Profit From the Next Downturn

If you believe, as does Ken McElroy, author of “The ABCs of Real Estate Investing”, that a real estate downturn is imminent in 2021, then you are also admitting that we are at or near the top of the cycle right now. If that’s the case, you have some decisions to make.

The ideas expressed below are my opinions, and are not to be taken as legal or financial advice. Consult a competent attorney, accountant, or financial advisor for guidance in those specialty areas. For assistance buying or selling investment real estate in Texas, click the “Request Information” button to the right of this article. 

Just What kind of investor are you?

The Capital Gains Investor

The capital gains investor purchases a property with the belief that it will go up in value. This may be due to the efforts of the investor such as with remodels and renovations, or it may be due entirely to market forces. Either way, when the asset has appreciated, the investor is in a position to make a capital gain. To realize that gain, he must sell. There is simply no other way to capitalize on appreciation. If you are a capital gains investor, and you believe your market is at or near its peak, find yourself a competent real estate agent and sell high.

The Cash Flow Investor

The cash flow investor has a few more options:

Option 1: Sell at or near the top with a tax deferred exchange

The cash flow investor’s first option is to do like his counterpart and sell high. Nothing wrong with making a capital gain. Well nothing except capital gains tax of course, so talk to your accountant about deferring the capital gains tax using a tax deferred exchange to purchase a more valuable, higher income-producing property. 

Option 2: Refinance

The benefit of refinancing is that we can pull all of our initial investment out, making it so that we now have none of our own money invested in the deal. This is how Robert Kiyosaki achieves infinite returns on his investments. Best of all, we keep the income producing asset and need not pay a capital gains tax. If considering this option, a proper accounting is critical to ensuring the property will continue to cash flow after taking on the larger debt.

Option 3: Ignore the market and maintain the status quo

Many cash flow investors, ignoring the benefits of appreciation, will happily hold their property all the way through a real estate downturn so long as the rents continue to exceed the expenses. While this is certainly the simplest thing to do, as it means continuing to do what you’re already doing, the missed appreciation you’d be giving up may turn out to be higher than the next 15 years of cash flow combined. This is exacerbated by the fact that income and expenses constantly vary, and cash flows can become negative without much warning.

The Bottom Line

There are many factors involved in building wealth through real estate. There are no guarantees when it comes to flipping houses, holding rental properties, investing in multifamily or anything else. While you shouldn’t fear market downturns, you should be aware of their signs and symptoms and position yourself to profit by becoming aware of the different strategies available to you and employing them when the time is right.