Russell Gray, co-host of The Real Estate Guys Radio Show, shares some very valuable insights on how can real estate investors do to prepare to ride a potential downturn, as well as what asset classes could make sense during a potential recession. Russ is also a financial strategist with a background in financial services dating back to 1986. Russ also taught Real Estate Finance to Realtors® pursuing the prestigious GRI designation.
How can investors prepare to ride this recession since we are in the early stages, and hopefully there's still some preparation that they can do?
There's a thing in business called a SWOT analysis where you do a strengths, weakness, opportunities and threats assessment on whatever you're doing. If I would have done that, in 2008, I would have recognized some of the vulnerabilities that ultimately took me down. So I think that's the first thing you have to do, you have to just look at your portfolio, you have to say, What if interest rates went up? What if rents went down? What if vacancies went up? What if this local market economy changes?
You just have to begin to go through and ask yourself, what are some of the things you're hearing, what are some of the possible or probable outcomes of what's going on and how will my portfolio respond to that. That's number one.
And then begin to take corrective action, whatever you need to do, you're probably going to realize that you've got some things in your portfolio that are marginal, they're not really that strong. You might want to think about getting rid of those. That's what my buddy Kenny McElroy did. Coming into this, he just began to look at his portfolio and say, I'm going take everything that isn't top performing, super strong, great market, great tenant, great management, great property condition, anything that isn't top tier. They're all good, but I'm going to take the bottom few, and I'm going to get rid of them. I'm going to get liquid because I think the market is going to turn and I think there's going to be opportunity. And that's number two, get liquid now. Getting liquid can be selling things and sitting on some cash. It could be borrowing. Well, the borrowing is good if you still have equity and you still have good credit, documentable income and there are loans available for the types of properties that you have. And you can lock those rates and payments in long term. Now is a great time to do that. I think you might be a little bit late to the party. But if you can do it, I would definitely be doing it. Some people say, Why would you want to increase debt in the middle of all of this that's going on? Don't look at it as increasing debt, look at it as increasing liquidity, because the equity is probably going to end up disappearing at least for a period of time.
As prices fall, your debt is not going to fall, your equity gets eaten up. So if you can liquidate that equity and protect it from the market that serves you in a couple of different ways, when in a downturn, when things are tight and things go wrong, it's always good to have some cash.
Number two is if credit markets fall apart, which I think is a likely outcome and that doesn't mean they're going to be gone forever, but it'll be like it was in 2008, where things get tight. We're already starting to see some of that. Then being liquid gives you a competitive advantage. The debt coming out of the marketplace is going to cause prices to drop because not as many people can compete because they can't get funding. But if you have cash, then you can take advantage of those lower prices. And when funding comes back, then that puts air back in the pricing and equity happens. And you end up with a boost of equity. You can't have that boost if you aren't able to buy when air is out of the market, and then ride it up.
In terms of the cash flow, it shouldn't be that difficult. If you can borrow money at three, four or 5% it shouldn't be that difficult to at least invest in something relatively conservative that cash flows that can give you enough money to cover that after you take into account the tax breaks. I'm a big fan of equity arbitrage where you borrow equity at one price a 4%. And then you take a percentage of it, in this case, 50% of it, and you invest it at double the rate, 8%, and there's definitely 8% money out there. Now I've got the other half of the cash out proceeds sitting completely liquid with no payment associated with it because I've covered 100% of the payment on the cash out with only 50% of the cash out proceeds. If you're really concerned about the dollar, and I've been talking about this since we did our Future Money and Wealth conference, you could take a portion of that liquid cash out that doesn't have a payment associated with it. And you can go buy some precious metals, precious metals gives you a place, a home base where you can pivot into any currency, can you go into the dollar, you can go into the Euro, you can go into the yuan, if you wanted, you can go in any currency you want. So if the dollar ends up in a crisis, and the dollar ends up becoming weak and another currency is strong, then you can pivot. Now, again, if you do all your business in dollars, then that may or may not be valuable to you. If you have more of an international approach to your investing or if you want to just bet on the direction of currency you could do that too. But I do think it makes sense to hedge a little bit against difficulties with the dollar, and you do that two ways you do that by being in debt. Debt is effectively a way to short the dollar. You borrow the dollar and down the road, you pay back with cheaper dollars.
And the other way you do it is with precious metals and real estate, and precious metals together gives you the opportunity to combine both, you just have to make sure that you have a plan for the cash flow on the cash out proceeds. So those are things that I think people ought to be taking a hard look at right now. And then don't be too quick. If you find a deal in a market with a team that makes sense, and you can get financing and structure and you feel very comfortable that you can control that property through a downturn, then by all means, do the deal. Great deals like that don't grow on trees, you go through all the work to find one, do it. With that said, I think that it's not a horrible time to be patient, because I think that we still have got a lot of insulation from the effects of what's happening. It's it's a wave.
We're not even sure that the health side of the crisis is over yet. We're just now beginning to talk about opening up the economy. We don't know when people start to congregate, if that's going to mean more infections and more lockdowns. And it doesn't matter if you believe that the crisis is real or that pandemic is a true threat, or if the lockdowns are justified. Sometimes you have to set aside your political views or what you think that people in power should be doing. It doesn't matter what you think, it only matters what they think. And it only matters what they do. And sometimes we can't acknowledge what they're doing, because we're so hung up in what we think should be happening or what we think what we think is happening, that we can't look at what really is happening. And so we're not even sure the economic crisis is over yet because we're not even sure the health crisis is over yet. And until the economic crisis is resolved, you can bet there's going to be financial strain, you can't just print money and paper over everything at some point, inflation is going to pop up. Because if you could just print money and solve all the world's problems, then why would anybody work? But goods don't come into existence from printing money, goods and services come into existence when people get up and they actually go to work and produce things. So if we don't fix that, then there's excess inventories.
And you hear all this talk about supply chains. When you have limited supply of goods and services because people aren't working, and you have gobs of money that's being printed and handed out for free so the debt can be serviced, the probable outcome is going to be a rising in consumer prices. And if you're a residential real estate investor, especially in apartments, you have to be concerned about that because if the cost of living goes up at the street level for people that don't have assets that are going to go up as a result of inflation, and they don't have any savings, then the only thing keeping them afloat is the government handout.
Now that becomes a vicious cycle, how does the government wean them off without collapsing everything. So it's a very, very difficult situation that the people who are controlling the levers, the policymakers are trying to deal with right now. You have to stay awake, you have to stay alert. I think you need to stay plugged in, listen to shows like this and hear what other people are thinking and seeing and doing. And then I'd suggest getting into some type of a mastermind group, or finding a way to get together with other investors that are also looking at these things, and talk and rub your brain against other people's brains who are engaged.
I think those are things investors can be doing: pay attention, get liquid, do the SWOT analysis on your portfolio, do deals that make sense, but don't be too hot to take advantage of bargains because I think that we're a long way from seeing a bottom and there's going to be time. Work more on getting in position to recognize and see and act on those opportunities when they come.
If you had unlimited funds to invest, when do you think will be the best time to invest during this crisis? And which asset classes would you focus on?
I think if you know how to raise money, technically you do have unlimited funds. And that's why I'm such a big fan of syndication. You can really do anything you want. It makes sense. I think that part of it is it's about you. I'm a big believer in personal investment philosophy. So just because you can make a bunch of money if you have to deal with a geography or a political environment or a demographic, or a set of problems or people that you would just prefer not to, then no matter how much money you can make the deal doesn't make sense. So spend some time figuring out your personal investment philosophy. I think that starts.
Number two is once you figure out what you would like to do and where you'd like to do it, then I think that you have to figure out what it is that you're trying to accomplish. If you're a little bit more speculative and you're trying to get in on the ground floor of a market that could emerge, you might want to take a look at the re domestication, if you will, of manufacturing. I think one of the things that happened in this COVID-19 crisis is that we found out that China is not our friend, we found out that we are dependent on China for certain key things like medicines and medical equipment and masks and all that stuff, personal protection equipment, they call it PPP, and probably a whole lot of other things. There was already a little bit of a movement towards bringing manufacturing back to the US. I think that that is something that's going to grow in popularity as a result of this. So there could be markets that have been very looked past with low property prices, decent population, decent transportation, infrastructure, but a great place to put a manufacturing plant, which takes up a lot of land. And so states that have good business climates, inexpensive land, decent labor force, and access to transportation infrastructure to ship finished goods, I think they could end up being winners. You could also look for things like I talked about earlier, where there's a trend growing out of this crisis, like the residential assisted living where people are going to be trying to get their folks out of the big boxes into the smaller properties. I was already a big believer in residential assisted living for other reasons. Now, I think that that opportunity actually gets a little bit better. So you could be looking at those types of things.
My partners and I were big proponents of resort property, and yet, the country that we chose to develop in, it never occurred to us that they would completely shut the borders and block all tourists from coming. So our resort has been 100% shut down. You just never really know what's going to happen. But fortunately, we structured ourselves in such a way that we don't have a big debt ticking time bomb, it's obviously difficult when you're not generating any revenue. And again, no business is geared for no revenue. But if you're structured right, even if you end up in the wrong place at the wrong time, you can usually weather the storm and hopefully, we will.
I think there's going to be a big opportunity in lending. A lot of times real estate investors only think about being on the equity side. But if capital markets end up falling apart, I think there's going to be an opportunity to do private lending, get above average yields without the equity exposure, or some of the landlording hassles and risks that you have. And you probably could get a decent amount of protective equity, meaning that people are going to have to come in with bigger down payments. So there could be an opportunity there if you're more of a cash flow investor.
Obviously residential is always a safe place to be especially multifamily because institutional money likes that, government subsidized financing likes that. The challenge in multifamily of course, is the customer. Some of the folks who are apartment dwellers are going, Gee, I don't know that I like living on top of so many other people, I'd like to get out to the suburbs and get a little bit more spread out. So I don't really know that I'm quite ready to say where I think the best opportunities are going to go. It goes back to what I said earlier, this is something that is evolving and emerging. And I'm spending a lot of time talking to a lot of smart people and really trying to think through where the opportunities are going to be. But just off the top of my head. Those are some of the things that I'm thinking about now.
I'd be very careful about getting involved in flipping things, or even trying to develop product, especially if you're dependent upon takeout buyers with financing because that financing could not be around for a little while. The flip side of that is you may be able to pick up some failed projects for pennies on the dollar, assuming that you have the cash, and you said unlimited money. So you can probably pick up some things that are going to be seriously distressed that can be finished with cheap labor and cheap goods. And then later on, when things come back around, you're going to be in a good position. So part of it is going to depend on your time horizon, what you're trying to accomplish, and I think most of all, who you're connected to, because you're not going to do this on your own, real estate investing is a team sport.
I will take a great team in a lesser market, even in a niche that isn't quite as good. I wouldn't go into catching a falling knife, I don't care how good your team is. When Detroit was sinking fast, almost nobody is going to figure out how to make money in that market until some of the core issues get resolved. But setting something like that aside, and I'm not slamming Detroit because I know that they've been working hard to come back. My point is, pay a lot of attention to your team. And let them help you decide where the best opportunities are, especially on the property management side, because those are people whose interests are going to be aligned with yours. They make money based on the production of income, the cash flow, the properties being occupied, and well maintained.
I love brokers, but brokers and developers are interested in getting the sale now. And sometimes they are less concerned with what it looks like for you a year or two, or five years down the road. Whereas if you're working with your property management team, or you've gotten yourself positioned with the developers or real estate agents, where they value you as a long term client because you bring something to the party besides just the transaction at hand. Or you're indexed, or tied to somebody who's bringing some of that kind of clout, that long term relationship clout. I think all things being equal, I prefer to be focused on my property management team, making sure that I have a great property manager on whatever project, or construction manager if I'm doing development, and a sales team, but ultimately, I think income is what you're going to want to focus on in what's coming.
Is there anything else that you think is important for our audience to know?
I think I've said what I need to say, I'm not hard to find, www.realestateguysradio.com listen to the Real Estate Guys Radio Show and you could listen to us blabber on for an hour once a week, and we have a big library as you well know. I love the fact that you're doing this stuff. I think that it sharpens you as an investor, it gives you a chance to get into a lot of great conversations. And it adds a lot of value to the world. And the more perspectives that listeners can have, and the more things they can hear, and the more ideas you can get exposed to, it just makes everybody a lot smarter. I'm a big believer in tribal knowledge. So congratulations and keep up the good work.