is needed to see a project to completion, developers look for bridge financing.
The capital stack looks like this:
The Emergence of Debt Funds Post-Financial Crisis
In recent years, changes to the debt financing landscape have made debt instruments in real estate more rewarding and attractive for investors. The advent of online lending, and the increase of alternative lenders after the passing of the JOBS Act of 2012, has made debt funding more attractive and lucrative for investors while providing some of the same benefits as equity investments. As a result, the alternative lending sector is much more competitive.
New technology has led to new and innovative approaches to lending. Real estate crowdfunding has exploded while securitizations have become more common for startups looking for operating capital. For the investor, these business models represent a steady income with a lower risk threshold.
One emerging investment product is a debt fund. A debt fund is a pooled investment where investors combine their capital to take advantage of new opportunities for returns that were not available to them just a few years ago. Quite often, these funds invest in a diverse range of fixed-income opportunities from commercial real estate to long-term bonds. Generally, the fees are lower than those for traditional equity funds due to lower management costs.
Another unique aspect of a debt fund is the distributed risk factor. Because debt funds invest in a variety of securities with different risk profiles ranging from low risk to very high risk, investors spread their overall risk among the various investments in the fund. Operating like a mutual fund, investors also mitigate risk by sharing it with other investors.
How Real Estate Debt Funds Compete Using the Capital Stack
The key to attracting investors with any debt instrument is to create a product that appeals to their interests. Generally speaking, investors want low risk and high returns. Not all investments, however, can offer both simultaneously. Investments have traditionally worked this way: The higher the risk, the higher for potential returns; lower-risk investments generally offer lower returns.
The increase in real estate debt funds, on the other hand, has turned this traditional model on its head. Debt fund managers can use the capital stack to offer competitive investment opportunities for investors. Here’s how.
- Diversification – Lending is risky. Even senior debt, the highest priority on the capital stack, offers some risk. By diversifying the debt instruments within the real estate fund across multiple opportunities, the risk to the investor is mitigated as opportunities within each fund act as a hedge against each other.
- Focusing on the lowest risk categories – Even though diversification lowers the risk threshold, the rise in real estate lending in the last decade has offered debt fund managers plenty of opportunities to focus on senior debt, the lowest risk category on the capital stack. Fund managers can still diversify within that category and remain competitive. Every investment in the fund still has a higher priority than mezzanine debt and equity investments while offering respectable returns.
- Steady and frequent returns – Rather than tie up investor capital on long-term debt instruments, today’s debt fund managers can focus on short-term investments that provide higher returns even while diversifying portfolios. These opportunities generally yield income monthly until debt instruments are paid off.
- Rotating opportunities – Since debt fund managers focus on short-term debt opportunities, frequent maturation is a built-in component of real estate debt funds. That means fund managers must replace maturing instruments with new investment products on a regular basis. Therefore, investors often see a 100 percent turnover in investment opportunities within the fund every 12 to 24 months. These rotating opportunities serve to lower risk, diversify the fund portfolio, increase returns for investors, and offer a steady income.
Thanks to the rise of real estate debt funds, investors have better opportunities for returns than ever before. Many lenders focus on single investment types such as multifamily or commercial while others diversify their offerings across several types of investments. When performing due diligence, investors should ask how debt fund managers select the investments that are featured in their funds.
In today’s real estate lending landscape, platforms that offer debt funds for investors must offer investors high-return opportunities while mitigating risk. Using the capital stack to build the fund portfolio is the best way to achieve the best possible rewards.
Fix-and-flip investors take great care in buying properties. The BRRRR process involves some math. To ensure a profit on the back end, you have to buy right on the front end. That means calculating purchase price and rehab costs to figure total investment and comparing that to expected sales price at the completion of the project. Investors generally look at loan-to-value (LTV) ratios and after repair values (ARV) to determine whether a project is a good investment or not.
Another strategy called Buy, Rehab, Rent, Refinance, Repeat (BRRRR) is emerging in the real estate investing marketplace. It’s not new, but it does offer some advantages to a straight fix-and-flip strategy. Let’s discuss those.
Buy the Right Property at the Right Price
There are two types of fix-and-flip projects that fit into the BRRRR strategy. One is where the investor goes into the project knowing in advance that he will rehabilitate the property and convert it into a rental property, adding it to his buy-and-hold portfolio. In that case, the investor must calculate expected rents and determine if it will lead to cash flow, or determine if there is potential equity after holding for a few years. If property values go up, he can sell the property later for a nice return.
The other type of fix-and-flip project that might end up in a buy-and-hold portfolio is one that was intended to be sold immediately after repairs, but a change in market conditions has caused the investor to change his strategy to buy and hold mid-stream.
In either case, buying the property at the right price is essential to getting the return on investment expected.
Rehabilitate the Property
Whether you intend to flip the property or convert it to a rental, the rehab part of your project is very important. You don’t want to spend too much money on the rehab or it will eat into your profits. On the other hand, you want to ensure the property is functional after the repairs have been made. If possible, you want to focus on repairs that also add some value to the property, which is very important if you intend the sell the property later.
Rent to the Right Tenant
In a typical fix-and-flip project, immediately after the rehab phase of the project you’ll move into sales mode and try to find a willing buyer as soon as possible. Holding properties cost you money. However, if you are transitioning to a buy-and-hold strategy, then you’ve got to turn the property into a revenue generator as soon as possible. That means you need to find a tenant as soon as possible.
You want to do this before you refinance because most banks don’t want to refinance a property that isn’t occupied. Having an occupant will increase your chances of refinancing.
Refinance to More Favorable Terms
In order to refinance, you need to ensure you have some things in place first. For starters, you’ll need an appraisal.
As soon as you have tenants in place, make sure they know an appraiser will be stopping by to look at the property. You don’t want to surprise them. After you get your appraisal, interview a few banks and compare terms. Find out if the bank offers cashouts. If not, you want to find another one. The cash out is very important in the BRRRR strategy because it reduces your risk. Secondly, find out how long the bank’s seasoning period is. In other words, how long do you have to own the property before you can refinance it?
Seasoning periods are important because if you get stuck in a high-interest loan for long, it will slice into your profits. You want to get your interest down as soon as possible.
Repeat and Profit
When you find a strategy that works, you want to repeat it. Many buy-and-hold investors find that they like the BRRRR strategy and continue to implement it into their portfolios. There are several ways to do this:
- Go all-in – Some fix-and-flip investors convert to the buy-and-hold strategy completely. There are advantages and disadvantages to doing so. If you go all in, you’ll have a large portfolio of properties in your inventory that could be difficult to sell later if the market turns. It could also lower your liquid cash reserves as your capital will be tied up in properties. On the other hand, flipping produces short-term returns and higher capital reserves, which translates into more money for buying properties.
- Half and half – More popular than going all-in is the half-and-half method. Some fix-and-flip investors convert every other property into a buy-and-hold property. In effect, they flip one then hold one. That way, they can keep the short-term returns coming in while building their buy-and-hold portfolio.
- Create your own mix – Maybe you’d prefer to flip 60 percent of your portfolio, or one-third buy-and-hold matches your risk tolerance better. Creating your own strategy can also make you feel like you have more control.
The Benefits of the BRRRR Strategy
In a rising market, it’s usually better to buy and hold. The downside is, it is difficult to time the market. There is no fail-safe way to know the best time to sell. That’s why many BRRRR strategy investors use a 5-year benchmark. They buy, rehab, rent, refinance, and repeat, and in the fifth year, they put the property up for sale.
Using this strategy means you’ll always have properties on the market after the fifth year. If you buy your properties wisely, even in a market hostile to sellers, you could see returns on these transactions.
It’s still important to buy right. Using the same LTV formula you use for fix-and-flip properties will keep you on the right track. If it works for flipping properties, it should also work for your buy-and-hold strategy. The snag will be if you can’t find a renter during the rent phase. If that happens, you can still flip the property and aim for buy-and-hold on the next one.
Since real estate investing often means buying properties at a discount and selling them at full market value, the buy-and-hold strategy gives you an advantage, especially in a market where property values are on the rise. If the rental market is up and home sales are down, it’s also a good time to take advantage of the monthly cash flow that owning rental properties brings. However, you don’t want to get yourself in a bind by holding onto too many properties at once.
Be sure to calculate the costs of refinancing before you make a purchase. Lenders generally finance no more than 75 percent of a property’s value. If you aim for a 70 percent LTV, that gives you some wiggle room. Sixty-five percent is even better.
Banks also charge a refinancing fee. On top of that, you’ve got to pay for the appraisal, title work, and loan processing. It will be worth it if you can cash out your initial investment. That way, you have none of your own money tied up in the project while earning residual income. In the meantime, you can build equity. If you start with 25-30 percent built-in equity, you could be sitting on a gold mine.