In the January Issue
- Economic Outlook for 2019
- Economic Factors Influencing Today’s Market Climate
- Six Investment Strategies to Consider in a Downward Market
Happy New Year from everyone here at TF Management Group LLC!
We hope everyone had a wonderful holiday season with family and friends. With the first of the year upon us, it’s time to begin thinking about your investments for the upcoming year and how to invest your money with worsening market conditions on the horizon.
In the December newsletter, we mentioned the current state of the economy and how to tie up your year-end financial planning with rising interest rates in mind. This month, we’re going to kick off the new year by looking at a few key factors that are influencing today’s economic environment and specific ways you can invest in a downward trending market.
Let’s get started.
The Age of Rising Interest Rates
This past September we looked at the Yield Curve:, a financial tool used by many analysts to predict forthcoming recessions, and determined that the curve was headed toward an inversion since short-term rates are rising faster than long-term rates. Many analysts are saying the economy officially hit its slow down in October with an inversion likely this month.
It’s no surprise the stock market has been a great ‘bull’ market for 10+ years, but like the saying goes ‘everything good must come to an end,’ and that time is coming.
The Fed has been increasing rates at a fast pace the past couple of years– nearly 200 basis points. Recently, they announced they plan on slowing the interest rate hikes because it has destabilized some sectors of the economy (which is good news); however, the bottom-line is that interest rates will continue to increase… only a little slower. Let’s see how this might affect market affordability and corporate earnings.
Impact of Rising Interest Rates on Market Affordability
Because the economy has been strong in recent years, unemployment has remained at an all time low, so when interest rates begin to rise, the risk of wage and economic inflation drastically increase.
For example, over the past few years, you could’ve applied for a 30-year fixed mortgage at 3.25%, but now that rates have increased to 5% (nearly a 50% increase), you’re paying 50% more the amount in mortgage payments. This means that the new buyers today with the same amount of income as the old buyers cannot afford the same house price due to higher mortgage payments.
Currently, wages have stayed the same (rather than increased as predicted), so market affordability is decreasing, meaning people can’t afford as much as they could in the past. As a result, certain sectors of the economy begin to slide, like builder stocks. In the past, builders have focused on higher-end homes because the economy was doing well and people could afford them. Now, however, as affordability shifts downward, builders are focusing on affordable housing to fill in the demand.
*Investor Notes: It’s important to note that a decrease in affordability is a global issue with some markets being affected more so than others. For example, coastal markets have lower affordability than inland markets.
With affordability decreasing, what is happening to corporate earnings as interest rates rise?
Impact of Rising Interest Rates on Corporations
When wage inflation occurs, consumers gain more buying power because there is more money in their bi-weekly or monthly paycheck. The downside? Corporate earnings suffer.
Corporations have a variety of bonds– some are term bonds while others are lines of credit. When the Fed increases interest rates by a quarter of a percent, interest rates on a corporate line of credit rises and the debt service increases immediately. To emphasize, corporate bonds are very sensitive to interest rate fluctuations.
For 3 or 5 year bonds, on maturity, they will have to pay market rate in order to renew the bonds. The impact of higher interest rates is higher debt service for corporations over a period of a year or two as the bonds roll over.
In sum, corporate earnings hurt as a result of higher interest rates. But rising rates are not the only factor contributing to a market slowdown…
A Weakening Global Demand
If you’ve been watching the news over the past few months, you’re probably familiar with the threats of trade wars between America and other nations, specifically China.
The consequence of a trade war is uncertainty. This uncertainty is a bigger risk to the economy than actually paying higher tariffs because investors do not know which sector of the economy will be affected or improved.
Strategic investments can’t take place when there is uncertainty in global trade; corporations are unable to make production decisions because they don’t know how tariffs will affect their supply and demand. In the U.S., corporations are already issuing layoffs in wake of these trade wards, creating even more headwind for the U.S. economy.
Both rising interest rates and trade wars are lagging indicators of an economic recession rather than leading indicators. The consequence of these factors is that the GDP will begin slowing down and employment numbers will begin adjusting downward. Unemployment will no longer be at a historic low.
With all of that being said, how do you enter a downward market as an investor? In the next section, we’ll discuss various strategies to protect your investments in unstable market conditions.
Investment Strategies to Protect Your Money in a Downward Market
In the past, all markets have been like a rising tide; more than likely, all of your investments have been performing well. With a downward market, you have to be a little more prudent (or cautious) with your investments.
Here are ten basic investment strategies to consider in current market conditions:
1.Focus on Cash Flow
In a downward market, cash is king.
When looking at your investments, think about your cash on cash return and what kind of return you’re generating. It’s important to increase your cash reserves in a recession because this will enable you to take advantage of opportunities that come along in a recessionary market.
A simple tool to help you understand how your investment might perform during periods of rising interest rates is a stress test. To perform a stress test is to assume your revenue will fall by 10% while your expenses increase by 10%. When commodity prices rise during a trade war, your expenses will naturally rise, so a stress test will help you prepare your investments for worsening market conditions.
2.Focus on Value-Add Properties
During periods of market recession, value-add properties become opportunistic investments due to forced appreciation. *Reminder: Forced appreciation can occur regardless of market conditions because value is being added to ‘outside factors.’
The good news is that there are always distressed, mismanaged, or dilapidated properties on the market (and typically at a steep discount), so once you acquire one of these properties, you can implement a value-add plan to improve value and raise rents.
Like we mentioned before, it’s important to conduct a stress test even on value add properties during a downward market.
3.Invest in Alternative Investment Classes
While traditional investment vehicles tend to perform poorly in uncertainty, real estate offers predictability in cash flow for investors.
When looking at real estate, focus on the affordability of each investment. Entry level and multi- family housing are in high demand right now and are key investments to consider. Your riskier investments lie with higher-end homes and condominiums because as people lose their jobs in economic recessions, they tend to down-size.
Often times you can find investment properties in defensive sectors like single-family and multi-family housing. Self storage also offers opportunity in downward markets because as people downsize, they need a place to store their belongings.
Another defensive sector to consider in recessions is service-oriented retail space. This includes gyms, hair salons, medical offices, etc.– retail not affected by the “Amazon effect” or online shopping.
4.Look for Dual-Exit Strategy Investments
Investment properties that offer dual exit strategies tend to be a safer option for investors in times of recession and often outperform projects with single-exit strategies.
An example of a dual-exit strategy could be having the option to sell or refinance the property to be kept long-term. If the property is unable to sell, a great secondary option is to refinance and the return on capital is given back to the investors.
5.Diversify Your Portfolio
Diversification is key to a successful investment portfolio, especially in a market downturn. It’s natural that some investments will do better than others, so with a diversified portfolio, your returns level out.
One way to diversify your risk even further is by investing with partners you like and trust. By investing with others, you have access to more capital, opportunities, and connections.
6.Look for Distress
If you’re looking for an investment property, look for distress.
What we mean by that is people in distress are more likely needing to sell their property (and at a discount). As the economy slows down, there will be more distressed owners and therefore, more distressed properties on the market.
These kind of investment opportunities are why increasing your cash reserves is a good idea.
Wrap-Up
It’s clear the economy is beginning to slow down and the stock market is suffering, so now is a good time to evaluate your investment portfolio for the upcoming year. The new year is an opportune time to explore the alternative investment sector and diversify your money into various asset classes.
One of the best ways to protect your investments, however, is to stay informed on current market conditions. By doing so, you can stay ahead of the curve and protect your investment money in case the economy takes a sharper downward turn.
If you would like to learn more about current market conditions or how to invest in a real estate fund, contact us and we’d be happy to walk you through your options.
To learn more about where the economy is heading, visit our Podcast Page: to hear from myself and other economic experts about current market conditions.
Thanks for reading!
Mike Zlotnik
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.
