Despite the Federal Bureau of Labor and Statistics reporting the lowest unemployment rate—of 3.5%—in nearly 50 years in September, many economists and real estate professionals still worry about the impact of an economic recession on real estate and the health of the economy.
Recently, we discussed the effect of the job market on real estate, concluding that they have a correlative relationship: When people are gainfully employed, they’re more likely to invest.
According to a study by Zillow Economic Research, more than half of a panel of 100 real estate and economics experts say they expect the next recession to begin in 2020, with another third predicting it will begin in 2021. And although new construction homes hit a 12-year record high this summer, the panel expects home-buying demand to decrease next year.
Here, we’ll discuss the top economic factors affecting real estate today, the impact of an economic slowdown on real estate, and how investors can prepare for the possibility of a forthcoming recession.
Real Estate During the Last Recession
In order to understand the implications of economic recession on real estate investors and prepare for the recession effect on the real estate market, let’s take a look at what happened during our last US recession.
When was the last recession?
The worst—and longest—US recession since the Great Depression lasted from December 2007 until June 2009. During the recession, approximately 8.7 million jobs were lost.
What happened to real estate during the last recession?
Prior to the Great Recession (what economists deemed the last economic downturn), the US economy was on the upswing for years–GDP was positive, job growth was on the rise, etc. The housing market was also experiencing positive growth from the mid-’90s to mid-2000s; the average national price of a house was $314,000. In 2007, the housing market crashed.
Redfin recently studied which homes are most likely to maintain value during a recession–they analyzed over 100,000 properties before and after the Great Recession.
Here’s what they found:
- Single-family homes held their value better than townhomes or condos
- Older properties (built before 1940) held their value better than townhomes or condos
- Homes in more spread-out neighborhoods (i.e. fewer than 61 homes per square mile) held their value better than more dense neighborhoods
For real estate investors preparing for an economic slowdown, consider holding onto the investments above that fared better during the last recession—and perhaps selling properties that didn’t hold their value now in order to gain more cash flow.
What can real estate investors learn from the last recession?
During a recession, homeowners are more cautious and less likely to sell their homes or purchase new homes, which ushers in a buyer’s market as home prices fall.
- Sellers: During a recession, many sellers won’t be able to refinance or sell because they don’t have enough equity. They may have to face foreclosure or short sales.
- Fix n’ Flippers: Even before the recession, vacancies and days on the market are rising and their profit margins are decreasing. During a recession, there won’t be many flippers.
- Wholesalers: During a recession, wholesalers’ profit margins tighten, even though there are more distressed sellers, the lack of buyers causes many wholesalers to leave the marketplace.
Many estate investors will hold onto their money (and investments) during a recession because the cost-benefit of flipping, selling, or being a wholesaler isn’t profitable. Because there is less competition in the market, investors who have more liquidity could benefit from buying real estate at low prices in the down market.
What is the best option for real estate investors?
With many investors bowing out during a recession because of low housing supply and/or fears of a loss of cash flow (from losing employment, losing money on stock investments, etc.), there is still a good option for real estate investors: Become a cash investor.
Cash investors will fare better during an economic downturn because they can buy directly from the sellers, most of whom are willing to sell quickly because they need the money (i.e. due to job loss). To gain more capital to become cash investor, consider selling some of your properties to get more cash now in preparation for a recession.
To better prepare for a recession, real estate investors should first have an understanding of the real estate cycle, which goes through four phases, some longer than others, and then back around again.
Recovery: Demand < Supply
What Is It? The recovery phase occurs after an economic slowdown, like the Great Recession, for example. It’s marked by a low demand for homes, but as time goes on, demand slowly rises. No new construction initially, and rental rate growth is flat, or slowly rising.
Investor Opportunity: It can be difficult to time it right, but this is the best time to invest in properties, because the economy is strengthening, demand for homes is increasing, and costs are still low.
Expansion: Demand = Supply
What Is It? As time goes on, the economy continues to gain momentum and people’s outlook becomes more positive (as GDP growth is back to normal levels and job growth is positive). Vacancy rates lower, rent is on the rise. New construction ramps up to fill the higher demand for homes. At the high point of the phase, supply and demand even out.
Investor Opportunity: As rental rate growth increases, this is a good time to jump into development–either new constructions or renovating properties. The current demand for housing and space is at a high.
Hyper-Supply: Demand < Supply
What Is It? At this point in the cycle, demand begins to dip as the market for homes is in oversupply. The lower demand can be a result of excess supply or a pullback due to an economic shift. Vacancies are on the rise and rent growth rates may be positive, but at declining levels.
Investor Opportunity: While some real estate investors may decide to sell some assets to take over equity you may have earned, it’s also an ideal time to invest in fully stabilized assets that can offer long-term cash flow. Examples may be office space or home rentals with long lease terms.
Recession: Demand < Supply
What Is It? Here, the supply of homes outweighs demand, producing a higher vacancy rate. Rent growth can be negative. Economic factors affecting the housing market include job growth growth, which is declining during the recession (remember: during the last recession, almost 8.7 million people lost their jobs). As people lose their jobs and can’t afford to pay rent, the vacancy rate spirals lower. Some property managers choose to offer rent reductions to keep tenants.
Investor Opportunity: If you have enough capital, it’s an ideal time for buying real estate during a recession, because you can purchase properties at extreme discounts with way less competition (i.e. foreclosures or short sales). Investors will most likely be holding on to the properties until the Recovery phase steps back in and the demand for housing increases.
Preparing for an Economic Slowdown
As a real estate investor, it’s more important than ever to get ready for a looming recession. Do what you can to gain more liquidity or invest in long-term lease properties to sustain your portfolio through the recession and recovery phases. Need assistance with buying or selling your property. INVESTimate® – A Mynd Investment Platform is here to help.