I've studied many billionaire real estate investors to neutralize recession risks.
Below is my exact framework you can use👇🧵
Quick background:
With any new venture, I always first create a risk mitigation framework.
With my desired acquisition velocity (100 units in 3 years while doing a W2)
I wanted to be especially diligent to cover my blindsides while moving really fast.
I do that with a 2 step method:
Step 1) I study the successes and failures of the most prolific investors(like Sam Zell) who have seen many cycles.
I then extract commonality to create a base framework.
Step 2) Use my own exposure in consulting multi-million dollar companies across industries to further solidify it.
This usually means a lot of strategic and analytical thinking.
There is a lot to unpack for a thread, but I have done my best to zip it without missing much.
To get a much deeper dive, consider becoming a newsletter subscriber(link in bio)
Here we go:
1️⃣ ECONOMIC RISKS
The economy is like an ocean; no one knows when the choppy waters will come and how bad they will be like now.
The only thing we can do is make a damn good boat or, even better, make a submarine.
So, here is what I do for that:
👉 Buy for cash flow
To shield against economic risks, your main goal is not to be forced to sell the property.
People are usually forced to sell the property when the expenses > revenue, and they have to pay out of pocket to maintain the asset.
The greatest moat is to buy with a cash flow buffer.
If rents come down or expenses rise(e.g. with inflation), you have a cushion.
I never buy a property below 10% cash on cash return in the second year but ideally 6-8% in the first year itself.
👉 Get long-term fixed loans
The biggest x-factor in expenses is mortgage payments.
If you did not lock in a rate for the long term, the mortgage payment could increase out of nowhere, spiking your expenses.
This is the single biggest reason why people are forced to sell.
So, lock the rate in by only getting long-term fixed-rate loans.
Sam Zell, who sold his company for $39B to Blackstone in the largest leveraged buyout, has seen all the cycles since the 60s.
His main advice?
Investors with long-term fixed-rate loans always weather the storms.
Long-term fixed-rate loans ensure the banks can't hike the rates when the economy is in the dip.
If they did that, your expenses could be > revenue.
Meaning deficit, which is exactly what we are trying to avoid.
Consider >= 5 years fixed rate.
BONUS - Check with your bank and read the documents about what they might do if they go bankrupt or are acquired by a different bank.
The last thing you want is them calling loans on you (it has happened)
👉Have cash reserves for 6 months
You are in the 99 percentile and well prepared for the dips if you did the previous two.
But in the absolute worst case, if you overextended, have 6 months of cash reserves per property.
2️⃣ Geographical Risks
I see a lot of lists showing great markets to buy in now, but please know it's not about how good a market is now but about how it will be in bear cases.
The current state of a metro, a county, a city ≠ the future state
So don't just buy because there is a good cash flow now. You want to de-risk the future.
Here is how I do it.
👉Historical performance during the dips
See these two pics; what do you see?
To me, it's a red flag that the Rochester market never bounced back from previous dips and is, in fact, still declining.
Whereas Huntsville is seeing good job growth.
Surprisingly, Rochester shows up as a top market in a lot of articles because the rents have grown, and there is good cash flow now.
And it actually might work for many if they have a short-term(1 or 2 years)hold period.
But in the long term, it concerns me.
👉Buy in areas of population and job growth
Similarly, population growth means more demand for housing, meaning rents will stay up or keep growing.
Again, you can see the Huntsville vs. Rochester match here.
👉Avoid oversupplied locations
You want to make sure the supply doesn't exceed the demand, or rents will feel the downward pressure.
You can get granular here and look at the permits pulled, but for me, a good proxy is looking at the rental demand growth in the past years.
If the rents have good growth, it's a good indicator that demand is > than the supply.
Some like to see vacancy rates or unemployment rates and days on market, but to me, the rental growth indicator says it all.
👉At least 5 diverse industries
Needless to say, avoid areas with one major industry to avoid scenarios like Detroit.
As an additional measure, ensure no industry or company has > 20% stake in an area.
FYI- I like areas with healthcare as the biggest industry.
👉landlord-friendly
Self-explanatory! I avoid states like NY, where tenants can live forever without paying.
👉 A Great Property Manager
PMs can make or break your portfolio, and most of them are really good at being bad.
Not saying all of them are bad but many are.
In fact, the PM business model is innately flawed. When they charge x% every month, the incentives are not aligned with the investors.
They make money when you lose money, like charging for leasing or markups on the maintenance jobs.
With my in-house PM team, I have an incentive model.
They make a base but make more with less vacancy and fewer repair costs.
If you are not doing self-management, my rec is only to select a market based on a good PM.
In fact, this should be a requirement.
3️⃣Neighborhood Risks
Not many care about this as much as the main market, but I think this provides an extra layer of protection.
I try to find the sweet spots where I get good-quality tenants.
Two good measures are:
Good school districts or happening areas.
Close to highways & big stores - Nice to have!
But keep in mind that the better the tenant quality, the lower the cash flow.
My trick is to use my Chrome extension to spot-check returns in good school districts.
It makes me 80% efficient in finding micro areas with high cash flow without giving up on tenant quality.
These are areas least impacted during a dip, so it provides extra measure.
4️⃣Property Risks
After the offer is accepted, I get professional home inspections to find major flaws in the property upfront.
I would NEVER not do one!
Recently, I let go of a 17% cash on cash return property b/c the seller was not OK with an inspection.
After closing, I also mitigate ongoing risks by doing recurring inspections every 6 months - Kind of like the vitamin vs. pain killer approach.
Spend 100 now to save $10k later.
5️⃣Tenant Risks
To me, a great tenant is everything. I rather wait longer to get the right tenant than put the wrong tenant, who might not even pay.
This is why during COVID, every one of my tenants paid, and on time.
Here are the checks:
👉Professional background checks
It shows eviction, credit score, and financial history, which basically tells us about payment behavior and anomalies.
I use Zillow checks for it.
👉Have proper leases
The single most important piece of document you have as an investor.
Consider all scenarios and have a clause to mitigate any risks.
I literally spent a couple of grand to vet it by different lawyers.
👉Strict document diligence
Check tenant rent payment history and employment.
You can do this by getting bank statements and calling previous employers.
👉Follow Fair Housing Laws Compliance
This is an X factor. Avoid getting sued by the tenant by knowing the laws.
If you have a property manager, they will or should know this, but it is critical to select your words if you are self-managing and communicating with the tenants.
6️⃣Legal & Tax
👉Insurance best practices
Goes without saying - you want to get the right insurance for the right amount. This should not be a place to save.
If you don't have an LLC, also consider Umbrella insurance on top of your landlord insurance.
👉Multi-layer asset protection -
I am layers removed from potential lawsuits.
1- Property in an LLC
2 - LLC in a holding LLC
3 - Holding LLC in a favorable state
I also follow best practices for LLCs, or they will be useless.
Look up "piercing the corporate veil+LLC"
👉Anonymity
You can put elaborate structures in place, but most lawyers will tell you the best defense is anonymity.
There is a whole industry of squatter lawyers targeting publicly known owners.
My holding LLC is in Wyoming - no one can know who owns it because of state laws
That's it, friends!
Disclaimer: I am giving central ideas here. It's hard to cover nuances in threads like these.
But hope you are able to apply these tactics and not yield to emotion.
If you want deeper dives into how I implement a recession-proof strategy while reaching my goal of 100 units in 3 years.
Join >3,000 subscribers on:
rehacks.io/