You might think I’m feeling relatively sanguine during times of market volatility given less than 30% of my net worth consists of stocks. If the S&P 500 corrects by 50%, I only lose 15% of my net worth right? Well that’s absolutely wrong because whenever the stock market corrects, the real estate market is never too far behind.
Roughly 40% of my net worth is in San Francisco/Lake Tahoe/Hawaii real estate. If the weakness in the equities market continues, it’s always a reflection that corporate earnings are under fire. Less earnings means less jobs. Less jobs means less disposable income. Less disposable income means the demand for housing declines.
Even if you are doing relatively well, there’s a psychological desire to hold off on buying anything due to the expectation that prices will go lower. The specter of deflation is an economist’s worst nightmare.
DON’T FEAR A REAL ESTATE MARKET CORRECTION
I’ve come to grips my real estate holdings will decline in value over the next two to three years. If I could sell at least one property for less than a 1% fee in a click of a button, I probably would. Unfortunately, the internet has so far failed in lowering real estate commissions much below 5%.
For those of you with real estate, I think you should mentally expect a decline in your real estate holdings as well. Trees don’t grow towards the sky forever. Sometimes they get decimated due to wind, fire, lightening, or torrential rain.
So much about achieving financial freedom is believing everything will be OK in the end while doing everything possible to improve the things you can control. Let me share with you why I’m not worried about a large potential decline in my net worth, and why you shouldn’t either if you own property.
1) Your primary residence is your home. Real estate is my favorite asset class primarily because it provides incredible utility compared to stocks. During the housing crash, all I remember about living in my home is the late night snuggling on the coach watching a favorite movie, potluck parties with friends, and BBQs on the deck. There are so many fantastic memories even though at one point my house’s value probably declined by 20%. I prefer living in a nice home rather than trying to squirrel away money by living in a crappy rental. Life is meant to be lived now, and a home is where we spend the most amount of our time. Always buy real estate for a better lifestyle first, then consider capital appreciation and rental income.
2) Rents are incredibly sticky on the way down. If you buy gas for your automobile, you are understandably amazed and annoyed how quickly gas prices skyrocket, but decline so slowly. If you own rental property, there’s a reason for sticky rent. A contract! After 11 years as a landlord, I’ve never once had to lower my rent. By the time my tenant leaves, the downturn has ceased because bad economic cycles generally don’t last longer than the average duration of my tenant. For example, the last recession only lasted a couple years.
3) Occupancy can be improved through hustle. You have the ability to increase your occupancy rate if you negotiate and plan well. I’ve not had one month of vacancy in 11 years due to open communications and aggressive hustle. In other words, you can positively affect your outcome, unlike the stock market where you are a passive investor.
4) Costs decline in a down market. During the last downturn, for four years I successfully reduced my property taxes. The goal of every property owner is to make their house worth ZERO in the eyes of the property assessor’s office every year. You’ll also be able to refinance your mortgage as investors flee to the safety of bonds as they are doing now. I’ve refinanced multiple properties around 10 times, saving me hundreds of thousands of dollars in mortgage interest. Finally, when real estate is out of favor, you can get contractors to do home improvement projects cheaper.
5) Opportunities to upgrade increase. It’s human nature to always look to upgrade to that next nicer home. Even though your $500,000 home may have declined 20%, if the $2,000,000 home also declines by 20%, you’ve caught up by $300,000! (you lost $100,000, but the new house is $400,000 cheaper). I don’t plan on buying a new home in 2017-2019, but with my CDs coming due, perhaps I might just go for a nicer pad and write about my journey.
6) The government has your back. The government wants Americans to own homes. This is why they provide $250,000/$500,000 in tax free profits for individuals/married couples when they sell. The government also allows you to deduct 100% of your mortgage interest up to $1 million in mortgage indebtedness plus the interest from a $100,000 HELOC. If you make even more than $250K/$500K in profits, you can simply roll your property into a new one via a 1031 Exchange and never pay taxes. Finally, the government has a history of bailing out homeowners who’ve stopped paying their mortgages due to whatever reason. All of these benefits are for the price of yearly property taxes.
7) You’ll eventually have a paid off asset. No matter what happens in life, so long as you pay your PMI mortgage on time, you’ll eventually have a paid off home. If you look at property over a 30 year period, chances are extremely high the nominal value will be much more than your purchase price. During this time, you’ll have enjoyed your life (#1) while completely adapting your spending to your mortgage payment. I’ve owned one property for 11 years now and it feels amazing that even if I don’t pay extra principal, the property will be completely paid off in 19 years automatically.
8) It feels good helping the next generation. Buying a house after college can be very difficult given the downpayment and the price of homes in high job growth areas. If I can provide subsidized shelter for my children (not free, b/c there won’t be any free-riders in my family), then they can focus on pursuing a career more true to their hearts without overly worrying about making money. They can also focus on saving for retirement, starting a family, and all sorts of wonderful things when housing becomes less of a burden.
9) It won’t be as bad as the last downturn. The good thing about going through the worst financial crisis in history and surviving is that the next go around won’t be as bad. Since the last housing downturn banks have tightened their lending standards so that only the most prime borrowers who put significant down payments can get a loan. Banks, themselves, are much more capitalized with higher tier 1 capital requirement ratios. I feel happy that because my mortgage refinance was rejected in 2015, those who are getting loans have rock solid financials better than a 800 FICO score and $250,000 in income.
FORTUNES ARE MADE DURING DOWNTURNS
60-70% of my net worth is going to take a hit from a potential downturn. I’ve accepted this inevitability and so should you if you own stocks and real estate. In the meantime, I’m working hard to build more income and savings through my online business and other side hustles to help soften the blow. My hope is to actually make my business so big that it pushes stocks and real estate to comfortably under 50% of my entire net worth.
Nobody should be in a rush to buy real estate now. Periods of weakness never only last for a year. Be super picky about what you buy and the terms of your contract. Don’t be afraid to back out of a deal because there will always be another real estate opportunity. The best time to buy is almost always when there’s blood on the streets. The key is to have enough cash and cash flow on hand to take advantage of opportunity.
Look into real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today. Real estate is a key component of a diversified portfolio. If you study the asset allocation mix of college endowment funds and high net worth individuals, you’ll see real estate weightings of anywhere between 5% -25%. Real estate crowdsourcing also allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. Check out my Fundrise review as well.
Shop around for a mortgage: Mortgage rates have collapsed after Brexit, and US assets are aggressively being bought by foreigners due to our stability. Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible. This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.
Updated for 2017 and beyond.