10 Ways Recessions Impact Real Estate (& How to Dodge the Worst of It)

10 Ways Recessions Impact Real Estate (& How to Dodge the Worst of It)

 

Given the recent stock market volatility, many real estate investors wonder, “Are we headed into a recession? How will that affect real estate? And how long is Brandon going to stay committed to that beard?”

 

The beard is a puzzle that’s baffled scientists for years—but when predicting how the next recession will affect your portfolio, history can be a guide.

 

Is Real Estate Recession-Proof?

 

This is a common misconception. Unfortunately, it’s not.

 

Many silly real estate investors who believed that myth got wiped out during the last recession. But the good news is that real estate can be recession-resistant. With proper precautions and an understanding of recession dynamics, you can prepare your portfolio to navigate choppy economic waters.

 

I had the great privilege of going through the horrific, Armageddon-like real estate collapse of 2008 with multiple properties. It was like a Michael Bay movie—people screaming in the streets, explosions, cars flipping over…

 

OK, not exactly. But it could’ve been if they’d have let him direct “The Big Short.”

 

I had six multifamily properties at the time.

 

Below I’ll walk you through the economic cause-and-effect patterns that impact rents, values, and the ability to maneuver (sell/refinance) during recessions.

 

The Pre-2008, 2008, and Post-2008 Investing Climates

 

It all started pleasantly enough…

 

I discovered real estate investing in 2000 and loved it. Everyone did. You couldn’t lose. That went on for seven years. Then, 2008 happened.

 

Lehman Brothers and Bear Stearns, two of the world’s largest investment banks, collapsed. The stock market plunged, and the financial world went into panic mode

 

Sound kinda familiar?

 

These events then unleashed an economic chain-reaction. Below are several of the ways real estate was impacted.

 

 1. Real Estate Investment Activity Ground to a Halt

Shell-shocked investors watched with fear, uncertain how long the economic slide would last. Values were at record highs prior to the crash, and many felt this was a long-time coming. The sense was that things could get a lot worse before they got better.

 

When investment stopped…

 

 2. Construction Ground to a Halt

New construction projects, and many already in the pipeline, were put on hold. Investment dollars dried up, because the investors providing those dollars were reeling from their own losses. And confidence that new projects would get completed and be profitable was in doubt.

 

One thing was certain: The boom clearly over.

 

Ten million workers are employed by the construction industry. Many are project-based, not salary-based. So when the construction activity stops, a chunk of the labor pool becomes unemployed overnight.

 

Many other industries are impacted by the health of the construction sector.

 

Also… in boom years, there’s a tendency to overbuild.

 

You’d think that building would be based on need. But when the spigot of construction financing flows enthusiastically, no one’s there to monitor how much gets built and turn off the spigot.

 

The result is oversupply.

 

There’s a saying that goes, “Boom markets die from oversupply.” Another one goes, “Cranes in the air, investors beware.”

 

For some reason, there are a lot of cute rhymes about overbuilding. I think Dr. Seuss may have moonlit as a construction economist.

 

3. Banks Became More Conservative

The recession began with a spike in delinquencies and defaults, which turned into a tidal wave of foreclosures. Lenders who’d made risky loans started going bankrupt, culminating with the world’s largest lender at the time: Countrywide.

 

So, banks reacted by becoming more conservative, making it difficult for struggling property owners to refinance. And purchase loans were given much more scrutiny.

 

This conservative lending added to the market slowdown.

 

Meanwhile…

 

4. Renters’ Incomes Went Down

The stock market plunge and growing layoffs caused consumer confidence to drop. People were cautious and spent less. This caused corporate profits to go down, resulting in salary cuts and layoffs.

 

We were seeing a steady uptick in unemployment.

 

Many of those laid off were renters, who then struggled to pay rent. Many others were homeowners, struggling to pay mortgages. (I won’t go into the compounding effect of adjustable-rate mortgages, because it was specific to 2008. The intent here is to highlight general recession patterns.)

5. Renters Sought Cheaper Alternatives

Renters in high-priced, A-class apartments moved down to more affordable B-class units. Others moved in with friends, or back home with their parents. There was a “renter consolidation” that caused…

 

6. An Uptick in Vacancy

It was most pronounced in A-class properties, but it was felt at all tiers and exacerbated by the overbuilding of recent years. Much new construction tends to be A-class, because it’s the most profitable.

 

However, apartment vacancies were mitigated, because a new pool of tenants was entering the market…

 

7. Former Homeowners Became Renters

Job cuts caused many struggling homeowners to fall behind on their mortgages. Here’s yet another downer saying, “Recessions create renters.”

 

Not as catchy. It doesn’t even rhyme.

This brought some stability to multifamily occupancy levels.

But due to the confluence of factors—oversupply, lower incomes, investor fear, and tightened lending…

 

8. Property Values Declined

Single-family residences were hit the hardest. There were far more sellers than buyers.

 

Also, SFR values are based on buyer sentiment (or “emotional buyers”). The emotion had been irrational exuberance during the preceding years, but now it was fear.

 

Multifamily values were more stable, due to their income stream supported by leases. But that didn’t mean multifamily properties were in the clear.

 

Rent growth stalled, transitioning into rent declines in some locations hard-hit by the recession.

 

Additionally, unit class mattered. Rent drops were most precipitous in A-class, as many tenants could no longer justify paying top-of-the-market rents for luxury units. Many A-class renters relocated to B-class properties.

 

Meanwhile, to address the turmoil…

 

 9. The Fed Stepped in and Lowered Interest Rates

It was an attempt to stimulate the economy, and it provided a lifeline for many property owners in trouble.

 

Owners who were not in trouble (aka were prepared for the recession) had an opportunity to refinance at rock-bottom rates, improve the health of their portfolio, and navigate out of the storm.

 

But the lenders were still reeling from their losses. And as values went down, they were enforcing the “maximum loan-to-value” clause—a clause often forgotten in normal times because loan balances go down and property values go up.

 

But during recessions, when property values slide, borrowers who had been at max leverage (often 75 percent LTV) find themselves having to pay down their loan to meet the required LTV.

 

What does this mean?

 

Basically, if you bought a property for $1,000,000, and the lender’s max LTV (leverage-to-value) is 75 percent, they will give you a $750,000 loan. But if for any reason your property value drops to, say, $900,000, your $750,000 loan has now increased to 83 percent of value. So, the lender will require you to pay down the loan to get to 75 percent LTV.

$900,000 x .75% = $675,000

Therefore, you’d be on the hook to fork over another $75,000.

This happened to me.

 

I had to pay down a loan by $95,000 to meet the LTV requirement. The upside, however, was that due to the Fed’s rate cut, my interest rate went from 4.5 percent to 3.5 percent, and my loan balance was now lower—resulting in a big boost to cash flow.

 

And luckily, I had the reserves to make that $95,000 payment!

 

Lastly…

 

10. Where You Invested Mattered

Each market experienced the recession differently. The severity and recovery timeline varied depending on where you were. Markets with diverse economies were the most resilient.

 

Prices recovered sooner in major markets, as cautious investors sought the safety of top-tier markets.

 

Those top-tier markets then became the first where prices became overheated as the economy recovered, so investors moved on, seeking returns in secondary and tertiary markets.

 

And the whole cycle began again…

 

Key Takeaways from the Last Recession

  • Don’t over-leverage. Especially late in a boom market.
  • Be prepared for rent volatility. Many investors don’t realize rents can go down. But they do!
  • Have reserves, and bolster your cash positions (no-brainer).
  • Monitor the supply of new units being built in your market. (I make a point to invest in cities where it’s very hard to build.)
  • Buying value-add helps—you can offset declining values through forced appreciation.
  • Avoid A-class properties, or bolster those reserves. (I’m not anti-A-class, but I prefer to buy these premium assets coming out of a recession, when they’re beaten up and bargain-priced.)
  • B & C-class multifamily is most stable (but not immune). This was my experience, and statistics seem to support it.

Rent Declines 2008-2010 and Rent Growth 2010-2018

 

I’m fortunate that all of my multifamily properties survived the 2008 recession. And yours can, too—just prepare!

 

I hope this was helpful and good luck!

 

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9 Ways to Survive (and Thrive) During the Next Market Crash

9 Ways to Survive (and Thrive) During the Next Market Crash

Interest rates have been rising. Single family residence prices are softening. Does that mean we’re headed for a downturn?

 

Well, sure—at some point.

 

Recessions have been around forever—they’re an unavoidable part of the investing landscape. But you don’t need to fear them. You can prepare for, and even thrive, during a recession if you have the right tools and strategies.

 

This is the story of my first recession. As recessions go, it was a doozy.

 

Getting Started

 

Throughout the 2000s, I was pumping every dollar I earned into value-add multifamilies in up-and-coming neighborhoods in Los Angeles, like Koreatown and Hollywood. I loved it. I was a multifamily evangelist.

 

But by 2006, nothing seemed to make sense, and, like a lot of investors, I was anticipating a downturn.

 

That’s right—the correction didn’t come out of the blue. The warning signs were everywhere. Reckless lending practices combined with the irrational exuberance of the market had most sensible investors cowering for what was to come.

 

I stopped buying in 2006, waiting for the inevitable correction. I’d be ready to jump in, lock in discounted “correction pricing” before values once again reverted to their upward, long-term trajectory.

 

Timing the Market

 

It came in early 2008. Prices slid 10%, then started to tick back upward. This was my chance, and I jumped in. I found a C+ class multifamily property with cashflow and value-add. The sellers were suing each other and were motivated to sell. It was a great deal.

 

And pretty sweet market timing on my part. Right?

 

Not exactly. It turned out that this 10% decline wasn’t the end of the correction, it was just the beginning. That tick back upwards in values? It was caused by investors like me, waiting on the sidelines to jump in after a correction. We all jumped in, and it caused an uptick.

 

But we were still at the top of the waterfall.

 

A Seductive Temptress

 

I’ve read that this is a common occurrence during recessions. There’s a portion of investors anticipating a downturn, who wait on the sidelines, ready to jump in once prices correct. After a 5-10% decline, the first wave of side-liners jumps in to lock in the discount. This wave of buyers results in a slight uptick in the market. The uptick is misinterpreted by the rest of the sideline investors as the correction being over, and they rush in so as not to miss it! But the reality is that the crash has just begun. And they all go over the waterfall.

 

They call it the seductive temptress of a market crash. It takes down the foolish investors, but seduces otherwise smart ones as well. Cruel—but kinda funny, right?

 

I was one of those idiots.

 

To make matters worse, I’d convinced some work colleagues to invest with me. We bought with confidence, feeling good about our price. But then Lehman Brothers collapsed—and along with it, our entire economy and real estate market. We entered the worst real estate crash in the last 50 years.

 

It was Armageddon.

 

My greatest dread was losing my colleagues’ money. (I would much rather lose my own money than to have people trust me, then blow it.)

 

A Resilient Asset Class

As real estate news got more and more grim—mass foreclosures, investors walking away from properties—something strange was happening at our C+ class building. Rents were actually inching upward.

 

Renters in higher-end properties were facing layoffs and salary cuts, causing them to move into more affordable, mid-tier units, like ours. And former homeowners were becoming renters. During the recession, demand for this asset class actually increased.

 

The recession was nerve-racking, but fortunately, we survived. I was able to deliver my work colleagues triple their money (crushing the stock market returns during the same period). I felt more relief than triumph.

9 Takeaways From the Great Recession

The experience taught me a lot about recession-resilient investing. I’d completely mistimed the market, but was saved by other factors—some that were part of my strategy, others accidental.

Here are strategies I now use to invest with confidence in any market:

 

1. Stick with B and C-class properties.

I have no problem buying A-class buildings at the beginning of a recovery—when I can buy them cheap. In late stages of a real estate boom, they’re overpriced and I avoid them like the plague. I also avoid turnkey. The high end of the market is the first to get slaughtered in a bad downturn. I aim squarely for mid-tier properties I can improve!

 

2. Multifamily is resilient.

Recessions tend to create renters, so multifamily tends to be resilient during downturns. From 2008-2012, 8 million single-family homes went into foreclosure. During the same time, multifamily default rates were less than 1%.

3. Buy as cheaply as possible.

The saying goes, “You make your money when you buy.” If you want to overpay, do so at the beginning of a market recovery. But not now. Prices are high, but deals still exist. Be patient. Make sure you’ve got that cushion that will allow you to absorb declines in value that could wreck other investors. Learn how to negotiate. Battle for the best price possible.

4. Cash flow is a must.

Late in a real estate cycle, positive cash flow is a must. I make sure the buildings I buy generate income from day one. An added benefit of this is that you get a better loan-to-value. Bonus! An adjunct to this is: Don’t over-leverage. Only borrow what the property’s cashflow will cover.

 

5. Buy in an up-and-coming neighborhood.

Even during a downturn, submarkets are evolving. Some evolve in response to the downturn—renters move out of pricier areas into nearby, more affordable neighborhoods and then make them cool! This lead to the birth of neighborhoods like Silver Lake, in LA, a neighborhood that is downright posh now. Catch neighborhoods on the rise.

 

6. Beware of oversupply.

Another saying goes, “Most real estate booms die from oversupply.” Keep this in mind. Supply and demand is a basic fundamental of investing. Overbuilding is a growing concern in several markets, especially at the high end of the market. Track your metro’s supply/demand stats, absorption rates, etc., so you don’t get caught.

 

7. Add value.

This is a must for me in any economy. If you can reduce expenses or increasing cashflow with strategic renovations, you are increasing the value regardless of the economy. So you don’t really need to worry about it. It’s another layer of cushion.

8. Have cash reserves.

This is basic common sense and key during any stage of a market cycle. The reality is your expense projections will usually be too low. Be prepared with reserves.

 

9. Don’t try to time it.

I tried to time the market and failed. Market cycles are predictable, but the timing of them is not. Our economy is too complex to know the event that will trigger the investor fear and cause a recession.

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Investment Principals

Investment Principals

Investment Principals

1. Risk Mitigation

 

We invest conservatively during all phases of the real estate cycle, buying only properties that can be acquired significantly below market value, in up-and-coming neighborhoods where values are rising faster than the Los Angeles median. 

We buy properties with positive cash flow, plus the potential for significant value-add.  We buy B and C-class properties, the segment of the rental market in shortest supply, and highest demand. 

This demand only increases during recession, when renters move down from more expensive A-class units.  This has proven to be among the best risk-adjusted investment strategies during all market phases.

2. Transparency 

We take the privilege of being stewards of your hard-earned capital very seriously. 

We seek to provide clarity and full disclosure throughout all phases of the investment cycle.  From acquisition to operating strategy to disposition, we allow investors access to our process, and the information they need to be as integrated in the decision-making process as they desire.

3. Discipline + Experience

We have two decades of experience, and an intimate understanding of the neighborhoods we invest in, along with extensive broker relationships.  Due to our track record, we are given first shot at some of the most undervalued properties and exceptional deals. 

We then put our knowledge and experience to work adding value and decreasing expenses in multiple ways through our value-add business plan. This has resulted in exceptional returns in good markets and bad.

4. Impact Our Communities

We believe that by improving the often-neglected living spaces that we purchase, we’re generating a better experience for our tenants, and improving the community at-large.

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