The IDEAL Investor Show: The Path to Early Retirement

Ep 89 Unstable Markets: What's Happening and What Do You Do?

• Axel Meierhoefer • Season 2 • Episode 12

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Hello, and welcome to another episode of the The IDEAL Investor Show season two ways to focus on cash flow. And one of the things that obviously impacts cash flow is on the one hand, how much does it cost us to actually acquire a property? But then the other part is, how dependably can we expect to collect the rent. Because our cashflow is always the difference, at least the way we define it and look at it is the difference between what the income is, which is the rent and what the expenses are. So that's property management, property taxes, mortgage, and all these other kinds of things. So the topic of today's episode is unstable markets. And that has become much much more of an important topic nowadays, in 2023. And beyond, than it used to be like, just two years ago, if you really think about it, like as long as interest rates were stable, inflation was low, real estate was growing in value, and lots of people were interested to get into real estate. But fundamentally, we had a relatively stable environment. So then we basically had significant increase in inflation, which ultimately made mortgages way more expensive. And the problem with more expensive mortgages is, on the one hand, much, much fewer people are qualifying for a mortgage, which would be good for us as investors because we don't have to compete with those people that would want to buy the same house, they really want as an investment for themselves to move in. So that's a good thing. But on the other hand, when you keep in mind that the positive cash flow is the difference between rent income and cost and mortgage is one of the biggest components of cost, then it is harder to actually generate good positive cash flow. Now, the issue with unstable markets is that when there is volatility, when things are getting out of this steady flow that we had for years and years and years, the lack of stability is on the one hand associated with risk assessment. And with unpredictability risk assessment comes from what do the banks think will happen in the medium to near term future? And why are they interested, if you think about it, if you got a mortgage, either for an investment property or for your own property, let's say anytime before end of 2021, then you probably got a mortgage somewhere with a mortgage for your own house around 3%. And for an investment property, somewhere between four and maybe up to 5%. And now, when you look at the mortgages for like owner occupied is in the five and a half to 6%. So that means the mortgages that the banks gave out just two years ago, are making way, way, way less money than what the banks would be making now. And obviously, nobody wants to sell something that doesn't really perform very well, in just two years into the future. If the whole deal is for 30 years. So banks are concerned about how much more rich do they want to give at these current levels? Because nobody really knows, is it going to keep going up further? Or is it going to come back down again? Now I predict it's going to come back down again. The other thing is that people in banks, economists in general are thinking, Okay, what is going to happen to the economy, and every time whether it's for your own occupancy meaning like you buying yourself a new place, or you investing in a place? The question is always, how likely is it that the predictions that go into this deal will actually come true? So what are the predictions, the first prediction is that we as investors will be capable of paying the mortgage, that's the most important thing for the bank or for the lender. So if we, for some reason, would not be very likely to pay the mortgage, the bank would say, we're not gonna give you the money. That is one aspect of stability. Now, if you have built your investment portfolio to a point where you're not just dependent on your own income from kind of a W two job or if you have a small business from what your other business is basically generating. And from the bank's perspective, they would say, if the mortgage is due, and you have no rent, can you step in and pay the mortgage? So obviously, the more positive cash flow you have generated through all your different investments, plus your other source of income, whether it's a job or a business income, the less risk If you are for a bank to give you another mortgage now on the other hand, even if you have that income, if like in my case, you have like 10 properties, if suddenly all my tenants would move out and no new tenants would come in, would I be able to pay the mortgage for all 10 properties, while maybe for a few months, but not very long? And that is the other part about unstable markets is it's not so much only do I have the capability? But it's also the question, how likely is it that tenants in the locations where we want to invest, have the ability to continue to have a job continue to have sufficient income continue to be able to pay the mortgage. And that is also obviously a thing, and you have probably heard that we may be in a recession, we might go into a recession, the economy might get into a recession. So there's a lot of uncertainty. So far, we haven't seen it. So far, employment has been really good. And when employment or I should say the other way, unemployment rate is three and a half percent, historically low. That is great for us as investors because it means our tenants are most likely going to pay the rent. And even and this is important to realize, even if they were to lose a job, because the unemployment rate is too low, it's very likely that they can find another job. Now let's just say the unemployment rate goes to 5% 6% 7%. Now the banks would say, Well, okay, you want me to give you money to invest in this property. But how likely is it that you find a stable tenant who is paying you every month, so that you have some dependability on the income that you need to pay the mortgage. So those are some of the things now on top of that is if inflation remains high, then the last part of unstable markets to consider is how likely are people at some point going to prioritize other things over paying their rent. And I believe this is a low risk, but you should be aware of it. Most people would say the most important thing that I need to be able to do is to take part of my money and feed my family or myself, then the next thing is basically shelter, which is I need to be able to pay the rent. Now what can happen is that people find out, okay, I live with my family in this house that Axel or anybody in idea with grower has purchased as the owner and they're renting it to me. But maybe renting a house is too expensive, I need to go back where I came from and live in an apartment, even though I don't like to, just because I might get that for a little cheaper. Right. So that's one part of the volatility. But generally, what you want to keep an eye on in the context of unstable markets is if you start seeing signs that unemployment is rising. And what we have seen in the last couple of cycles in the past is unemployment, even though the government is saying is a certain fixed number, like 3.5% 4.5%. But it's not all the people across the United States, and then three or 4% of them are unemployed of those who could work. There are pockets where unemployment is much higher in pockets where unemployment basically doesn't exist. So what you really want to pay attention to is where is your next investment in where are your currently existing investment properties in those locations that might be vulnerable to an increase, a sudden increase in unemployment, and these sudden increases can come I don't have any properties anywhere close to a car manufacturing facility. But if you listen to the news, you will have probably heard that all the traditional automakers like Ford and GM, and Chrysler and all the different names that you might know, they all used to build internal combustion engines that you put your fuel in. And they are trying to transition to electric cars and electric engines. And it takes way fewer people to build an electric car because it has so much fewer parts than a regular car. Why? What do these companies do? They close factories that used to build the regular cars and build new factories to build the electric cars. What that also means there are not just factories that build a car start to finish. Some factories, for example, specialize in mufflers and others factories specialized in seeds and other factories specialized in engines. So if you have an investment property in a city or a village or community, and a lot of people in their community work at the factory that makes engines for cars, normal regular engines, and the company that puts these engines in the cars is shutting down because they don't need these engines anymore. They want to bid electric cars, then you might have a situation where hundreds if not 1000s. Since of people that had stable jobs for decades, suddenly get in a situation where a lot of them lose their job. And in that particular spot in the economy, unemployment might go from 3% to 10%, or 12%. And if you have investment properties in those locations, it can be a vulnerability that you want to be aware of. So what does that mean going forward, unstable markets can be markets, where you have what looks like a good year, a good property to invest in the numbers work, you have some minimum positive cash flow, which I always say should be at least for single family around$200, unless it's a brand new property, but anything renovated should still pay you at least$200 positive cash flow. But if you find that that property happens to be in an industry and in a location that is very dependent on one big employer, and you start studying what industry is that employer in, then you might find that the investment that otherwise really looks good, should not be made, because the market environment is too unstable. So those are the aspects that I want you to be aware of. We also will have some guests to talk about unstable markets in the context of real estate investing in general. But I wanted to give you a little bit of an idea, especially because we are currently living in times where nobody is really clear to say, are we in a recession? May we be in a recession? Are we done with raising interest rates? Will they go any further? Is inflation contained and gonna continue to come down? Or is it just making a pause and then when the summer or fall comes around, it's going up again, all these things are possible. And that volatility that uncertainty is a typical sign of unstable markets. So if you listen to this as a podcast, I would like to ask you to download the episode. Give it a rating, give it a comment, because that really helps us to produce more episodes. And if you see this on YouTube, please if you haven't already subscribed, give the episode a thumbs up and give us a comment and let us know in addition to what you learned, or what you got out of this episode, what other kinds of topics you would like me to address so be well stay safe and see you in the next episode. Thanks for listening and I hope you enjoyed today's episode of the The IDEAL Investor Show more info and the links we mentioned during the show in the show notes or you can go to our website at Idea redcross.com and sign up for the Apple podcast link. And if you'd like to talk to me sign up for a strategy call. Hopefully you want to share what you learned with your network and bring more people in we are really eager to hear your comments and until next time, be well stay safe and ciao.