Real Estate Investing During a Recession (or Depression)
We've experienced an unnaturally long boom period since the end of the Great Recession -- it's been largely due to artificially low interest rates, record government spending, and a ballooning amount of corporate debt which has spurred a ton of business investment activity.
But all bull markets and boom cycles must come to an end. And it looks as though the writing is on the wall -- the stock market is officially in bear territory, cryptocurrencies have been hammered, inflation is at 40-year highs, and mortgage activity has plummeted since the fed started raising interest rates.
But there are ways to prepare, and history gives us some insight into how real estate markets react during downturn cycles and how you should consider adjusting your real estate strategy.
Guide to the video
- Historically, real estate markets follow predictable lifecycles during broader economic downturns
- The right blend of debt vs. equity across your real estate portfolio will help you remain liquid enough to take advantage of buying opportunities while also reducing risk
- Different types of real estate react uniquely during recessions
- As the economy transitions from a high inflation environment to a secular inflation environment, real estate is poised to be a good long-term investment
Video transcript follows
There’s a lot of speculation floating around as to what’s going to happen over the next 6, 12, and 24 months.
GDP growth in Q1 of 2022 fell short of expectations, declining by 1.5%. If the trend continues for the 2nd quarter, we’ll officially be in a recession. But even if in hindsight, the recession is officially backdated to later this year, or early 2023, the writing is on the wall.
The downturn has already started, and inflation isn’t slowing down - we are staring down the barrel of the dreaded stagflation.
But it begs the question. As investors, how should you be preparing? I am going to cover all that and more in this video.
What’s up everyone, it’s Matt Marsh, founder of Marsh & Partners.
Marsh & Partners is a development and national consulting firm that helps business owners and investors maximize their real estate and transform their businesses.
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Background on the coming recession
So here is where we stand today…
- The stock market is in a bear market
- Bitcoin is down over 30 percent in the past month, and Ethereum is down nearly 50% over the same time period
- The federal reserve has hiked the fed funds rate to 1.75%, with more hikes anticipated over the coming months
- Inflation is at 40-year highs – and really it’s much worse if the CPI was calculated the same way it was in the 70’s
- And new mortgage applications are at their lowest rate in over 22 years
So, all that is to say that we are treading on pretty tenuous waters right now. And the prospects for a quick economic recovery look bleak, don’t expect a soft landing. Especially since the federal reserve’s spent the last decade and a half inflating the “everything bubble” via historically low interest rates and record stimulus.
But there are ways to prepare. And it begins by investing in real estate.
But it’s important to keep in mind that with these economic booms and busts, and peaks and troughs, come different downturn and recovery stages – and they each require a different approach and different preparation.
So in order to really dive into real estate investing during a recession, I’m going to break down the life cycle of a recession into two different time horizons – short term and long term.
Because simply saying “invest in real estate” isn’t an adequate answer.
Let’s jump right in.
How to navigate the next 24-36 months
So I want to be up front about something. I don’t see a way that the federal reserve can navigate a soft landing with this one. The government’s response to the last several recessions have only served to kick the can down the road. And now, even if the only solution was to pull a Volker and raise the fed funds rate to 20%, there is no political will to do it.
So I am coming at you from that lens. The lens of someone who has always taken a bit of a contrarian approach to finance and politics.
Academics will tell you that since WWII, recessions have ranged anywhere from 6-18 months, for an average of 11 months. And while that’s technically true, the negative consequences of recessions are felt much longer. This one will last longer than 11 months, I can almost assure you that.
In fact, one of the reasons we’re suffering from such a crippling housing shortage problem is because of the underdevelopment of homes since the Great Recession.
I should also tell you that I’m not going to come at you with the boiler plate wealth manager spiel either.
You don’t need to hear that you need to pay down your credit card debt, or you need 6-12 months of living expenses in a reserve account. And dollar cost averaging into stocks or crypto at lower entry points is great, but leaves you exposed to substantial short-term volatility.
Over the next 2-3 years, however, certain types of real estate, and the right investment approach can help you weather the storm.
Leverage vs. liquidity
Let’s first discuss leverage and liquidity. There are two school of thought on this.
Leverage during a recession can be a scary thing. Anyone heavily invested in real estate during 08/09 knows that those certified letters come fast and furious, and they don’t stop. But conversely, debt, especially during times of inflation, can be a powerful asset. As the rate of inflation exceeds the nominal rate of interest on a note, the real borrowing rate is negative. And if you believe the U.S. dollar will come out the other side of this much weaker than it was going in, taking on debt today to invest in assets like real estate and cryptocurrencies may be practical.
But leverage also plays into the concept of liquidity. It’s wise to keep as much cash on hand to navigate whatever changing circumstances may occur over the next couple of years. That could be to take advantage of buying opportunities that will surely present themselves over the short-term, or just for peace of mind. And financing acquisitions with some debt can help preserve your liquidity.
Ultimately, you’ll want to consider recapitalizing your portfolio to achieve a more optimal debt and equity blend for current assets and any planned acquisitions.
Finding the bottom of the market
But what about finding the bottom of the market? If you have some extra cash on hand, you’ll obviously want to deploy it at the right time. Conventional wisdom says that you shouldn’t try to time the market. And that’s true. But history gives us some insight into how real estate markets evolve during recessions which can help you better prepare to make smarter timing decisions.
If we look historically, the first stage of a recession in the real estate markets is signaled by a period of price discovery. Buyers and sellers need to wade through the obfuscation that’s clouding their expectations. Lenders evaluate their loan portfolios and ready their playbooks while the market takes 6-12 months to establish a new baseline for pricing guidance.
The next 1-2 years are when the real opportunities present themselves. Property owners will look to get out from under failing assets and lenders will look to rid themselves of bad debt.
But here’s where this downturn looks a little different. Real estate returns over the short-term recession will be largely location driven. We’ve already seen it over the last couple of years with the great migration, but certain metros have completely outpaced a majority of the country in population and rent growth and asset valuation.
People flock to where the opportunities are, right? Or they move to where they might experience a little more freedom than they would have otherwise.
But that means that it will also be important to reevaluate your real estate strategy. As asset prices have ballooned and investors have looked for places to put their money, many have resorted to investing in properties with the singular hope of capturing value appreciation. But that strategy leaves you exposed, especially if a property’s underlying cash flow doesn’t justify the purchase price.
Cash flow deals are hard to find, but they are still out there. And over the next couple of years, they’ll begin to present themselves as the market cleans itself of malinvestment and looks to return to some semblance of equilibrium.
What type of real estate does well during a recession?
The last thing to consider as you prepare your real estate investing strategy for the coming recession is product type.
I already mentioned that the U.S. is suffering from a substantial housing shortage as a result from underbuilding over the last decade. That’s a fact that policy makers are rushing to combat. But what’s also a fact is that people need a place to live.
So, what type of real estate does well during a recession? Let’s again turn to historical data to inform our decision making.
If we look across the last several recessions, apartments and multifamily properties have almost always outperformed alternative investment vehicles. But that’s not to say that every multifamily investment is the same. Luxury, class A apartments are generally less resistant to downturns than class B or class C alternatives.
And as interest rates rise, and homeownership becomes less affordable for a larger swath of the population, many resort to renting. And the short supply of affordable rental options in many markets leave apartments as the only option.
What about industrial real estate? After all, it buoyed the real estate market during the downturn of 2020. Well, it looks like the shine is coming off that apple a little bit, especially with some of the larger bulk class A industrial space. But well positioned, higher margin, and smaller more agile industrial properties in key markets will remain an excellent investment.
Single family property investments are also worth consideration. Just as rising interest rates turn potential home buyers into apartment renters, they too turn buyers into home renters.
Consider too that developers and homebuilders may begin to pullback from their frenzied building pace of the last two years, which will further exacerbate the affordability and supply challenges we’re presently facing.
Rental properties in market sustained by population in-migration and job growth are historically good inflation and recession resistant investments.
Real estate investing and the long-term ramifications of a recession
Recessions inevitably create unease. But they’re often looked at fantastic buying opportunities. A lot of life changing wealth is made during downturns with a sound and prudent strategy.
It’s also worth mentioning the wealth effect when we talk about real estate’s long-term trends resulting from a recession. As households become poorer, at least on paper because of depreciating stock, bond, and cryptocurrency values, they’ll begin to pull back on their spending habits.
Not only may they be less inclined to take vacations or go out to eat, but many households look to cut their monthly mortgage or payments if possible.
That means that more families turn to entry level real estate options, like starter homes or more affordable apartments as they look to live more within their means. This further cements the opportunity that well positioned real estate, in the right market, offers for investors.
But the most important long-term trend we need to consider is the effect of inflation.
Let’s assume that the federal reserve gets inflation under control over the next 12-24 months through rate hikes and whatever other tools they have at their disposal to plunge the economy into a recession. That’s a huge assumption, and one I’m not inclined to believe will be the case, but bear with me here.
Once we’ve come out the other side of this period of high inflation, we’ll transition into a more prolonged period of mild, steady inflation, or secular inflation.
And that secular inflation spells good things for natural inflation hedges over the next 10-20 years – think gold, real estate, and in some circle’s cryptocurrency, especially if you believe the era of the dollar’s dominance is nearing its end.
I should also note too that most of the world is living in a country with a currency that is experiencing rapid inflation – while historically, it’s typically hovered about 20% of the population.
That means that more and more investors will turn to alternative forms of sound money and asset backed investments to preserve their buying power. And what does that mean ultimately? A higher demand for real estate and rising asset prices over the long term.
As we navigate these next couple of years, it’s critical to view your real estate strategy through the lens of both a short and long-term time horizon.
Optimize your portfolio in the short term by investing in historically recession resistant types of real estate, de-leveraging and freeing up some cash if necessary, and identifying your target markets carefully. Also keep in mind what rising interest rates will do to real estate over the short term and how that volatility may impact the value of your portfolio near term.
But once we make the transition into the post-recession economy and settle in before the next boom-bust cycle, real estate is poised to be an important part of that conversation.
If you’re concerned and want to talk about strategies, we might be able to help.
We also have investment opportunities in some of our ground-up development projects as well as acquisitions here in the Raleigh, North Carolina market. You can reach out if you want to learn more.
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