{"id":138964,"date":"2021-07-06T14:54:24","date_gmt":"2021-07-06T20:54:24","guid":{"rendered":"https:\/\/biggerpstaging.wpengine.com\/?post_type=guides&p=137499"},"modified":"2022-09-16T13:32:26","modified_gmt":"2022-09-16T19:32:26","slug":"real-estate-recession-prep","status":"publish","type":"guides","link":"https:\/\/www.biggerpockets.com\/guides\/real-estate-recession-prep","title":{"rendered":"The Investor’s Guide to a Recession-Proof Real Estate Investing Strategy"},"content":{"rendered":"\n

It\u2019s never fun to navigate stormy times, but economic downturns are just as much a part of investing as sunny upturns. Smart real estate investment strategies will keep you steady despite rough waters.<\/p>\n\n\n\n

The rollercoaster start to 2020 might have made you anxious about your investments, but the experts at BiggerPockets know exactly how to weather an economic downturn. Here\u2019s what you need to know about today\u2019s economy, including how to manage your existing investments and where to put your money next.<\/p>\n\n\n\n

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Don\u2019t repeat the mistakes of the past<\/h2>\n\n\n\n

When I asked J. Scott, the author of Recession-Proof Real Estate Investing<\/em><\/a>, his advice for investors who haven\u2019t weathered economic downturns, he had\u2014unsurprisingly\u2014a lot to say.<\/p>\n\n\n\n

\u201cI remember a couple occasions in college stumbling back to my apartment after a few too many drinks, the room spinning, lying on the edge of my bed and thinking to myself, \u2018I will never do this again,\u2019\u201d he says. \u201cAnd for a few days, maybe even a few weeks, that memory was enough to keep me from doing it again.\u201d<\/p>\n\n\n\n

But the memory of the misery didn\u2019t last. \u201cThe pain, sickness, and nausea were no longer fresh in my mind, and I was free to be the same stupid kid, making the same exact mistake,\u201d he says.<\/p>\n\n\n\n

What does this have to do with real estate investing? A lot, actually.<\/p>\n\n\n\n

In the early aughts, before the effects of the 2008 recession started to fade, Scott spoke with a number of shell-shocked investors. All of them faced financial and investing struggles, \u201cBut we made it through, each of us with a newfound perspective on what a massive economic shift could do to our industry and with a healthy fear of it happening again,\u201d he says. \u201cAt the time, it was hard to imagine the good times ever returning.\u201d<\/p>\n\n\n\n

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As investors, we must always remember that things are never as good or as bad as they seem. The economy, the markets, and real estate itself is cyclical. It will get better. Things will return to normal, and we must make good investing decisions that will prepare us for when that shift back to \u2018normal\u2019 occurs.<\/p>\n <\/blockquote>\n

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– J. Scott<\/figcaption>\n \n \n <\/svg>\n Tweet This\n <\/a>\n <\/div>\n <\/figure>\n\n \n\n\n

Things did get better. We\u2019re here, a decade later\u2014and like those hazy college nights, the memory of 2008 has faded away. \u201cI still have the memories of feeling scared, confused, and overwhelmed, and feeling things would never return to normal,\u201d Scott says. \u201cBut I just can\u2019t put myself back in that place to really feel it. It\u2019s more like a dream than a memory.\u201d<\/p>\n\n\n\n

He\u2019s not the only investor that feels that way. Many have been operating like 2008 never happened, and have lost their perspective on how bad things can be. In this current crisis, Scott says he sees a lot of investors who are suddenly snapped back to reality, once again catching a glimpse of the potential bad times that real estate can bring.<\/p>\n\n\n\n

Except we\u2019re not college students anymore. As real estate investors, we have the gift of hindsight\u2014and we can\u2019t hesitate to use it.<\/p>\n\n\n\n

\u201cAs investors, we must always remember that things are never as good or as bad as they seem,\u201d Scott says. During the bad times, \u201cWe have to remind ourselves that the economy, the markets, and real estate itself is cyclical. It will get better. Things will return to normal, and we must make good investing decisions that will prepare us for when that shift back to \u2018normal\u2019 occurs.\u201d<\/p>\n\n\n\n

Hindsight is important for the good times, too. \u201cWhen it seems like the party isn\u2019t going to stop, when it seems like real estate prices will never stop going up, we need to remind ourselves that every bull market has an expiration date,\u201d Scott says. \u201cAs difficult as it can be to remember what it felt like last time, we must try to put ourselves back in those shoes so that we can adequately prepare ourselves for an unavoidable period of angst and uncertainty.\u201d<\/p>\n\n\n\n

Ready to prepare yourself for a successful financial future? Here\u2019s how.<\/p>\n\n\n\n

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Protecting your investments during an economic downturn<\/h2>\n\n\n\n

Nobody ever feels adequately prepared when markets become unstable. The news flow comes fast and furious, and some people make a living peddling fear out of self-interest, compounding investor anxiety. Every investor should practice patience in times like this.<\/p>\n\n\n\n

Economic downturns present a valuable opportunity to revisit your allocations and your investment timeframe. Remember: Time has always rewarded consistency with strong returns in stocks, bonds, and real estate.<\/p>\n\n\n\n

Patience prevails<\/h3>\n\n\n\n

Being a long-term investor means staying invested even when the market is in turmoil. In an average year, the S&P 500 has a decline of at least 13% at some point on the calendar. Yes, this decline is certainly steeper than most, but if you make regular contributions to a 401k or an IRA funding program, your next monthly contributions are buying more shares for the same amount of dollars.<\/p>\n\n\n\n

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In fact, the most successful investors use market downturns to sharpen their education, expand their toolkits, and prepare for the next opportunity. And they never make rash decisions.<\/p>\n <\/blockquote>\n

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– Mindy Jensen<\/figcaption>\n \n \n <\/svg>\n Tweet This\n <\/a>\n <\/div>\n <\/figure>\n\n \n\n\n

Here\u2019s an example. Let\u2019s say you own 100 shares of stock. They were worth $50 per share at the beginning of the year, making your investment worth $5,000. If the stock falls by 50%, your investment is now only worth $2,500\u2014but you can now buy another 100 shares for only $2,500 more. When the stock eventually rebounds and returns to $50 per share, you\u2019ll own $10,000 worth of stock, with a cost basis of $37.50 per share (half at $50 per share and half at $25 per share), and you\u2019ll have earned $2,500 on the position.<\/p>\n\n\n\n

This process of investing the same dollar amount in stocks or funds at specific times, regardless of what the market is doing, is called dollar-cost-averaging. This method is the most efficient way to invest in the stock market, assuming you plan to participate for 10 years or more. It takes emotion out of the process and allows time to be your ally. And opportunistic investors with long time horizons even come to appreciate finding the stock market on sale!<\/p>\n\n\n\n

Worried about your 401k? If you\u2019re not retiring soon, make sure to keep contributing at minimum whatever percentage your employer is matching\u2014these contributions are on pre-tax dollars and it\u2019s just too much benefit to pass up. You are literally getting a 100% return on any matched amount your company contributes\u2014even if you have to wait for that contribution to vest. And if you are close to retirement age, your financial plan should already include at least 60% of your assets in risk-averse, fixed-income securities. Most bond funds have held up very well so far in 2020, with some even putting up strong gains as investors fled stocks and searched for safer pastures.<\/p>\n\n\n\n

Economies and stock markets work in cycles, and every prior bad cycle in the history of time has worked out just fine, rewarding committed long-term investors. In fact, the most successful investors use market downturns to sharpen their education, expand their toolkits, and prepare for the next opportunity. And they never make rash decisions.<\/p>\n\n\n\n

Let me repeat that for those in the back: They never<\/em> make rash decisions.<\/p>\n\n\n\n

Markets fall. Economies run in cycles. This is inevitable\u2014but your long-term investments won\u2019t suffer, as long as you remain committed to strategizing and improving your financial education.<\/p>\n\n\n\n

Don’t fall into the trap of 2008 comparisons<\/h3>\n\n\n\n

Because it was the most recent recession, it\u2019s natural to want to draw comparisons to the recession of 2008. But it\u2019s an extremely poor comparison to make, and real estate investors could wind up in trouble if they react according to ill-informed expectations. All signs point to this coming recession being nothing like 2008\u2014or the 2001 recession, for that matter.<\/p>\n\n\n\n

In 2008, the housing market was flooded with subprime mortgages given to people that couldn\u2019t even come close to affording a home. Lenders allowed zero-income verification loans with no cash down\u2014so when the market crashed, they were forced into foreclosure. Additionally, people were flipping houses two or three times per month, and the rising prices validated their bad decisions. Builders were constructing new homes as fast as they could. All this formed a bubble focused squarely on real estate. As a result, real estate prices fell dramatically. Some markets saw valuations drop by more than 35%.<\/p>\n\n\n\n

But in most recessions, real estate holds up just fine. In fact, sometimes prices don\u2019t fall at all, or simply remain flat for a couple of years. No problem at all for the buy-and-hold real estate investor. In fact, this historical housing market strength contributed to the 2005 through 2008 bubble. Everyone thought, \u201cWell, real estate always goes up, it never goes down. Let\u2019s plow in.\u201d<\/p>\n\n\n\n

Wrong then. But not necessarily wrong now\u2014because investors learned valuable lessons about excess from the 2008 recession. For example, housing starts (or new home constructions) were much lower in 2020 going into this downturn. Interest rates are also much lower, creating more demand.<\/p>\n\n\n\n

Pay attention to interest rates<\/h3>\n\n\n\n

Most real estate investors know that mortgage interest<\/a> rates tend to move as so-called \u201cbenchmark\u201d government bonds rates, like the Fed\u2019s discount rates, move higher or lower. When government bond yields are rising, mortgage rates typically rise as well, and vice-versa.<\/p>\n\n\n\n

Mortgage rates, should they continue their historical pattern of tracking treasury rates, could hit new multi-decade lows in the months ahead\u2014after all, 30-year Treasury bonds now yield less than 1.5%. That doesn’t mean that a 30-year fixed-rate mortgage will eventually drop to 2%, but it will likely fall further.<\/p>\n\n\n\n

Typically, it takes three to four weeks before mortgage rates adjust to market interest rates, because major banks must adjust their underwriting process and market their updated rates to customers and mortgage lenders. In times of severe financial distress, like we\u2019re seeing now, this lag time usually increases; there\u2019s more uncertainty on the part of both lenders and buyers.<\/p>\n\n\n\n

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Real estate risk factors during a recession<\/h2>\n\n\n\n

It\u2019s not so simple as lower mortgage rates bringing more buyers to the table and keeping property prices on their upward trajectory. Back in January, CoreLogic estimated that residential real estate values would rise more than 5% in 2020<\/a>; that estimate is no longer anyone\u2019s expectation. The strong recent run of property appreciation will at least take a breather; whether the picture will darken into declines in property values over the course of 2020 is uncertain.<\/p>\n\n\n\n

Here are the biggest risk factors to property values in 2020:<\/p>\n\n\n\n

  1. Widespread layoffs and job losses from a protracted \u201csocial distancing\u201d environment, leading to household incomes plummeting. Foreclosures and evictions would rise, lowering cash flow for rental investors and making lending a riskier proposition for banks. It could also increase the supply of vacant properties.<\/li>
  2. Real estate investors \u201chunkering down\u201d with cash, pulling away from buying real estate. Stock losses create a \u201cnegative wealth effect\u201d feedback loop. (What\u2019s a wealth effect? It comes from behavioral psychology. We spend more and \u201cfeel richer\u201d as our assets in things like real estate and stocks appreciate in value. The same is true in reverse\u2014when stocks or real estate fall in value, we spend less and feel poorer, regardless of the actual impact to our monthly income and expenses.)<\/li>
  3. Residential property buyers can\u2019t visit open houses so traffic comes to standstill, further increasing the supply of available homes.<\/li><\/ol>\n\n\n\n

    We already see signs that large banks are more hesitant to lend capital. They have no choice\u2014in addition to mortgage lending, these banks also lend to airlines, hotels, and cruise ship operators. These industries and companies may default on large loans without a massive government bailout.<\/p>\n\n\n\n

    Banks don\u2019t want to take on extra risk. Why should they? Millions of consumers are being laid off or having their incomes drastically reduced. This could go on for 12 to 18 months, according to some medical experts\u2014secondary and tertiary waves of the outbreak next fall and winter could happen because nobody has immunity to this new virus. Banks have to be ultra cautious.<\/p>\n\n\n\n

    There may be relief in (some) rentals<\/h3>\n\n\n\n

    \u201cThings aren\u2019t all bad during a recession,\u201d says Scott. Yes, renters have less money to spend on rent\u2014and high-end rentals, often known as Class A rentals, might see drop in market rents as renters flee to cheaper units. Class B rentals may experience a similar effect.<\/p>\n\n\n\n

    But everyone needs a place to live.<\/p>\n\n\n\n

    \u201cWhile renters will often move down in class, they generally aren\u2019t going to go homeless,\u201d Scott says. \u201cWorking class rentals often see increased demand and increased market rents due to all the renters moving from Class A and Class B rentals, as well as those transitioning out of homeownership during foreclosure.\u201d<\/p>\n\n\n\n

    Another hot rental opportunity? College housing. \u201cA lot of people tend to use temporary layoffs as an opportunity to go back to school,\u201d Scott says. As a result, college rentals tend to outperform other residential real estate during a recession.<\/p>\n\n\n\n

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    What happens if a recession becomes a depression?<\/h2>\n\n\n\n

    What if we see not just a recession, but an economic depression\u2014or a significant drop in GDP over several years? In that dire scenario, hundreds of billions of dollars in loans would be defaulted on by everyone from large corporations to individuals and households. A bank\u2019s main concern at that point would be just staying solvent; running out to lend more money would be unthinkable.<\/p>\n\n\n\n

    There\u2019s evidence that banks are hesitating: Mortgage rates are actually creeping higher, despite large drops in benchmark bond rates. A surge of mortgage refinancing applications have outstripped the amount banks want to lend out. Essentially, banks and lenders want to disincentivize new applicants by raising the interest rate.<\/p>\n\n\n\n

    This may only be a temporary pause, but we just don\u2019t know when travel, work, and social restrictions will be lifted\u2014so expect mortgage rates to move more based on lender morale than on the benchmark rates.<\/p>\n\n\n\n

    One potential silver lining: Rental rates traditionally aren\u2019t impacted much by a recession. That model could go out the window if the economy gets into a multiyear slide, with unemployment rates of 15% or more.<\/p>\n\n\n\n

    However, in the 2008 recession, rental rates for three-bedroom apartments actually rose, despite the steep drop in real estate prices. Demand for rental units increased as people downsized from homes, and the recession\u2019s relatively short timetable\u2014helped by massive government stimulus\u2014kept the rental market from experiencing drops in average rates.<\/p>\n\n\n\n

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    So what should investors expect?<\/h2>\n\n\n\n

    Real estate investors shouldn\u2019t feel pressured into FOMO-fueled recession investment snap decisions. History suggests there will be plenty of time to carefully assess one\u2019s options\u2014and that time will be best spent seeing how fast the economy rebounds.<\/p>\n\n\n\n

    The best recession outcomes<\/h3>\n\n\n\n

    If a recession fades out quickly, we may see limited damage to the economy. Positive potential outcomes include:<\/p>\n\n\n\n