Don’t Lose Your Principal

It’s times like this and for the inevitable near-term where smart investors remember the first rule of investing: Don’t lose your principal. 

Why would I say such a thing now, in the middle of perhaps the greatest real estate run up the Willamette Valley has ever seen? Simple: What I see now takes me back to 2006-2008.

Let me give you some context: I started my real estate investing journey with very little. I bought my first investment property in 2004. It was a vacant house in a rough part of Salem. It had a little For Sale By Owner sign in the window. You know the type: Black and white with orange lettering. An “805” area code telephone number was listed, which I knew to be Vermont (I had a client in Burlington in my other business), which to me meant that the owner was likely absentee. So, I called. And, in a matter of days, I had a deal started and in escrow. I had done enough research in that neighborhood and knew the comps and bought it at such a good price, I knew I could sell it quickly. And I did. Before I even closed, I had multiple offers and in fact, the only money I ever spent was my earnest money, which was promptly returned. I think you’d agree that deal would light a fire under anyone. It sure did me.

For the next 4 years, I was a very active investor. I bought and sold just about everything you can think of. Raw land, single family houses, and commercial. Then 2007/2008 happened. The details of those years for me are more vivid than most, even now, 14-plus years later. For many, it was painful. For me, I saw 4 years of hard work unravel. But, the lessons I learned were incredibly invaluable. They’ll stick with me until the end. And, right now, while I don’t know what will upset the runup in residential pricing or when it will happen (I write a column every month for a local brokerage on the “state” of the residential market), there will be one. 

No one could have predicted a pandemic would hit. But what many thought would spurn a market downturn, has yet to materialize. The mortgage-backed securities mess that fired the greed of the 2008 crash had much more of a “tell” to it – in other words, many knew it was coming. I had sage friends who’d survived prior crashes (barely) that told me what was coming. But, I knew far more than they and didn’t heed their warnings. Brings us to the present: Where we are at now, who knows what could set the fire if not a world-wide pandemic that literally shuttered the economy? 

On the residential housing side, it seems simple: Demand continues to outpace supply. The number of new residential subdivisions is relatively flat. Lot prices are exorbitant (thanks in no small part to high development costs levied by municipalities). Interest rates remain at historical lows (Buyers are getting sub 2.75% loans right now) which one could see as a form of stimulation (unnatural market forces at work, perhaps, to keep rates artificially low?) to keep the market strong. Oregon remains popular as a “move-to” state. Salem, in particular, is one of the more reasonably priced areas. (Barely, however. In December, according to WVMLS.com, South Salem outpaced Benton County on a price per square foot basis for what I believe is the first time ever or at least in many years). 

My daughter is a Realtor® here in Salem. Clients of hers with homes to sell in the $300-$400,000s experience bidding wars. Which means her Buyers have a hard time securing a home in that price range. Small multi-family investment properties are being sold for top dollar. Investment properties under $500,000 don’t last. 

But what about commercial properties? Right now, when you can find a decent one, they are rarely offered at a high 6 or better cap rate. 

Popularity of real estate as an investment (lack of inventory), low rates for borrowers and lack of other vehicles to generate sufficient returns at an acceptable rate are in part driving the commercial market. 

Based on all this demand, one might think preserving principal should be easy. Here are some cautions I’d extend to you:

We just experienced a change in leadership on the federal level. That means perhaps a new Fed Chair, definitely a new Treasury Sec in Janet Yellen (former Fed Chair), and overall, new money policy which will likely be “old” and familiar policy since most dogs rarely find new tricks – which means what will happen in this new administration will be predictable – mostly.

Here’s the challenge: the last 12 months have seen the Federal government and every state government bleeding money and giving it away by the billions to keep the economy from tanking in the middle of a pandemic. The statistics we can read now don’t reflect it, but that rooster must come home to roost at some point. The trillions in debt will have to be paid back. And, as such, take your pick: higher taxes or inflation. 

In the world you and I work and live in, the real estate world, investors have taken a hit on their incomes in 2020 from late and no rent received. Many have mortgages to service. There are no consequences to speak of yet, at least here in Oregon. And, the can got kicked down the road a ways when the Governor signed off on an 80/20 bill whereby landlords can qualify for an 80% payment of rents due from tenants, paid by the state, if they forgive the other 20% due from tenants), but there’s nothing at the federal level at this time.

So we’re back to the original statement I made in my opening paragraph: How do you avoid losing money in the mess that’s likely to ensue?

When you do find a property, ensure your principal is protected as much as possible. Ask yourself: Are you insuring against the downside? How? Sure, loan rates are low, but what’s your leverage like? Can you cover it if rents drop or go away altogether? Are your properties in such good shape now that you can avoid capital investments for a period of time, in the event funds become tight? What will you do if a major system or two blow out: A roof? Several RTUs? Parking lot? New siding? What if you lose a major tenant or two?

In thinking through all this, one client of ours comes to mind – they’ve strategically spent the last year securing their tenants for the long haul (lease renewals), investing in their building (parking lot, roof, siding, landscaping, etc.) and storing any excess cash. Bluntly, they’ve been making smart decisions. 

It might well be time to take some chips off the table before the unraveling. If you watch the smart money folks that have weathered cycle after cycle, they’re probably not buying a lot right now with the glut of cash and low inventory available. They may be selling off some of their assets to start storing cash. For some, they are more likely to build during downtimes and sell during the good. It’s worth thinking about. Keep in mind, what’s right for you may not be right for everyone. It’s all dependent on your goals, the nuances of your particular holdings and the level of risk with which you are comfortable. 

If we can help you navigate through different scenarios like a continued upswing or downturn, manage property, or provide real estate consulting services, contact me to learn more.