This post was originally featured on Forbes Real Estate Council on Forbes.com.
If you’re a real estate investor and been keeping up with current events, chances are you’ve asked yourself this question: “How will Trump’s presidency affect the market?”
Since Donald Trump has made millions as a real estate entrepreneur, common sense says he will likely implement policies to strengthen the real estate industry. At the very least, he wouldn’t make a decision to undermine it. He wouldn’t hurt his own bottom line, right?
But with the current political climate as it is, it’s difficult to predict what Trump will do. If you’ve tuned in to any of the major news networks since the beginning of the 2016 presidential campaign, one of the most consistent things you’ve seen from Trump is … well, inconsistency.
I don’t know what will happen over the next four to eight years, and I don’t think anyone does —Trump included. I am not a politician, nor a political strategist. But I am a real estate entrepreneur. And the good news from a real estate perspective is that Trump’s actions shouldn’t matter.
Ultimately, as investors, we can’t make decisions based off of who the president is or who controls the House or the Senate. While Donald Trump’s inauguration and the ensuing tweetstorm are causing some Americans to celebrate and others to mourn, there are three simple principals that real estate investors must follow to thrive in the current market of uncertainty — tried and true methods that work in any market, at any time in the market cycle.
1. Don’t buy for appreciation.
Natural appreciation is a simple concept. It’s an increase in the value of an asset over time. From 2012 to 2016, for example, real estate prices in the U.S. as a whole increased by 13%, according to Zillow. If you purchased a property for $1 million in 2012 and sat on it, making no improvements, the property would have been worth $1.13 million in 2016.
Sounds like a good investment strategy, right?
It’s important to make a distinction between natural appreciation and forced appreciation. Forced appreciation involves making improvements to the asset that either decreases expenses or increases incomes, which in turn, increases the overall property value. Unlike forced appreciation, natural appreciation is completely outside of your control. Say you purchased the same property in the example above for $1 million in 2008. Four years later, the property value would have decreased by $229,000.
Many investors, past and present, buy for natural appreciation, and it is a gamble. Eventually, they all get burned—unless they’re extremely lucky. Buying for natural appreciation is like thinking you’ll get rich at a casino by playing roulette and only betting on black. Maybe you can double up a few times, but sooner or later the ball lands on red or — even worse — double zero green, and you lose it all.
That’s why I never buy for natural appreciation. Instead, I always buy for cash flow. When you buy for cash flow (and as long as you have a large supply of renters), you don’t care what the market is doing. In fact, if the market takes a dip, the demand for rentals will likely increase. When real home prices dropped 23% from 2008 to 2012, the number of renter-occupied housing units increased by 8%.
2. Don’t over-leverage.
Leverage is one of the main benefits of investing in real estate.
Let’s say you have $100,000 to invest. If you decide to invest all of your money in Apple stock, you would control $100,000 worth of stock. On the other hand, if you wanted to invest all of your money in real estate, you could spend $100,000 on a down payment at 80% LTV (loan-to-value) and control $500,000 in real estate. If you’re a creative investor, you could use that $100,000 to control an even larger value of real estate. That’s the power of leverage.
But there’s also a catch.
The less money you put in the deal — or more specifically, the less equity you have in a deal — the more over-leveraged you are. Consequently, the higher your mortgage payment will be. In a hot market, over-leveraging may seem like a brilliant idea, but what happens when property values start to drop?
According to Zillow, from 2008 to 2012, real property prices in the U.S. dropped by over 20%. If you purchased a property in 2008 with less than 20% equity and wanted to sell in 2012, you would have lost a decent chunk of change.
My advice? Always have 20% equity in a property at a minimum. Avoid the tempting 0% down loans at all costs. Doing so (in tandem with committing to not buy for appreciation) will allow you to continue covering your mortgage payments in the event of a downturn.
3. Don’t get forced to sell.
When you’re forced to sell, you lose money.
The main reasons people are forced to sell or return properties to the bank are that they speculated and bought for appreciation, or got caught up in a hot market and were over-leveraged.
Another reason you would be forced to sell is if you have a balloon payment on a loan. This is typical for commercial real estate but not residential. The problem investors have is when they have a balloon payment come due during a downturn in the market.
A way to mitigate that risk is to be aware of when your balloon payment is due and plan years ahead of time for what type of exit strategy you are going to pursue.
Some common exit strategies are:
- Selling the property
- Refinancing into another loan
- Paying off the balloon payment
By sticking to the three principles above, I’ve personally accumulated over $170 million in real estate assets over the past four years, and at the same time, I’ve helped countless of my investors generate passive income streams. Regardless of what President Trump does or doesn’t do over the next four or eight years, if you stick to these principles and invest in income-producing real estate, your investment portfolio will not just survive. It will thrive.
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.