Taking market exposure is the worst way to invest in real estate, but there are ways you can avoid doing this.
Are you worried about losing money through real estate investing? If you’re using it the wrong way, then you should be. And the worst way to invest in real estate is by taking market exposure.
Taking market exposure means whether or not you make money on the deal depends on what happens with the real estate market. Even though nobody can tell you exactly where the market is going, as of now, there is a lot more possibility for the market to go down than for it to continue to go up. If you’re fixing and flipping and investing in real estate, make sure you’re taking as little of that market exposure as possible.
How do you avoid this mistake?
First, if you’re doing a fix and flip, make sure you’re doing a project with a very quick turn. You don’t want to take on really long projects that could last a year or more. You want to take on projects that allow you to buy and sell in the exact same market. The great thing about the real estate market, as opposed to the stock market or the bond market, is that when it’s going down, it can’t happen all at once by the function of how real estate is sold.
The stock market can go down 20% or 30% over the course of a few months—sometimes even faster than that. When the real estate market goes down, it goes down slowly, and the real estate market goes down once inventory starts to accumulate.
By “quick-turn” projects, I mean projects you can buy, renovate, or sell within a 90-day period in the same market. That eliminates the risk of market exposure instead of buying a property, renovating it, and selling it a year later. Even though the real estate market goes down slowly, a lot can change in one year. One year is a long enough period of time to lose 10% to 15% value on a project, which is why you want to fix and flip in 90 days or less. If the market falls 12% over the course of a year and you were able to fix and flip in 90 days, you’d only be taking on 3% of that 12% exposure.
Another thing you can do to eliminate market exposure is to wholesale. In our current market, there’s no better opportunity than wholesaling. Not only are homeowners overpaying for deals, but investors are overpaying for deals too. In some markets, people doing wholesale deals are making the same, and in some cases more, than the people they’re wholesaling the contracts to.
If you’re unfamiliar with the concept of wholesaling, all it means is that when you get a property under contract, you give that contract to another investor for a fee. When you wholesale a deal, there’s no defined amount you can make, but typically speaking, people in this market are making anywhere from $10,000 to $30,000. What you make on a wholesale deal is dependent on what kind of deal you get. The better deal you get, the more you’ll make.
The third thing you can to do avoid market exposure is if you’re buying a multi-family property, make sure the cash flows on day one. Never buy a rental property based on appreciation—it should be cash-flow positive from day one. There are some markets across the country where this is almost an impossibility. Even in our market here in Boston, it’s tough to buy properties where the cash flows from day one, but you can’t let that rule stop you. Make sure you’re getting great deals and properties below market value so they produce cash flow from day one.
To summarize, doing lengthy projects in our market is very dangerous. If you’re going to close on a property, make sure it’s a quick-turn project. If you don’t want any market exposure whatsoever, wholesale the property. If you’re buying a property to buy and hold, make sure it’s cash-flow positive from day one.
Never buy a rental property based on appreciation.
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