There are growing concerns of a housing market correction after two years of record home appreciation, in which the average national home price rose 34%. It seems the fix is finally here. Home sales and mortgage applications for April and May are down significantly, while new home listings have risen rapidly as homeowners try to make house price gains before the market turns.
But there is good news. The start of a real estate market correction is the perfect time for investors to prepare for what could be to come.
First things first: a fix is not a crash
A real estate correction is not the same as a real estate market crash. During a correction, home prices return to normalized buying and selling levels. You don’t fall suddenly and dramatically like in a crash. In other words, things balance out. In today’s market, that means slower home price growth and potentially longer market duration.
Properties that have been listed for top dollar banking due to continued market competition and limited supply are likely to receive fewer offers. Some sellers may even need to lower the asking price to get more realistic prices, although not every market will experience the same slowdown or price drop as others. It all depends on the cause of the demand and lack of supply that drove prices up in the first place.
save your money
Real estate market corrections are a great time for investors to stock up on real estate while prices are falling. Lower purchase prices mean greater chances of higher returns. However, as interest rates rise, borrowing costs become more expensive, and lower purchase prices may not translate directly to better returns. Having the money to buy real estate without borrowing money could mean you take advantage of opportunities that others don’t.
Reduce your leverage
Real estate market corrections do not equate to recessions. For example, real estate prices skyrocketed during the COVID-related economic downturn in mid-2020. This time around, however, there are many signs that house prices could fall as the economy shrinks.
During recessions, economic spending slows. Rents and property values often fall when demand falls. This can result in properties that once performed well generating less-than-ideal returns or even negative cash flows during the downturn.
It’s a good idea to save some money to cover losses incurred during this time, but it’s just as important to make sure you’re not over-indebted. Over-leveraging your investments means you won’t have enough income or cash flow to cover the property if it doesn’t pay even part of the time. If you recently took out a line of credit and your profitability margins have narrowed, it might be a good idea to sell the property now while prices are high to reduce your debt exposure.
Hold for the long term, sell what isn’t profitable
Buying low and selling high is one of the cornerstones of profitable investing, but selling real estate when it’s high isn’t always the best move. Cash flow is one of the most important benefits of real estate investing. Even if your property’s value has gone down, that doesn’t mean your returns have. If you have a property with strong cash flow that is producing a good return, sticking with the investment for the long term can provide protection during tough times and combat periods of high inflation like the ones we are experiencing today.
Tax deductions from depreciation and certain real estate expenses are another benefit that should be seriously considered before jumping in and selling while prices are high. When you sell a property, not only are you giving up any cash flow that the property has generated, but you are also required to pay capital gains on any gains made from the sale, in addition to recovering all of your prior depreciation. Those who’ve seen values rise 40% over the past year could be facing a hefty tax bill at the end of the day.
I recommend evaluating your portfolio and only considering selling properties that are not performing well or may be at risk of default if the market deteriorates. If the property isn’t producing cash flow in its current form, it could be an advantage to sell it now and save the money to reinvest in cheaper properties and higher yields as the market corrects over time. Prices can drop a bit in a real estate market correction, but if you take a long-term view of your investment and focus on the value it brings with income and tax benefits versus the value of the property itself, weathering a market correction will be a breeze.