The Sky is Falling
Market crashes happen every so often. That’s just how the economy works. Sadly, this means there’s no shortage of people who constantly say that a crash is just around the corner. Even a broken clock is right twice a day; eventually, these doomsday prophets will be right about a market crash.
The reality is that market crashes are cyclical in nature. The last few crashes have happened around 1997, 2000, 2008, and 2020. Check out this Business Insider article that highlights the stock market crashes that shake the entire economy, including the property market. The stock market is forward-looking and is often a few months ahead of the actual economy; what happens to the stock market will eventually ripple out to the rest of the economy.
Here are some of the typical consequences of a market crash:
- Companies tighten their belts, spending decreases, and people get fired
- Business don’t hire as much, unemployment increases
- Banks tighten their lending criteria or reduce lending
The knock-on effects on housing markets are felt widely. Some examples of this include: property prices drop; people generally don’t buy real estate but “stay put” until the economy begins to improve; anyone looking to buy will encounter stricter lending processes when it comes to applying for mortgages with banks; tenants may fall on hard times (especially if they lost their job).
What happens to the property market in specific locations depends on the local economy, population profile, and more. Some areas might see a decline in property prices with decreased rental prices; other areas might see an increase in rental demand and increased property prices and everything in between. It really does depend on the location and how a market crash affects that location.
Let’s take the worst-case scenario and say your investment property or properties are in an area hit by a market crash. Here are four tips to weather a property market crash.
Tip 1 – Emergency Funds 24/7/365
The fact is that when a market crash happens, people may lose their jobs. Unemployment numbers tend to go up. People tighten their belts and cut costs.
Guess what? Rent is part of that cost, and some people may decide not to pay their rent or move to cheaper accommodations.
Part of the emergency fund is to anticipate that you’ll have vacant periods or have to think about eviction procedures (which has added legal fees and other costs). You need to have an emergency fund that can finance repairs, maintenance, and additional expected property investment costs, as well as the extra costs that come around with a market crash. This emergency fund needs to be accessible 24 hours a day, seven days a week, 365 days a year!
If you think keeping aside a pot of cash as an emergency fund all the time (24/7/365) is silly and that money is better used elsewhere, all I can say is the price to pay in the event of a market crash is way more significant, in my opinion. It comes down to planning for the worst-case scenario as best you can.
In my experience, and in having spoken with other experienced investors over the years, the savvy investor is one that is prepared for a crash at any time. The less intelligent investor takes more considerable risks and then complains or cries when a crash happens.
Side rant: rightly or wrongly, landlords are seldom painted in a positive light during tough times. Many people think that landlords are all “rich” and can make do without tenants paying rent for a while. The truth is, not all landlords can weather vacancies, repairs, taxes, mortgage payments, and other costs – but that’s a topic for another day, perhaps!
The bottom line here is that you need to have a healthy emergency fund that you can access, at any time, to deal with costs your real estate investment portfolio might need to carry during a market crash.
Tip 2 – Work with Your Tenants
Tenants are individuals, and everyone is in a challenging position during a market crash. If you treat your tenants right, the chances of them treating you right are higher than if you mistreat your tenants.
Whenever there’s a market crash, I’m proactive with my tenants and have offered discounts in rent or given rent reductions. If a property is vacant, I might drop the asking rental price to match a weaker rental market. Rental prices are NOT continually increasing, and you have to be flexible and accept where the market is, especially during a crash.
Work with your tenants and accommodate where you can, agree to a payment plan if needed, or perhaps they can do yard work in exchange for a reduction in rent. Think outside the box and form win-win solutions with your tenant.
Eviction procedures should be a last resort. This is because there are additional costs and time involved, and this can be stressful for everyone involved. Be sure to consult with a lawyer, so you know your legal rights if you need to go down the eviction route. Your lawyer might even offer different ideas on reaching a resolution with your tenant.
By working with your tenants, you stand a higher chance of weathering a market crash together – you may even come out of the whole experience stronger!
Tip 3 – Sell up
Selling up is ALWAYS an option, but wouldn’t be my preferred option during a market crash. Property prices are typically depressed during this time, and selling during a market crash is not ideal.
If you purchased your investment property a few years before the crash, your property may have increased in value. If this is the case, you might have some capital gains that you’re sitting on, even in a depressed market.
On the other hand, let’s say you purchased your investment property a month before the crash. You might see a drop in value; now you’re “underwater,” and selling up might result in a loss. Hopefully, the loss won’t be too significant or set you back too much. Consider your options carefully to know if selling your investment property is really the best way forward.
Either way, speak with a qualified and experienced accountant to determine the capital gain or loss position, and the taxes associated with selling up.
Although selling up is always an option, you give up the future cash flows on your investment property.
If the pressures of being a landlord in a market crash are too much to bear, there’s no shame in tapping out and moving on. You will have gained a lot of insight into the real estate industry and will start from experience in the future.
- Diversify so you can weather the storm – check out this article.
Tip 4 – Diversify
I’m a big fan of diversification – I wasn’t a fan early in my investing journey, but I’ve had a change of heart! Here’s my blog article on it.
If you play your cards right, diversifying your portfolio may soften the blow of a property market crash. This isn’t guaranteed – nothing is guaranteed – but it’s better to have several income streams as opposed to having all your eggs in one basket, and a storm hits that one basket, causing you to suffer financially.
Picture a chair with four legs, and each leg of this chair represents a stream of income. If you have four legs, you’re fine; three legs, you’re mostly fine, but two legs or less… you’re not doing so well. Your investment property portfolio represents one leg in a 4-legged chair.
If a market crash happens, you want to ensure that you have assets that will step up and deliver during a recession or market crash. This will minimize the pain from investments that perform poorly during a market crash.
In the event that a property crash occurs, you may find your properties not performing well, perhaps due to decreased rent, increased vacancies, or any other potential issue. By not having all your eggs in one basket, you’re more likely to survive a market crash.
Honestly, I wish I had been wiser about diversification, especially just before the 2008 Great Financial Crisis. Having made an investment property purchase two weeks before this crash hit, I could have saved myself a lot of heartache and financial pain if I had some diversification in place. If you want to read about this experience of mine, check out my book UK Property Investing for Complete Beginners.
Summary or Conclusion
Knowing a market crash is cyclical and will likely happen at some point in the future, you better have a plan. My suggestions in this article are summarized below:
- Emergency funds 24/7/365
- Work with your tenants
- Sell Up
My final thought on this:
Always be prepared for a potential market crash!
I look forward to seeing you there soon. Drop a comment, so I know you popped by. I reply to every comment personally. ☺
PS: Not sure if you might be interested, but I’ve got a property checklist that is available for download here, completely free of charge.