Over the past year or so, it’s been impossible to escape real estate market doomsaying. It seems everyone is holding their breath in anticipation of a bursting bubble or housing crash. That, however, doesn’t seem as likely as a slow housing market correction.
But what exactly happens in a market correction, and how will it impact real estate investors? Here’s what you need to know!
What Is a Housing Market Correction?
As with many things, there’s no formally recognized definition of a housing market correction. However, most experts would say you can identify a correction by a 10% drop – give or take as long as it’s less than 20% – in housing prices.
The idea is that when we’re in untenable market conditions, a gradual decline is necessary to bring things back into a normal, healthy range. It follows the straightforward laws of supply and demand. As home prices grow too high, buyers stop buying. Prices must then drop to lure buyers back to the market.
The Fed amped up interest rates to curb the rapid (and, at times, unreasonable) growth of housing prices. However, persistently tight inventory prevented these hikes from having the desired effect.
The Motley Fool points out that a housing correction has been a long time coming, as median prices have grown an astonishing 34% over the past two years. We’ve been talking about a price shift for months now, but we may be about to truly see it happen.
So how do real estate investors prepare for this kind of market change?
3 Things Investors Should Do in Preparation for a Market Correction
1. Guard Your Credit and Assets
Although a correction means listing prices will decrease, it doesn’t mean interest rates will go down. Borrowing is more expensive right now than it has been in some time. Even when the interest rate exceeded today’s, the median home price was lower – resulting in a lesser impact. Investors would do well to save their hard-earned money in preparation for acquisitions in this new market environment.
Similarly, it’s time to work on your credit score. If it’s less than optimal, work to pay down bad debts and improve your creditworthiness. Minimize existing liabilities if you plan on utilizing leverage for your next property. Lending standards are going to stay tough, and you want to be able to secure the best rate possible.
2. Start Looking for Opportunities
Inventory is still tight. Your chances of finding a diamond in the rough are rather slim, but you should be looking at what’s out there, even if you don’t intend to acquire new investment properties just yet. Staying abreast of availability in your investment markets allows you to see three things:
- When inventory increases.
- When prices shift significantly.
- A realistic idea of housing costs.
You may need to adjust your expectations if you haven’t purchased a property in a few years. Inflation means it may take longer to secure that downpayment, and ongoing expenses will cost more. Prepare accordingly by recalculating your goal metrics. How much can you spend to maintain favorable profit margins? How big of a safety net do you need?
Reevaluating these baselines will enable you to see and seize prime opportunities as the market adjusts.
5. They encourage ongoing investor education
Finally, focus on refining your portfolio. As conditions improve for buyers, you need to be sure you’re not carrying any dead weight. Cull chronic under-performers, plan for their replacements, and consider new ways to diversify your portfolio. Assess your leverage (including loan-to-value ratios) to ensure you’re not overleveraged.
If you need to sell, you want to do it before the corrections fully kick in. With that said, your mind should be on the long term. Plan to hold your properties. Even if the value of your property declines during a market correction, it’s not the sole reason to sell. As long as cash flow remains strong, you can hold a property and wait for it to gain value back over time.
If you jump the gun and sell, you’re looking at both capital gains taxes and losing a stream of income. Simply put, you want to think very carefully before you sell an investment property. You want several compelling reasons to do so.
Ultimately, a real estate market correction should ease the burdensome conditions we’ve been experiencing. Investors should brush up and be ready to acquire new rental properties if they’ve been delaying due to high prices. It may be time to jump back in and grow your portfolio.
With 20 years of experience under our belt, we know how to guide investors through market conditions.
