With the current economic expansion surpassing ten years and some potential headwinds on the horizon (e.g., tariff battles), some economists and others are calling for a slowdown. If you are a New York City real estate investor, this is a potentially particularly harmful development.
Real estate is sensitive to the economic cycles, of course. During good times, people feel more confident and have access to borrowing to purchase their home. For move-up buyers, he or she can sell his or her property easier, too.
An existing homeowner may wait out the slowdown. That might not be an option for some real estate investors, however. A real estate investor has different objectives. One strategy is “flip” the property relatively quickly in the hopes of capturing a nice profit and healthy return on investment. Even if you are a buy-and-hold real estate investor, a recession or even an economic slowdown could crimp your cash flow.
While no one has a crystal ball, keeping abreast of economic developments and the real estate market can help you take steps ahead of a downfall.
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Leverage can significantly enhance real estate investors’ returns during good times. That is when property prices are appreciating, and rents are rising or stable. This has been the case in New York City over the last several years. However, it can have devasting effects when the market turns downward. Therefore, if you are anticipating a downturn, you would be wise to use your monthly cash flow to pay down debt to put yourself in a stronger financial position.
For starters, borrowed funds allow an investor to purchase a more expensive property. This amplifies your return on investment when prices are going up. The use of leverage means higher monthly cash outflows for interest, and, during a market downturn, raises your financial risk.
To see how this might work, assume you purchase an investment property for $1,000,000. You have an upbeat economic outlook and expect the real estate market will strengthen. Therefore, you decide to invest with a 10% down payment, financing $900,000.
Within a year, your property value has appreciated to $1,100,000. Furthermore, assume your net cash inflows from rent were $2,000 per month or $24,000 for the year. Your price appreciation and rental income total $124,000 while your cash investment was $100,000.
On the flip side, if the real estate market turns down sharply, your monthly rental income could be severely impacted. You face the double whammy of lower prices and higher vacancies. You still must pay your monthly financing, however. To boot, you may find yourself with negative equity if the property’s price falls below what you owe.
Fill those vacancies
Real estate investors never want to have any vacancies, of course. He or she relies on rental income to generate cash flow. But, if you think NYC’s real estate market is going to change for the worse, it is in your interest to fill the vacancies sooner rather than later. You may also wish to sign longer-term leases to lock in the price. This may require offering a slight discount off the monthly rental price, but it ensures the unit is filled. You also have potential recourse if the tenant breaks the lease.
Filling the vacancies ahead of the downturn protects your rental income and avoids vacancies and discounted rents down the road.
There are steps you can take with your properties. If you planned to monetize the asset via a sale, you could shorten your time horizon and pursue that avenue now, while the city’s market remains healthy. Then, you can use the proceeds to pay down debt, reducing your financial exposure and debt payments. Alternatively, you can sit on the cash you receive from the sale and wait until the cycle shifts downward. At that point, you could start buying properties again.
If you are planning on initiating or expanding your real estate investments, you can hold off until you feel the time is right.
You can also take steps to minimize your exposure. For example, you could pare back on real estate properties that are in economically sensitive neighborhoods.
Avoid the flip
When you are buying flip properties, the key to earning an attractive return is to sell quickly. The idea is to buy a property that needs work, complete it as soon a possible, and sell it for a tidy profit. While you are holding the property, there are carrying costs, however. You must pay the mortgage (assuming you used financing), property taxes, utilities, common charges (condo), and other monthly costs. The longer the sales process, the higher your costs. Worse, your sales price is likely to decrease the longer it is on the market, and potential buyers dry up.
If you are anticipating a changing landscape, it behooves you to avoid investing in flip properties.
Forecasting the overall economy is fraught with difficulty. Even zoning in New York City is challenging, and it is certainly not immune to the nation’s economic developments.
Nonetheless, if you see signs that the real estate market is slowing, you can take steps to protect your investment.