Aside from the Great Recession, the last major housing crash was in the 1930s and 1940s during World War II. Crashes are far less common than many think, but the recent scar of the Great Recession has left many worried that we are in a housing bubble after several years of record growth in home prices.
As housing data continues to roll in, it's becoming blatantly clear that the real estate market is cooling down. The verdict is still out as to whether or not a housing market crash will follow, but those who are concerned can rest easy knowing these three things.
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1. The housing market will recover
Markets don't stay down forever. After recessionary periods where values or demand fall, markets will eventually rebound. In the Great Recession, which is considered one of the worst housing market crashes in history, property values fell 37% over a period of six years. But five years later, the housing market had returned to its pre-recession peak and continued on to increase 59% in value over the next five years.
No one wants to see property values drop, but any loss in value is only captured if you decide or are forced to sell during a crash. Remembering to take a long-term approach to investing, riding out downturns rather than selling, helps avoid a loss. It's also a good idea to focus on cash flow over appreciation for investment properties because cash flow can help an investment remain profitable even if the value has fallen.
2. Low leverage is your best risk hedge
In some down markets, rental demand can falter, leading to lower rental rates or higher vacancies, which can reduce or eliminate any cash flow. If lower demand is sustained for anywhere from a few months to possibly a few years, that means it's your responsibility to float the property's expenses and costs until it's profitable again.
If you're overleveraged -- that is, you don't have enough extra money to cover these costs -- you could be forced to sell while the market is down. It's a good idea to have an emergency fund for your investment properties. The more you have saved, the better, but having at least three months to cover expenses and debt obligations is a good place to start.
3. Down markets are opportunities to buy
The real estate market following the initial crash of 2007-2008 led to tremendous buying opportunities for those who had the knowledge and the capital. Higher inventory and less demand lead to deflated real estate prices; lower real estate prices can lead to better returns and better appreciation down the road.
It's important to remember that mortgage rates are rising right now, and with inflation remaining somewhat untamed, it's likely those rates will increase. Higher rates mean a higher cost of borrowing, making cash king after a crash. Those who have the funds or private capital available to take advantage of low prices will likely be rewarded for being able to buy low.
A housing market crash seems unlikely, but no one can truly predict what's to come. Thankfully, a down market doesn't have to be a bad thing. Keeping these three things in mind, you'll be positioned to ride out the storm with ease and possibly be in a better position because of it.
