There's been a growing concern about a housing market correction after two years of record home price appreciation, during which the median national home price increased by 34%. It appears that correction is finally here. Home sales and and mortgage applications for April and May are down notably, while newly listed homes have risen rapidly as property owners try to capture home price gains before the market turns.
But there's good news. The start of a housing market correction is the perfect time for investors to prepare for what could be coming.
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First things first: A correction is not a crash
A housing correction is not the same thing as a housing market crash. During a correction, home prices return to more normalized levels of buying and selling. They don't fall suddenly and dramatically as they would in a crash. In other words, things balance out. In today's market, that translates into slower home price growth and possibly longer time on the market.
Properties that were listed for top dollar banking on continued market competition and limited supply will likely see fewer offers. Some sellers may even have to lower the asking price to meet more realistic pricing, although not every market will see the same rate of slowing or price decreases 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 down. Lower purchase prices mean greater opportunities for higher returns. However, with interest rates rising, the cost of borrowing gets more expensive, and lower purchase prices may not directly translate into better returns. Having the cash to buy properties without borrowing money could mean you seize opportunities that others cannot.
Reduce your leverage
Housing market corrections are not synonymous with recessions. For instance, during the COVID-related economic downturn of mid-2020, housing prices soared. This time around, however, there are a lot of signs that housing prices could drop while the economy shrinks.
During recessions, economic spending slows. Rental rates and real estate values often fall as demand lessens. This can cause properties that were once well-performing to garner less-than-ideal returns or even negative cash flows during the slow period.
It's a good idea to have some money saved to cover any losses incurred during this time, but it's equally important to make sure you're not overleveraged. Being overleveraged in your investments means you don't have enough income or cash flow to cover the property in the event that it stops paying, even temporarily. If you recently took out a line of credit and your margins for profitability have thinned, it could be a good idea to sell the property now while prices are high to reduce your debt exposure.
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Hold for the long term, sell what isn't profitable
Buying low and selling high is one of the cornerstone principles of profitable investing, but selling real estate when it's high isn't always the best move. Cash flow is one of the major benefits of real estate investing. Even if the value of your property has declined, it doesn't mean your return has. If you have a strong cash-flowing property that is netting a good return, holding on to the investment for the long term can offer protection during tough times and combat high inflationary periods like those we're experiencing today.
Tax deductions from depreciation and certain property expenses are another benefit that should be seriously considered before jumping the gun and selling while prices are high. When you sell a property, not only do you give up any cash flow the property was generating, but you also have to pay capital gains on any profit earned from the sale in addition to recapturing all of your prior deprecation. Those who have seen values rise upwards of 40% over the last year could be left with a hefty tax bill at the end of the day.
I recommend evaluating your portfolio and to only consider selling properties that aren't performing well or could be at risk for default if the market were to worsen. If the property doesn't produce cash flow as-is, it could be beneficial to sell now and save the money to reinvest in more affordable properties and higher returns as the market corrects itself down the line. Prices may sink for a bit in a housing market correction, but if you take a long-term approach to your investment and focus on the value it brings with income and tax benefits over the value of the property itself, riding through a market correction will be a breeze.
