RECESSIONS, REAL ESTATE, AND WHEN TO BUY?
Back in mid-March, I thought, okay, here we go. Here comes the great recession 2.0. The world's economy had shut down, the stock market had tanked, and surely real estate was soon to follow. While many were predicting a V-shaped recovery, I tended to align with those who predicted a Nike swoosh, if you can picture that. A funny thing has happened in terms of real estate. Good old Supply vs. Demand seems to trump all. In terms of residential, I don't know about your neighborhood, but everything in my community is rapidly escalating in price. You still have the bidding wars, as people are lining up to pay for over-valued homes. Whether it is foreign investment, Airbnb investors snapping up homes for their portfolio, rich folks, or people over merely over extending themselves, there continues to be a shortage of supply for home buyers.
Concerning commercial Multifamily, it is not too different. The stimulus has put a band-aid over the shutdown wounds, which has kept occupancy at over 90%. Not only that, but cap rates are actually compressing, which means values are going up in this real estate sector as well. Damn, for someone looking for buying opportunities, a guy can't catch a break.
Is that all about to change?
As we are well aware, the stimulus has all but dried up, and as of writing this article, our spatting, two-party system can't produce an agreement on a second round. If the moratorium on evictions and forbearance expires along the $600 a week in added unemployment, can this economy stand on its own two feet? Short answer – no. Many expect the fed to keep pumping money into the economy, but how long will that last? This is all so strange and artificial to me. If a global pandemic doesn’t bring down property values, what will? Based on the theory of 10-yr cycles, real estate was set to decline in 2018. Is this it? Are we on the precipice? How can we not be?
So, what happens to real estate in a recession? How much is the real estate market
affected? The question on your mind - when is the right time to invest in real estate?
Let us look at previous recessions, which will prompt you to identify
where the market currently is in its cycle.
What defines a Recession?
When the economy shrinks for at least 6 months or two quarters of the year, the negative
growth is called a recession. The GDP (Gross Domestic Product) represents the total value of
goods and services sold within a country. When GDP returns to pre-recession levels, that marks the end of the recession. Red flags that a recession is happening or is very close are spiked unemployment rates and erratic stock market fluctuations (hello 15%?). Experts often look toward history and highlight traits of The Great Recession of 2008 or even the Great Depression in the early 1930s. By examining and understanding recessions and the sequence of events that occur before, during, and after a recession, you can purposely create life-changing wealth during the recovery period.
Where are we now, what should we expect, and when should we
Based on previous recessions, here's what could happen to real estate during the next recession and recovery cycle. Track your current experience and research of the US economy
compared to the below stages, and you'll be prepared when it's the right time to invest.
Stage 1 - Unemployment Rates Increase
In the earliest stages of a recession, as I mentioned previously, unemployment rises. This is one
of the big waving red flags that trouble is on the horizon. Businesses begin to feel the effects of
fewer goods and services being exchanged (remember GDP?) and may close their doors or
choose to furlough or lay off employees. This is happening, and should really begin to ramp up I am afraid. Look at the airline industry alone.
During the Great Recession of 2008, 2.6 million people were unemployed, and during 2020, the
US hit an astounding unemployment number of 30 million, a historical record.
Stage 2 - Government Stimulus
As we've seen in recent history (2008 and 2020), the government may step in with a stimulus
to boost the economy with cash. Sometimes programs are offered to keep
businesses afloat, sometimes eligible households are sent currency, and sometimes all of the
Stimulus checks are a temporary band-aid that gets cash into the hands of Americans to
encourage spending. This is why, for the first couple of months of a recession, rents are still
paid. But what happens when people are still unemployed, and they've spent their stimulus
Stage 3 - Loan Defaults
The longer businesses continue to close, and consumer spending decreases, the more likely we
will see loan defaults. As tenants are unable to pay rent, real estate owners deplete their own
reserves, resulting in a wave of defaults for residential and commercial loans. As defaults occur, banks start to take over the properties, which brings us to the next step.
Stage 4 - Bank REO
When loan defaults occur, banks foreclose on those properties. Then, a wave of bank REO (real
estate owned) features appear on the market. Since banks aren’t in the business of property management, they are anxious to sell these properties quickly at a discount. At this point, real estate investors should be ready with their checkbooks.
Stage 5 - BUY!
In examining the real estate pricing cycle of the recent past, we saw peak market prices in 2019. So, when will bank REO properties begin to hit the market? This depends on several factors, including the speed at which the real estate market reacts, which is slow. Examine the historical trends - notice the “bottom” of the recession versus when REO properties become available. There could be years between these two events, which means patience is key. Many recall 2008 as the low, but that was just the trigger. Prices didn’t hit bottom until 2012.
Stage 6 – Inflation
A rise in inflation is the inevitable final stage of the recession cycle. Inflation is the result of
additional money being flooded into the economy (remember stage 2?) and ultimately devalues
the dollar. This is precisely why the same dollar buys much less now than it did 10 years ago, making real estate such an excellent investment. Real estate investments with a fixed-rate loan lock-in payments for about 30 years, hedging a bet against inflation. As the value of your currency decreases, your mortgage payments remain the same, and your real estate values appreciate.
What You Should Do Now
By examining the history and economic fundamentals, we can better understand when each stage presented above will occur. On the tail-end of a recession, during the recovery, it's likely that you'll see deals hit the market, and you want to ensure you're ready. In the interim, the best thing to do is focus on education & mindset and readying your personal financial situation so that you can confidently invest when a deal hits. Will we have to wait four years until a deal comes along in Multifamily? What has stopped many deals in their tracks is lenders requiring massive amounts in reserves. Bridge debt, which is the equivalent of 3-yr arm adjustable in residential, has all but dried up, foiling value-add business plans around the country. These shorter-term loans don't impose pricy loan pre-payment penalties of agency long term fixed debt. Value-add plans depend on these short-term loans. You can upgrade the building, refinance out of the existing mortgage (without penalty) for a higher value, and return a significant portion of investor capital, only after 18 months to three years. Now, if lending becomes liquid again, deals may start to present themselves overnight, so be ready in the long and short-term. Make sure that you are not wowed by the returns only, though. Make for darn sure that the deal is conservatively underwritten. We help you with the due-diligence.