Like all parts of the economy, the housing market goes through phases. These phases of the market are classified as times of expansion, peak, recession, or recovery. A downturn in real estate is typically the result of general economic turmoil, resulting in increased unemployment, reduced wages, and limited lending.
When the housing market “crashes,” there tends to be an observable increase in the number of foreclosures, fewer buyers, and reduced property values. Investment property owners may also experience higher vacancies, which leads to reduced market rents. And it is not uncommon to see landlords drastically lower rents to attract new tenants.
To best prepare for market downturns, it is important to have systems in place—specifically, those surrounding people, processes, organization, and technology. You cannot just wing it and hope for the best. As legendary investor Warren Buffett said, “Only when the tide goes out do you discover who’s been swimming naked.”
Read on for some of the challenges to expect when weathering tough market headwinds, as well as the keys to keeping your head above water until the sun comes out again.
What Investors Should Know About Recession Times
Access To Financing Gets More Difficult
In good times, investors should be building relationships with financial institutions. This is because credit tightens up and loans are harder to come by in bad times. That said, focus on building your credit, if necessary. Then, apply for lines of credit, restructure short-term debt, and start moving assets to cash ahead of a market downturn.
Keeping Good Tenants Becomes More Important
People will lose their jobs in recession times, meaning some will become unable to pay rent. Lost jobs and missed rent can amount to increased vacancies, and landlords typically have to offer incentives to attract new tenants (e.g., free toasters). For this reason (and several others), it is paramount that rental property owners attract quality tenants who pay their rent, take care of the property, and stay a long time.
Nature of Competition Changes
Oftentimes, real estate investors encounter increased competition during market downturns. For instance, fix and flip investors may be looking to buy while things are cheap—and perhaps rent those properties out until they can rehab and sell for a higher profit.
Plus, people can obtain better properties for affordable prices. If market rents fall, tenants who remain employed may be able to rent somewhere nicer—or even buy, instead.
Risk Levels Increase
Luxury properties may lose their allure. With loss of jobs, high-end housing can become more difficult to rent or sell. A lot of people will be looking to downgrade until the economy turns around.
It may also be harder to offload marginal properties. Investors who cannot afford to hold for 3-5 years should get out while they can. It is also smart to sell anything that can fetch a big premium from speculators.
Stress test your entire portfolio. If you own income properties that cannot handle a 10% decrease in rent or a 10% increase in vacancy, cut your losses and sell. For those who have properties in bad neighborhoods, or who have properties that are not generating decent cash flow, those rental units should go.
Now, let’s walk through the keys to success when navigating a downturn, broken down by investment strategy.
How to Survive a Market Downturn as a Real Estate Investor
Wholesaling in a Recession
While wholesalers are more immune to the effects of a market crash—they typically do not purchase property and are not holding property in inventory—their buyer pool may dwindle. This is especially true if primarily selling property to flippers, as flipping houses is inherently risky in bad times.
(That said, if you were flipping in good times, choosing to wholesale in bad times could be a wise strategy.)
In addition, wholesalers may face growing competition. Their service is less valuable if the MLS is flooded with cheap properties and short sales become more prevalent. Prepare accordingly.
Flipping Houses in a Recession
In down markets, it is imperative that investors flip with caution. Be certain of your numbers (ARV, rehab costs, holding costs, selling costs, etc.). Avoid thin deals and large amounts of leverage. Stay away from high-priced houses. Instead, focus on the median price point.
Lower your carrying costs, too. Aim to keep projects quick, and do not take on more projects than you can work on simultaneously.
In addition, ensure you have multiple exit strategies. Choose properties that appeal to as many potential buyers as possible. And avoid speculation unless you are willing to hold long-term.
Buying and Holding in a Recession
Housing crises create opportunities. Focus on having high-demand, low-supply housing. The best way to do so is to understand who your customer is and what their needs are. Then, create a product that exceeds their expectations.
At the same time, develop strategies to minimize turnover. It starts with screening thoroughly. Once tenants are placed, develop a tenant loyalty program, and focus on customer satisfaction.
And do not forget to stress test your portfolio, assuming 10% lower market rents, 10% higher vacancy. Let this assessment determine your next course of action.
How to Prepare for a Downturn
To recap, while it’s impossible to time the market, it is possible to prepare for every stage of the investment cycle. Here’s how:
- Start moving assets to cash
- Focus on building your credit
- Apply for lines of credit
- Restructure short-term debt
- Sell off income properties that can’t handle a 10% decrease in rent or a 10% increase in vacancy
- Get rid of properties in bad neighborhoods if they’re not generating decent cash flow
Bonus: Advice for New Real Estate Investors Wary of a Market Crash
If you’re new to real estate investing and the thought of a down market keeps you up at night, here’s what you should do:
- Work on yourself first
- Allocate time for education and training
- Understand your strengths and weaknesses
- Decide on your method of focus
- Find an experienced mentor who successfully navigated past downturns (“A wise man learns from his mistakes; a genius learns from others.”)
- Focus on building your credit
- Start moving assets to cash
In good economic times and bad, keep calm. Avoid making decisions based on emotions—putting a plan in place in good times makes this easier. Above all, remember the market is cyclical. Bad times will pass, and with proper preparation, you will come out the other end a better investor for having gone through it.