A recession creates a lot of fear and uncertainty from consumers and investors alike. However, there are good reasons why a recession shouldn’t scare you if you have rental properties or are thinking about acquiring rental properties. During a recession, the housing market, not the rental industry, tends to get hit the most. This can be seen through a historical look at recessions.
In 2008 and 2009, subprime mortgage lending left plenty of people in the mortgage and housing industry in financial distress. Many homeowners were forced to sell their properties and those who couldn’t afford to buy ultimately had to rent. This flooded the rental market with plenty of prospective renters. Rental properties are essential to life. When you take care of your rental property, you’ll always have a steady flow of quality tenants. Recession? You’ve got renters. Booming economy? You’ve got renters renting for more money. Either way, it’s a win-win for everyone.
But if we step away from our fears for one moment, we realize there are ways for an investment property to endure a recession and opportunities to begin investing and create a recession-proof investment property. If you own rental properties, follow these four key points and you will be riding this recession into the next market boom.
(1) The Right Tenants and Right Strategy
It’s more important than ever to find the right tenants during a recession. Consider tenants who will still need a place to stay regardless of the economic conditions. Hence, invest in rental properties close to local hospitals, universities and major employers. These groups of tenants will be looking for a place to live, despite what's going on in the economy. This strategy helps enhance long-term financial success.
What if the rental property does not cash flow as well? Consider buying a single-family home and renting out individual rooms to increase the monthly income. A common strategy for investment properties close to a university is to rent out to students or traveling professionals (i.e. nurses/doctors). For example, a 3 bedroom can run for $1500/a month if you rent each room for $500 while renting for a family will only yield $1000 in rent. This shared rent system makes it cost effective for students on budgets and increases the monthly income for investors, serving two purposes. In addition, since the average student is away at college for 2 to 4 years, this makes extended lease arrangements possible, thus reducing turnover and vacancy expenses.
Another option is to invest in small multi-family residences. These types of residences have the potential to provide better cash flow because there are many more units purchased for a slightly lower price per unit. Think of this as bulk buying real estate. Additionally, if one unit becomes vacant, the rent from the other unit will help cover your operating costs.
"A common strategy for investment properties close to a university is to rent out to students or traveling professionals (i.e. nurses/doctors)... This shared rent system makes it cost effective for students on budgets and increases the monthly income for investors, serving two purposes. In addition, since the average student is away at college for 2 to 4 years, this makes extended lease arrangements possible, thus reducing turnover and vacancy expenses"
(2) Offer longer leases and avoid ending leases during slow season
The recession can sometimes impair funding, as well as cause a drop in income for those in the workforce. If an investor can offer a longer lease and possibly lower rental rates, they can secure more stable income and ride-out the recession. Investors should test different rental rates, as long as they can still sustain positive cash-flow. Positive cash-flow is the minimal goal during a recession. Personally, I prefer to have the property rented quickly if it requires a lower rent. This is better than waiting for that extra $25 or $50 month, thus losing out of 1 month of vacancy. In a $1000/month unit, that one month of vacancy may take 10 months to recoup.
In addition, avoid leases that end during the winter months or in the middle of a school year if you’re renting near universities as these times are difficult to fill vacancies. Structure your leases to end in the springtime or extend your leases to 16 months to avoid vacancies in the winter time. Most tenants, who do plan to stay for many years, won’t care. If they do, move on to the next qualified tenant who will plan to stay at your property longer.
(3) Buy cash flow properties
Properties with positive cash flow are the best to own in a real estate market downturn. This is because they bring in money regardless of the changes in house value. Owning a rental property with negative cash flow during a real estate downturn can lead to great financial stress, especially if you have to resort to lowering rent. In some markets, particularly California, a rental property during a downturn may not yield positive cash flow, especially with mortgage, insurance and high property taxes. One vacancy, a roof leak or even a change in appliances will cause you to be cash flow negative that month, and possibly wipe out your entire annual return. Aim for properties that will provide at least $200/month in cash flow after all expenses and reserves have been set aside.
A good rule of thumb that is simple to remember is the 1% rule. If your investment property is $100,000, aim to set rent at or above $1000/month.
"Properties with positive cash flow are the best to own in a real estate market downturn. This is because they bring in money regardless of the changes in house value. Owning a rental property with negative cash flow during a real estate downturn can lead to great financial stress, especially if you have to resort to lowering rent...A good rule of thumb that is simple to remember is the 1% rule. If your investment property is $100,000, aim to set rent at or above $1000/month"
(4) Have a solid cash reserve
For most people, a recession is a difficult time. People tend to lose their jobs, businesses and their homes. However, with the right preparation, you can thrive in a real estate downturn as a real estate investor. In a down market, there is usually an increase of properties available at discounted prices, due to an influx of foreclosures. Property sellers are usually in financial distress and are looking to sell quickly. This is the opportune time for savvy investors to score an investment property at well below market price.
Thus, prepare to have sufficient cash reserves during a downturn in order to gain acquisitions. If you are able to access cash easily, you will be able to beat out the fellow investor who has to depend on lending. With greater liquidity, you increase your negotiating power and will be able to procure more real estate.
The great thing about real estate is its continuous demand. People always require a place to live. What’s even more appealing about buy-and-holds is a stable monthly rent check, as there will always be renters. Therefore, while other investments during a recession might be more risky, a rental property will still generate steady income. In sum, investing during a recession is not risk free but if you follow these simple tips, you can prepare yourself to minimize risk as much as you can. Keep in mind, investing always requires thorough research, but even more so during a recession.