By Charles Sells
Most analysts agree that we will see a recession in the next 12 months.
Will it be on the par of “The Great Recession” that followed in the wake of the last housing crash and subsequent global financial meltdown? Probably not, but real estate investors must accept we are overdue for an economic downturn. That downturn could be magnified by legislation and policy decisions made by politicians afraid to say “No” to an electorate comprised of many voters who were children during the last recession and, as a result, have an unrealistic fear of the concept of an economic cycle.
Think about it:
During the last recession, the Millennial generation came of age and was, largely as a result of the downturn, stalled out for years as they accumulated student-loan debt and struggled to launch into their own homes and lives. They have a skewed perception of economic cycles because the last one was so horrible for them and a “unique” perspective on how things might be better managed in order to prevent the catastrophe of a downswing ever happening again.
Younger adults do not even have the perspective that Millennials enjoy. They have no memory of adult life during a downswing and, as a result, cherish an unnatural fear of it.
These factors, along with the uncertainty that comes with every presidential election year and a number of classic market indicators that have been predicting recessions for the past century, seem to be driving the point that a recession (or a downturn) is coming home.
What can stop this downswing?
What could stall it and subsequently make the eventual downswing much, much worse?
Politicians pandering to their public and burying their collective heads in the sand.
It’s not a question of if a recession is coming.
It’s a question of when and to what degree.
Whether you agree with me that a downturn is likely by the end of 2020 or you believe that the window is a wider 12-24 months, the real question for smart real estate investors is:
“What do I do to prepare?”
We’ve all heard investors talking about what they wish they had done during the last downturn. I have heard so many people say things like, “I should have bought everything!” or “If only I had the capital then that I have now.”
Of course, in reality, just “buying everything” was only the starting point. Once the investors who did snap up properties in the wake of the housing crash acquired them, they had to maintain them. They had to generate returns. If they failed, they just lost the properties again in what, for many markets, was just the second wave of the crash.
Take Detroit, Michigan, as a prime example. You probably remember headlines about investors buying properties for literally one dollar. Then, a couple years later, you may recall that Detroit was still foundering and a lot of those properties were so neglected that the city had to demolish hundreds of them.
Did the investors who “bought everything” but couldn’t afford to maintain that investment ultimately score a big win? Absolutely not.
In fact, many of them lost their shirts just like the original homeowners did.
Don’t Forget the “Hold” in Buy-and-Hold
It is vitally important to not just acquire properties if you want to be prepared for a recession, but also to have the capital to maintain those properties. In the event of a recession, you need to have investments that will cash-flow in a down market or that you can afford to hold and maintain until the market starts to recover.
After the last housing crash, many of those Detroit investors probably thought they would rent the properties they purchased out to people who lost their homes during the mortgage meltdown. However, a lot of those people did not need to rent a home in Detroit anymore because they left the city completely.
Between the 2000 U.S. Census and the 2010 U.S. Census, the city lost a full quarter of its population! That meant a lot of empty homes no matter how cheaply you bought them. If you were going to hold onto those properties until they recovered, you had to hold a serious reserve of capital to sustain your budget while you waited for the recovery.
How do I identify properties that will cash-flow during a downturn and/or allow me some wiggle room to buy and hold them in a long-term portfolio play?
To me, this answer is simple. It is the same strategy I have been implementing for two full real estate cycles so far and that I plan to continue to leverage up to, during, and long after the conclusion of the next economic downturn.
I’m going to acquire real estate using property tax liens and property tax deed certificates while targeting markets where I know the population will likely opt to downgrade their living spaces long before they opt to leave.
Here’s the kind of market I like:
I want a secondary market in decent proximity to a 24- or 18-hour city in a region where the cost of living is relatively affordable compared to regions with similar employers.
States with this type of market include:
- Texas because it hosts a lot of the same type of tech and engineering companies that used to make their homes in California, but the cost of living is much lower.
- States in the Southeast like Georgia and South Carolina and in the Midwest like Illinois. Employers in the major metro areas of these states are unlikely to “jump ship” for another location if the economy corrects. Furthermore, these states’ populations will likely grow as more employers move their operations to business-friendly markets.
Now that we have some markets in mind, let’s talk about what we can do to make recession-resistant real estate investments in those markets. You must factor in two things when identifying what types of property you want to buy in this scenario:
- Will the price give me wiggle room if “Plan A” gets delayed?
- Is the property going to attract a resident or tenant in a down market?
The key to accessing “wiggle room” properties is to simply acquire those properties below retail. Examples of ways that have historically been well-suited to acquiring properties at low prices include foreclosure auctions, buying off-market, and, of course investing in property tax liens and property tax deed certificates.
Property tax debt is one of the best ways to acquire property at deep discounts at any time, regardless of the market cycle. As long as you carefully evaluate the properties in question before you bid and understand the auction system in your market, you will be able to identify and acquire properties that you can hold for the long-term that permit that “wiggle room” and be attractive in the event that the local population has to downsize. And that thought leads us to the second factor…
Will the property attract a resident or tenant in a down market?
Contrary to what you might expect, Class A, high-end commercial buildings and top-tier, luxury residential real estate typically do not do well in a down market. While both of these types of properties can be acquired using tax lien and tax deed investing techniques, they are not predominantly the properties that smart investors buy as insulation against a downturn.
Instead, look for properties that will attract tenants and residents when budgets get tight. Class A properties are the first to experience rising vacancies when things get rocky economically. That is when you want a large portfolio of solid, attractive, B- and C-Class properties ready to welcome downsizing residents home.
Preparation vs. Panic
The important thing for real estate investors at present is to get prepared. This means you need to be planning your strategies, solidifying your access to capital, and evaluating multiple exit plans for investments that will not serve you during an economic downturn.
Now is not the time for panic. Now is the time for preparation. Your portfolio and your legacy will show the fruits of this for a lifetime.