How to Survive a Real Estate Crash as a Landlord
---Seven Risk Mitigation Strategies That Helped Me Survive the Pandemic
The house rental business is probably one of the simplest forms of business because it has predictable revenues and expenditures (e.g., mortgage, real estate taxes, insurance, repairs, maintenance) most of the time.
However, if you stay in the rental business long enough, you will surely face a few of what I call “tsunami events” — pandemics, recessions, depressions, etc. — which disrupt your constant stream of monthly revenue, leaving you to figure out how to survive.
These tsunami events separate the successful real estate rental businesses from those that will most likely go under.
Murphy’s law says anything that can go wrong will go wrong. These words should be remembered by anybody who wants to enter the long-term real estate rental business.
You don’t need to look further than our current pandemic to understand the effect it has had on the regular mom-and-pop rental market. The eviction moratorium that was derived from this pandemic has really caught lots of landlords off guard. And frankly, it has forced a lot of landlords to sell.
In today’s blog, I want to provide you with some important, doable risk mitigation strategies to ensure your properties are adequately protected against the next tsunami event.
Before I tell you about these risk mitigation strategies, we must understand what our worst-case scenario looks like. So before we go any further, pull up your expense tracker for your rental house(s) (I know you’ve got one) and ask yourself the following questions:
If I can never rent out my property again and am forced to keep this property, how much money would that cost per month? Be sure to include your mortgages, real estate taxes, insurance, maintenance, and repair costs.
During a tsunami event, do I have other forms of revenue or cash flow to help pay all personal and real estate expenses discussed in the first question? (This could be your job, pension, stock dividend, etc.)
How secure are my other forms of revenue during a real estate tsunami?
Using your responses from questions 1-3 above, how long can you keep your property if you have no rental revenue during a real estate tsunami?
After answering these questions, you should have a pretty good idea, bleak or not, of how you would truly handle the worst-case scenario.
Now let’s see how we can improve our situation with the following risk mitigation strategies:
1. Cash is king
The famous saying that cash is king is exactly right. With enough cash, you can pretty much weather any storm where your revenue is hard to predict or even nonexistent. How much cash you need depends on how many expenses you anticipate incurring during this time, as well as the other risk mitigators that we are about to discuss.
2. Maintain positive cash flow from day one
You are “cash flow positive” when your rental revenue is greater than all your expenses including mortgage payment(s) (e.g., interest, principal, real estate taxes, insurance), repair, and maintenance costs.
When the unexpected hits, you will likely need to lower your rental revenue to attract a qualified tenant and weather the storm. If you’re cash flow positive, you have room to lower that revenue and still potentially make a profit, or at least break even, during tough times.
There are a few things you can do to ensure you are cash flow positive from the start. You can put down a larger down payment to make your monthly mortgage comfortably low. Or if you already have a house, you can refinance and put more money into the new loan so that it drastically cuts your monthly payment. Remember, the lower your monthly real estate expenses, the more likely you are to survive any real estate tsunami.
3. Do not overleverage
This goes hand in hand with the risk mitigation strategy we just discussed.
One of the main reasons we want to be a landlord is because we can leverage the bank’s capital at low, 30-year fixed interest rates to maximize our profit. However, overleveraging is dangerous. It is perhaps the number one reason landlords fail in the long run.
The best way to tell if you are overleveraged is to answer the four questions we went over earlier in this article. So for example, if you don’t have a way of keeping your property for up to a year, then I would say you are in overleverage territory, and you should start to formulate a risk mitigation plan.
4. Purchase desirable properties
The house rental business can be a completely different business depending on where your properties are.
If you buy a house in a low-income area where people’s jobs are heavily dependent upon the economic cycle, then the chances of not receiving revenue during a tsunami event become significant. So you probably need to have a much higher reserve of cash to cover your expenses just in case.
Of course, the opposite is also true. Buying a house near a desirable neighborhood means typically encountering higher-quality tenants as far as income stability. You’ll likely be able to find an ideal tenant even during a tsunami event. Thus, your rental revenue is a lot more secure.
5. Locate within diverse industrial bases
There is a world of difference between renting out houses in, say, a vibrant city versus some rural area that doesn’t have a diversified industrial base.
Imagine you rented out properties in North Dakota during the fracking boom a few years ago. You could have named your price as hordes of people flocked into the area! But when oil prices crashed last year, everyone was gone within a few months. The properties you bought and rented out at whatever price you wanted are now completely vacant, and you just know there will be pain ahead.
Now if you buy a property in a city that has a diverse industrial base, then you’re less likely to have this issue. A perfect example of this concept is northern Virginia. This area is full of federal and military jobs thanks to its proximity to Washington D.C. and the Pentagon. These jobs are essentially recession-proof. Even better, northern Virginia also boosts a healthy, diverse industrial base, ranging from technology and finance to healthcare and more. This allows you to diversify your tenant base so that if one industry heads into trouble, you can acquire tenants from other industries that are still thriving. In turn, this substantially increases your chances of surviving tsunami events.
6. Properly screen your tenants
If you don’t properly screen your tenants, Murphy’s law is bound to catch up with you. It is highly probable you end up with someone who does not pay you, and then you are forced to go through an eviction process. Screening your tenants properly allows you to get a feel for the tenant’s job situation and how stable they are. The more established your tenants are (and the more secure their sources of income), the more likely you are to weather a tsunami event without issues.
7. Stagger your leases
If you have multiple rental houses, make sure you don’t let all your leases end at the same time.
I always stagger my leases so that different houses have different lease end dates. The further apart they are, the better.
You don’t ever want to be in a situation where you have two or more tenants leaving at the same time. That requires simultaneously filling up multiple spots, and if your houses are next to each other like mine, it can be even more difficult.
If the market is down at the same time, you might not get a tenant in for any of the rental houses. That just multiplies the amount of revenue loss that needs to be actively avoided if at all possible.
Wrapping it up
These are the seven risk mitigation strategies that I have been most conscientious about over the years. They have all helped tremendously during this pandemic.
I hope you consider these risk mitigation strategies before purchasing a house. Make sure to subscribe for more on how to successfully grow your real estate rental adventure!