Let’s get the bad news out of the way first: Most economists think we’re headed for a pretty rough period for the economy. Between continuing supply chain problems (both from the pandemic and the war in Ukraine), runaway inflation, incipient stagflation, the last spasms of the pandemic (especially in China’s massive economy) and the Federal Reserve’s vow to raise interest rates to dampen inflation — the economy’s facing quite a few headwinds.
Recessions always wallop the real estate market. If there’s good news here, it’s that most experts think we’ll see a cooling of the hot market rather than a full on correction. But a housing crash is still a housing crash. Even if prices just plateau, that could play havoc with the plans of many investors, homeowners, and prospective buyers. We may see a lot of people frantically looking to sell their homes as they try to get ahead of collapsing demand, and many may try selling without a realtor just to save on commission. Some recent buyers, spooked by all this recession talk, may even turn around and sell before prices drop, risking a significant tax penalty in the process.
But there’s no reason to overreact, especially if you prepare for a downturn. Let’s look at the five best ways to prepare for a market crash!
Don’t Panic
While most experts agree that some kind of market decline or correction is in our future, they also agree that it won’t be anywhere near as bad as 2008, when millions of people lost their homes, and the entire economy flatlined. That’s because 2008 was a proper bubble, driven by subprime loans. The comedown was sudden and dramatic.
The future we’re heading toward now will likely be much less extreme. In fact, it will likely be more of a correction, which would manifest in home prices gradually dropping to more normal levels, with time on market increasing, and home prices appreciating at a slower pace.
Most of the slowdown will probably be concentrated on the upper end of the market, where sellers may have to lower list prices if they want to sell. Still, some markets will slump more than others, and many will only see a slight softening of demand. The takeaway? When the correction does come, don’t panic. It’ll be a bumpy ride, but it won’t be too rough.
Hoard Cash
One of the main reasons that everyone thinks a crash or correction is coming is that the Federal Reserve is raising interest rates to combat inflation. One of the surefire consequences of this is that mortgage rates will rise too, and borrowing money will become more expensive. Fewer people will be able to qualify for mortgages, and banks will offer fewer of them.
That means that a buyer with cash in hand will be in a perfect position to swoop in and buy when prices are low, with much less competition. The investors who were able to buy in the aftermath of 2008 saw stellar returns in the decade-plus afterward. If you’re smart, you should follow in their footsteps. Just remember to play it smart by following tried and true real estate investment strategies.
If you don’t think you can stockpile enough cash on short notice, a line of credit on your home or on an investment property is a good way to get quick access to cash. If you have a good relationship with your bank, they’ll often set up a line of credit on your property for free. Better yet, you don’t have to pay any interest until you actually take cash out.
Give Yourself More Margin for Error by Reducing Leverage
When the economy slows down, demand for rentals will fall along with property values. So if you have investment properties that are generating healthy returns right now, it’s very possible that cash flow might become sporadic or even dry up once the economy stalls.
If you won’t be able to cover the mortgage payments on your investment rentals if rents drop or disappear, you may want to act now and sell them while the market is still healthy.
Tighten Your Portfolio
Every investor has some surprises in their portfolio, whether it’s a seemingly great property that’s barely profitable, or an average-seeming property that’s appreciated wildly. Now, before a crash or correction hits, is the time to get those properties off your books. The less profitable ones for obvious reasons — when things get tough, the properties that are barely profitable will likely tip into unprofitable territory. And for the big appreciators, it makes sense to cash in now, before the values slump.
You want to get your portfolio down to the solid, high-value, profitable properties in markets that can weather some economic adversity, and have steady cash flow. As long as you have positive cash flow on a property — i.e. it brings in more than it costs to own it — a drop in property value isn’t that serious.
Don’t Forget About Tax Strategy
If you do sell, you’ll have to pay capital gains taxes on your appreciation, which is going to be significant after the previous decade’s run. That’s why you should consider using a 1031 exchange to sell your property and reinvest — without having to pay any capital gains — into another, better property. If you do this, you’ll be killing two birds with one stone: deferring capital gains, and essentially trading in one investment property for a different one that’s better qualified to weather a market downturn.
A potential complication here is that 1031 exchanges require you to complete your exchange within a very small window of time (45 days), so it will take some careful planning and coordination to pull it off in this hot market.
One other tax tip: Don’t forget that if you sell your property, you’ll not only lose depreciation on that property — one of the most powerful tax deductions available to real estate investors — but you’ll also have to pay depreciation recapture taxes. Make sure you take that into account when conducting your “sell or hold” analysis!
Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the LA Times, and more. Education: B.A. with Honors, Political Science — Stanford University
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