What Newbies MUST Know When Investing During a Recession
With several market cycles already under my belt as a real estate investor, I no longer hear the word "recession" and cringe. The fact of the matter is the market is cyclical—there’s no getting around it. Recessions are simply a natural part of that cycle.
And they’re not something to be feared. Rather, like every stage of the cycle, recessions offer unique opportunities.
If a new investor asked me for advice in a recessionary economy, here’s the number one thing I’d tell them:
“Understand what exactly your goal is before you do ANYTHING else.”
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It’s easy in this industry to get shiny object syndrome. I know, because I’ve experienced it more times than I care to admit.
Real estate investors have so many options and strategies available to them. Investors face a huge temptation to adjust their strategy and process to fit the next awesome deal they come across.
"I'll flip this one and put it on the MLS!"
“This one I’ll wholesale to a local investor”
"Here's a good rental for my portfolio. I'll do the BRRRR strategy."
My advice, especially in a recessionary economy, is to flip that script. Understand your goal, pick one strategy, and dig in.
Digging in means finding a mentor or group or meetup that can teach you about your strategy of choice, thereby reducing your margin for error. It’s not that you shouldn’t take action; it’s that you should take action with clarity and focus and with the right team in place to give you the guidance and support you need. You have to understand what you’re getting yourself into. Then, double down on the process of the one or two things you really want and only do activities that work toward those goals.
Don’t get distracted. Understand your goal and be disciplined enough to stay focused on it. This way, when you get a result, you can reflect back on what happened and why.
Advice on Investing in a Recessionary Economy
The dip that occurs in the housing market during a recession happens slowly and is rarely drastic in the same way as something like the stock market. Just look at historical data of real estate values. One of my favorite books, The Millionaire Real Estate Investor, quotes Nicolas Retsinas, director of Harvard University’s Joint Center for Housing studies: “From 1975 to 1998, only 14 of the country’s largest metro areas experienced price declines of 5% or more over a three-year period. Unless you overpaid walking in—if you’re prepared to live through the cycle—you’re probably not going to lose money over the long haul.”
Although we know the 2008-09 recession did have larger swings in some markets, looking at the recovery as a whole in the United States still far exceeded even the values prior to that recession. Because of this, investors need to focus on being strategic with their underwriting and getting their processes in place, so that as the dips slowly happen, they aren’t caught in a bad position.
Eventually, it’s highly likely you will be seeing more opportunities in a recessionary economy. You will start seeing longer days on market and more inventory in the marketplace. As long as you’re reviewing and underwriting your deals thoughtfully, you’ll have great opportunities to invest in a recession.
Since I told you to focus on one thing and dig in, let’s look more in-depth at the opportunities and risks for each strategy in a recessionary economy.
Opportunities & Risks for Real Estate Investors During a Recession
Opportunity: If you are priced appropriately and buy correctly, there’s still demand for very nice homes—even in a recessionary economy. People who are accustomed to watching lots of HGTV want these types of homes. If you underwrite it well, you can absolutely still sell retail flips, and you have the potential to buy a better deal on the front end, too. I tend to personally stay at or below the median house price in that market.
Risk: Depending on the price point and how fast those homes normally tend to move, retail flips are the properties I’m most concerned about during a recession. As more inventory comes into the market, especially above the median house price, the price point of the home—as well as the number of buyers—typically decreases. More available doors force price reductions because you have to compete with other inventory.
One interesting thing to watch: if the interest rates and inventory remain low, this could continue to put stabilizing or upward pressure on prices.
Opportunity: In a recession, there will be people who need help, whether they're in foreclosure or deed in lieu, etc. Wholesalers are uniquely positioned to help solve these very problems. Additionally, and especially for new investors, this is the strategy that is the easiest to get into as far as capital goes. It doesn't take a lot of capital to wholesale, and that remains true in a recessionary economy. If you're willing to put the effort in—by that I mean walk neighborhoods, knock on doors, research online—you can find great deals.
Risk: Wholesalers can and will do pretty well during a recession, but they have to get past where the homeowner believes the property is valued and what the “today” value is. A wholesaler’s most valuable skill will be in negotiating and learning how to understand that person’s problem and solve it for them, so they accept and are happy with the price you can offer.
Buy and Hold
Opportunity: Interest rates are awesome right now, and typically the Fed will want the interest rates lower to steady the economy in a recession. Even if the values of homes go down over a short period of time, they historically always come back up. Real estate appreciates over time, so buy and hold investors won't have lost anything unless they sell during the recession phase of the market cycle. Additionally, just like wholesalers and flippers, buy and hold investors will be faced with the opportunity of more inventory. This offers the chance to buy and scale at a much faster rate, since you're typically getting homes for lower prices.
Risk: For buy and hold investors looking to do the BRRRR strategy, you could very well have an after-repair valuation in a recession that is less than what you projected. You want to be careful of that. Additionally, depending on the lender’s terms, you may experience some changes in their underwriting. You may find out that instead of doing 80% LTV, they may have to do 75%. They might also require additional money reserves on your end. It’s important to understand the terms and have a good relationship with your lender, so that you’re on the same page in any type of market environment.
Buy and hold investors may also have some downward pressure on rental pricing. Especially when looking at higher price point rentals. But the primary area of caution for the buy and hold investor is the valuation piece. Be conservative with your underwriting during a recession to protect against this possibility.
Thinking back on when I first started investing in real estate and where I am now (doing 180 deals per year), the ability to understand why a deal made money (not whether it did) and how to scale correctly was paramount to my company’s success.
Everybody has big dreams, but they don’t always have the infrastructure in place. If you think about infrastructure from the beginning, as you have more buying opportunities, you’ll be able to make better decisions. You’ll be able to move quicker, weather any market condition, and achieve your ultimate goals. Because of this, I’d encourage every new investor to understand their goal first, and then pick a strategy and dig in.
Recessionary economies are full of opportunities, so go out and find yours!
What other questions do you have about investing during a recession?
Let’s chat in the comment section.