How Risky are Real Estate Investments During a Recession?

Sep 19, 2022

8

min read

I

s the recession a friend or foe for real estate investments?

Well, it depends. It is true that a recession drops the price of homes and eats all homeowner profit. But, to potential homebuyers, it's bliss since homes are more affordable. Recession investments are like a game: one's loss is another's gain. Nevertheless, the recession is the villain for most people, especially homeowners. Thanks to the traumatic 2008 recession, which left many homeowners underwater, just the word recession scares people.

But, it's essential to know that every recession is different and has its own historical context. The subprime mortgage crisis sparked the 2008 recession and, thus, had a significant impact on the real estate market. It was not the recession that caused the crash of the real estate market, but it was the crash that led to the recession.

So, should you invest in real estate during a recession? How risky is it to invest in real estate during the recession? Make sure you read till the end to find out the answers.

Character looking at house in recession — Source: Story set

Should You Invest in Real Estate During a Recession?

Most experts believe that a recession is the best time to invest, and real estate is considered the most stable investment during an economic downturn. Let's be honest; no matter what happens to the economy, people need homes, which keeps the demand for houses in every cycle of the market economy.

It would be best if you did not dive into real estate investments as there is high market uncertainty. Investing in real estate during the recession has pros and cons, and you should weigh both factors while deciding.

Here's why you should invest in real estate during the recession:

Lower Prices

House prices are low during the recession, making them more affordable. Similarly, many foreclosed homes sell at a low cost, which is a good deal for potential home buyers.

Low Mortgage Rates

During the recession, the interest rates are low to stimulate the economy. Thus, mortgage rates tend to fall, making it affordable for home buyers.

Calculating Budget in a Recession — Source : Vectorjuice (Freepik)

Low Competition

Most people struggle financially during the recession, putting off big purchases such as home purchases. Thus, there will be less demand for houses during the recession. As a buyer, you have the bargaining power for further discounts.

Housing Need

No matter the cycle of the economy, people need a roof over their heads. It's a basic need, and housing is the first priority for many people during a recession. Most people tend to rent during the recession as it gives them the flexibility to move. In a recession, people move a lot in search of a job due to a lack of employment. Thus, the demand for rental properties tends to be high.

Low Correlation Between Real Estate and Stock Market

During a recession, the stock market plummets as it directly correlates with the market economy. But, the real estate market is different. It has a low correlation with the stock market and the market economy. Thus, a recession does not have a significant impact on real estate. Most experts regard real estate as a recession-resistant and stable investment during a downturn.

Here's why you should not invest in real estate during the recession:

Job Uncertainty

It's the worst-case scenario when you have just bought a new home but lost your job. There is high uncertainty in the market during the recession. Thus, a big ticket purchase should be kept on hold. You must have enough resources to withstand the storm because you don't know how long and how hard the storm will hit you.

Character with Money Issues — Source : pch.vector (Freepik)

Strict Lending Criteria

Since property values fall during a recession, the bank is strict while lending you a mortgage. They only lend to people with good income, credit scores, history, and maximum down payments.

Title Issues

Things can get tricky if the seller of the house has foreclosure or defaulted on the mortgage loans. Thus, ensure the title company thoroughly checks the title to ensure no title issues impact the house purchase.

Should You Consider Residential or Commercial Real Estate Investment?

Before we dive in, let's briefly know what residential or commercial real estate investment is. Residential real estate is primarily built for people to live in, whereas commercial real estate investments are made for business purposes such as offices, restaurants, and cafes. Overall, residential real estate investment is better than commercial real estate investment during a recession. Here are the reasons :

Hard Hit Business

Businesses are hit hard by the recession. Due to decreased consumer spending, companies faced a decline in sales and profit during the recession. Startups and small businesses are the worst hit as it may even lead to shutdown and bankruptcy. Similarly, the recession is not the best time to open a new business, so this has a massive impact on the commercial real estate market.

Low Demand for Commercial Real Estate Investment

The Covid-19 Pandemic has completely changed the landscape of the real estate market. Previously, people preferred to move to city areas for good job opportunities, schooling, and a better life. This increased the need for both residential and commercial real estate markets. The demand for commercial real estate, such as coffee shops, restaurants, and shopping malls, was high. But, then, post-pandemic, we saw a total reversal. People are leaving and moving back to their cities, decreasing the demand for commercial real estate.

Technological Shift

The pandemic has accelerated IT innovations, and the world is shifting toward the digital space. Online shopping, food delivery, work from home culture has been increasing significantly, reducing the demand for commercial real estate. The business is going through a technological transformation, and the pandemic has accelerated the pace of that transformation. Thus, the technological shift to digital space has reduced the demand for commercial space.

Fusion of Residential and Commercial Space

Due to the work-from-home culture introduced by the pandemic, people's homes have transitioned into residential and office spaces. Thus, people are looking to move into more extensive areas or upgrade their residential homes to have office space within their homes. Therefore, residential homes demand has been soaring.

Foreclosures

The ugly side of recession is that due to unemployment, high living costs, and interest rates, most people cannot pay off their mortgages, causing foreclosure. The home they used to live in is seized from them. Most end up homeless, but some look for rental properties to live in. Thus, due to this reason, the demand for residential rental properties is usually high.

Thus, the commercial real estate market is not dependable as it used to be. However, some commercial real estate investments, such as warehouses and self-storage companies, have high demand in the market. The eCommerce companies need warehouses to store their products and self-storage spaces to remain stable in the market as people have things they need to store elsewhere temporarily. If you want to invest in commercial property, warehouse and self-storage space is a good deal.

Best Real Estate Investments for a recession

Rental properties can be a good bet for real estate investment in a recession. Similarly, you can consider the following real estate investments that are best suited for the downturn:

Single-family homes
Tiny homes
Apartment
Condos
Farmland
Warehouse
Self-storage space
College housing
Senior housing
Real estate investment trusts (REITs)

What Are Some Real Estate Investment Strategies to Stay Recession-Proof?

Buy and Hold Strategy

In a recession, most house prices fall, making it an ideal time to buy and hold property. Most real estate people purchase homes to earn a particular profit margin and sell them quickly. It's not applicable during the recession when house prices are falling. Thus, you should hold on to your purchased property, rent it out and earn the monthly income. Even if the property price has fallen below the price you bought, there is no need to worry since you are not selling the property.

Focus on B and C-Class Housing

Due to the economic downturn, people's living standard is highly affected. Many people lose their jobs, business, and profit. With less income, they switch to comparatively cheaper houses and will move down in the housing class. People in A-class housing might not afford to live there and downsize to B or C-class housing; thus, the demand for C-class housing is still there, making it an ideal real estate investment during a recession.

Consider Warehouse and Self-Storage

In a recession, people downsize their houses but need space to store their stuff. Thus, people look for self-storage to keep their belongings. Self-storage investments were the only commercial real estate investment to produce positive returns during the Great Recession of 2008. Similarly, businesses tend to stock their products during the recession. Thus, demand for the warehouse will be high.

Storage Facility — Source : Macrovector (Freepik)

Consider Medical Centers

People need healthcare regardless of the economic cycle. Thus, the demand for medical centers is persistent. Furthermore, many US consumers have health insurance making healthcare more attainable and making the investment in medical centers safe, low-risk, and high-yielding real estate investments. Thus, medical centers are recession-proof. Therefore, you don't need to worry about the business going out of business.

Consider College Housing

The secret is that during a recession, college enrollment increases. This is because most people won't find steady jobs and think this is a great time to return to school and earn degrees and skills. Thus, there will be high demand for housing rent in the college areas.

Rental Strategy

During the recession, it's better to negotiate a long-term lease agreement, a minimum of at least six months, to ensure that you are getting the rent out of your investment property. Since people are financially struggling, you can expect a drop in rental values. But that should not matter. You just have to make sure you can cashflow the property the whole time. Occupancies tend to drop as people move out to affordable places during the recession. Thus, don't make the mistake of increasing rents during the recession. You can temporarily cut off the cost of the tenants to retain them for the long term. It's better to accept lower-rate rentals than to keep vacant property with negative cash flow.

Receiving Keys for a Rental Property — Source : upklyak (Freepik)

Low Leverage

Leverage is the double-edged sword of real estate finance. It's one of the reasons why many homeowners went bankrupt during the 2008 recession. People started to leverage their property value when the property prices were appreciating. They began to refinance to benefit from the increasing property price. But, when the price dropped, their equity eroded, and they had to pay back more than they owned. Thus, they filed for bankruptcy. Learning from history, you should not highly leverage during the recession. Get a maximum of 70-80 loans so that even though the property value drops, you still have equity left and won't be underwater.

Consider Location

Location is significant when choosing real estate investments. When looking for a place, choose the highly demanded area with high rental values. For instance, the area around the best colleges will always have a high demand for rental properties due to the continuous flow of students.

Flipping Properties Strategies

The experts do not suggest flipping home strategies. But, if you want to flip the houses during the recession, you should be very careful and employ the right tactics as it is risky. In flipping, you purchase a home at a lower price, renovate it and then sell it at a higher price. But, in a recession, house prices are falling, and the strategy does not work. But, then house prices do not fall dramatically. So, you can still profit if your turnaround time is short, so you don't get hit by the market price fall. Likewise, focus on the median price. The properties much higher than the median price tend to slow down first. The properties at the median price tend to be stable. Also, flip in the places with high real estate demand.

Real Estate Investment Trusts (REITs)

If you want to invest in real estate but are skeptical about the risk, then you should invest in Real Estate Investment Trusts. REITs are companies that purchase income-generating real estate, such as warehouses, offices, hospitals, etc. You can buy these companies' stock and be the property owner. The company has the experience and skilled real estate professionals who know how to weather the recession so that you don't have to. However, you must do plenty of homework before investing in REITs. It's advisable to invest in healthcare, self-storage, and residential REITs. Investing in different REITS will add diversification to your portfolio, which is essential during a recession.

Top Lender That Funds Investment Homes

New American Funding

New American Funding is a California-based direct mortgage lender founded in 2003. It offers affordable home loan options, including investment property loans. The application can be made online, in person, or by phone. The minimum credit score required is 620, and fixed and adjustable rate options are available.

Features

Top-notch customer service
Multiple options for a mortgage, including low and no down payment
Specialize loans to minority borrowers
Quick and convenient loan service
Inclusion initiatives like bilingual customer service
High DTI of more than 45%
Easy refinancing

Loan Depot

Loan Depot is a California-based mortgage company founded in 2009. It offers consistent and secure low-rate investment property loans. Furthermore, it has a fully digitalized mortgage process making it convenient for the borrowers. Online closings are 75% faster than the industry average, and average closings take eight days. The minimum credit score required is 620 for a conventional mortgage.

Features

Nationwide presence
Exceptional customer service
Competitive loan products
Tech-enabled lending platform
Fast approvals

Visio Lending

Visio lending is Austin, Texas-based lending company founded in 2012. It offers various investment property loans, including rental, commercial, vacation rentals, etc. On top of that, it is the nation's leader in rental loans and offers affordable loans at competitive rates.

Features

Streamlined mortgage process
Blend of innovative technology
Experienced mortgage professionals
Competitive rates
Fast approvals.

Loan Guys

Loan Guys are California-based mortgage lenders. It offers a tailored loan program for the investment property loan, called Long term rental loan, that allows the borrower to get the loan based on the value of the property and estimated rental income. This means that income verification is optional. Also, it requires a 20% down payment and a minimum credit score of 640. The property value should be more than 100k, and the closing takes around 14-21 days.

Features

20% down payment
Income verification is optional
Competitive rates
Purchase, refinance, and cash-out options are available
Hybrid ARM option available, 5/1, 7/1, 10/1. Amortized over 30 years.
No former experience and tax returns required
Fast closing time

Local Government Federal Credit Union (LGFCU)

Local Government Federal Credit Union (LGFCU) is a North Carolina-based credit union. It offers rental property loans for people looking for investment loans. It also provides cash-out refinance, purchase, and refinancing options with a maximum loan term of 15 years. However, the rental property must be located in North Carolina, South Carolina, Virginia, Georgia, or Tennessee, and the members must reside in North Carolina or bordering states to be eligible.

Features

15 years loan term
80% LTV for general loans and 65% LTV for a cash-out refinance.
If the financing is less than $500 K, 90% LTV is available.
Exceptional customer service
Fast closing time
Competitive rates

North American Savings Bank (NASB)

North American Savings Bank (NASB) is a full-service bank based in Kansas City. It was established in 1920 and is FDIC insured bank. NASB has tailored an investment property loan that allows qualified borrowers to purchase second homes, rental properties, and commercial real estate. It has online banking services and a mobile app that eases its mortgage application process.

Features

Minimum 20% down payment
An employment history of a minimum of two years is required
A minimum credit score of 620
Debt to income ratio (DTI) of 36% or less
Competitive rates
Personalized customer service

Conclusion

A recession is an economic cycle in which the economy contracts. Technically, recessions are not the best time to invest since there is market uncertainty. There is a significant drop in the value of assets, including stock prices and real estate. But, as the economy is a cycle. The contraction of today's economy means the expansion of tomorrow's economy.

So, if you can hold the property and wait till the value appreciates, you can invest in the recession. But, the market is unpredictable, and we cannot say how long the recession will stay and how hard it will hit. Thus, investing in real estate during a recession is perilous, but with the right strategy, you can offset the high risk and enjoy a high return.