Many wealthy people have at least some assets allocated to real estate. Whether through single-family homes, multi-door units, or syndications, real estate is an asset class to which most with some wealth want exposure.
But in challenging economic conditions, making prudent investment decisions with an eye toward consistent profits can be difficult. Now that we’re battling increasing inflation, navigating a slowing economy as the most recent data suggests, and still trying to knock down Covid, your once-clear crystal ball on real estate investment can become cloudy fairly easily.
How does one profit with real estate in the midst of economic volatility?
This guest post was submitted by Ken Boyd with CPA Accounting Institute for Success. We have no financial relationship.
The economy has been through its fair share of ups and downs during the pandemic, but recent inflation has caused most people a significant amount of financial stress. When mortgage rates reached record lows in 2020, several investors scooped up any property they could find with the hopes that the economy would rebound, and rebound it did.
Now, getting into the real estate investment scene is harder than ever, especially in big cities. However, your investment won’t just turn a profit once inflation hits. Real estate investors have continued to make recession-proof portfolios, even when real estate becomes expensive.
Managing Risk Before a Real Estate Purchase
Real estate can often be seen as a risky investment for investing newbies, especially during an economic downturn. Any investment comes with some degree of risk, but real estate in itself isn’t as dangerous to spend on because it’s protected by necessity: everyone needs a home.
That doesn’t mean that every real estate investment strategy is foolproof. Simply buying a property won’t guarantee success in the market, so you need to assess several risk factors:
- Market Risk: Interest rates, inflation, economy, and other market trends
- Credit Risk: Length and stability of cash flow (if the investor is renting the property)
- Specific Risks: Risks based on property purpose (corporate vs. residential)
- Inherent Risks: Neighborhood, location, access to public transit, pollution, etc.
- Leverage Risks: The more debt tied to the investment, the bigger the risk
Any successful investor will look at their risks before purchasing an investment because it can offer them greater protection against a recession.
You’ll need to strike a reasonable balance between risk and reward to consistently profit from real estate, regardless of the economy.
Here are some basic rules all real estate investors follow:
Finance With a Fixed-Rate Mortgage
Adjustable mortgages, short-term loans, and balloon payments are way too risky. Once inflation hits, you could be paying twice what you used to pay per month, which may affect your long-term investment goals. A fully amortized fixed-rate mortgage is the best way to mitigate cash flow problems.
Research Your Properties Extensively
Real estate is a long-term, expensive investment, so rushing to buy up a property is always a bad idea. Always be picky about the properties you invest in and don’t accept marginal return deals. Consulting an investment real estate agent can set you and your future property up for success.
Concentrate on Consistent Cash Flow
Your first few properties should be rented out to tenants because you’re guaranteed some sort of consistent cash flow. Even if you lower the rent prices, you’ll still have something coming in, which gives you more room for error if something goes wrong.
Some cash flow is better than an empty house.
Prioritize Lowering Your Leverage Risks
A high-cost property is nice when the economy is on the up and up, but you may not be able to fill vacancies before inflation returns. Decreasing your leverage increases your margin of safety and cash flow, so aim for a leverage position of 50-70%.
Avoid borrowing more than 75% of your investment. Once you know how to set yourself up for success, you can start protecting yourself when mortgage rates plummet. Once they do, you’ll be able to purchase even more real estate. By then, you should have a recession-proof investment portfolio you can always rely on.
Although market changes are normal, no investor likes uncertainty. As a positive, you can prepare yourself for an inevitable down-market cycle by getting ahead of the collapse.
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5 Things Investors Can Do to Prepare for Market Changes
When a market crash hits, there are still many things you can do to minimize the impact on your investments or potentially profit by seizing opportunities other investors aren’t prepared for.
Watch Your Expenses Carefully
There are two types of real estate expenses: fixed and variable. Paying your insurance, mortgage, and routine repairs are considered fixed because they aren’t sensitive to market fluctuations. However, your variable expenses are susceptible to economic shifts. Before a recession, consider your variable costs, like marketing and upgrades. During a recession, either cut your spending in these areas or remove them from your balance sheet. Either way, you have to carefully measure your ROI to ensure your head stays above water. Keep an eye on your operating expense ratio as it compares your recurring expenses to the income your property generates. Your profit/loss statements will guide you through hard times.
Run Different “Stress Test” Scenarios
It’s important to note that your tenants suffer the most from a recession, meaning they may not be able to make rent. All at once, you may have significantly less cash flow. If you can’t supplement missed rent from your own paycheck, you could default and lose your property.
For this reason, it’s essential to perform a stress test to prepare and adjust your real estate portfolio for market gyrations. Run scenarios to see what properties are your biggest risks:
- Double, triple, or quadruple tenant turnover or vacancy rates.
- Assume your tenants will pay 30-60 days late.
- Reduce property value/rent by 10-30% based on market trends.
After running these simulations, you should know what properties are likely to stay in the green regardless of the economy. If a property’s risk is too high, consider selling it as soon as possible.
Invest in a Completely Digital Business
During the pandemic, real estate businesses had to invest in technology to uphold social distancing protocol. You’ll need the same kind of tech to account for a recession as your tenants are less likely to take time off of work to view apartments and fill out paperwork in person.
Along with attracting more attention to your vacancies, you’ll also save time and money on the process if your tours are pre-made and recorded because only serious renters will contact you.
You don’t have to be tech-savvy to go completely digital. For example, you can use video conferencing software, like Zoom, to host virtual tours or use Google Forms to create rental applications. Then, use eSignature apps like DocuSign to execute legally binding leases.
Get to Know and Understand Your Tenants
Your tenants are human beings, but it’s easy to become impersonal and out of touch with your tenants when the market is good. Real estate is 100% a people business, so you need to keep your tenants happy if you want them to continue to rent from you, even during a recession.
Since an economic downturn is tough on everyone, make sure you:
- Maintain the property at all times and make prompt repairs
- Allow reasonable charges on your lease based on market trends
- Avoid increasing rent in the short term or increasing the rent significantly
- Speak to your tenants regularly to increase tenant satisfaction
- Screen new tenants carefully to avoid mishaps in the future
Treating your tenants with respect and empathy is the best way to avoid a potential vacancy. If at any point your tenants stop paying, approach them with kindness and understanding.
Focus on Marketing and Branding
Although marketing is a variable expense, there are still ways to market your business without spending a lot of money. Keep in mind that you have to prepare for a market collapse and its recovery. Marketing and effective branding can help you grow and stay competitive at all times.
Here are a few inexpensive ways to make your brand more visible:
- Create a meetup group for other local investors
- Connect with journalists and local news media
- Start a blog on your social media or website
- Make a weekly podcast intervening real estate agents and investors
- Film videos on YouTube about your apartments or business
- Livestream real estate events or investment classes
An effective marketing strategy can boost the number of visitors to your website, increase cash flow, capture market share from your competitors, and generate more profits faster.