A market downturn can be a scary time for investors. As people spend less and the economy slows down, many of your investments are likely to pay off less than stellar returns and you may encounter some losses. However, some investments can help you emerge even stronger on the other side of the recession. Real estate can be one of those assets.
Of 58% of economic experts as we expect a recession later this year, it is time to plan for resilience. Since stocks are likely to take a hit if the market falls, real estate may seem like a promising option. But is a market downturn a good time to invest in real estate? Here’s a closer look at when it might be the right choice and why.
Advantages of investing in real estate in a falling market
Investing in anything during a recession can seem intimidating, but real estate has several advantages. Here are some of the most important.
There is always a demand for housing
The greatest strength of real estate is that people will always need housing. While spending tends to fall in a recession, housing isn’t something you can cut out of your monthly budget. Consequently, rental income will not fall in the same way as equity prices.
Past housing bubbles prove that real estate is not completely immune to economic uncertainty, but is generally more resilient than other assets. Stocks rely heavily on the overall economy, Bitcoin prices down with the stock market in 2021 and interest rates will have a major impact on bonds. While some of these issues also affect real estate, they don’t change the fact that people still need houses at the end of the day.
Because housing is always in demand, you always have the opportunity to take advantage of it, even in a recession. That reliability can help offset losses elsewhere.
Real estate can create cash flow
Another reason you want to invest in real estate during a downturn is to generate cash flow. Many assets don’t pay out until you retire or sell them, but real estate allows you to collect rental income. This regular cash flow can give you the necessary liquidity in a falling market.
History shows that rents rarely fall in a recession – in many cases they go up. People are also less likely to make a major purchase such as buying a house in this area, so many residents will continue to rent. In the light of these trends, renting a home can provide you with a nice extra.
Liquidity is important during a market downturn, as you will likely have to adjust elsewhere. If you other investments falter or you have to pay more for some services, additional rental income provides a useful safety cushion.
Recessions can create opportunities
An economic downturn can also be the ideal environment for buying real estate in the grand scheme of things. If you’ve been wanting to get into real estate anyway, a recession can be a strategic time to do so, as it can improve your returns over time.
House prices fell an average of 5% on an annual basis in four of the five recessions since 1980. In some quarters, those declines have been as much as 43%. If the oncoming recession follows this historic pattern, you could buy a home relatively cheaply, making it easier to sell for a hefty profit when the market recovers.
Market research shows that the highest real estate returns tend to follow recession periods. That doesn’t mean a market decline guarantees high returns later, but it makes those gains much more likely with the right approach.
Disadvantages of investing in real estate in a falling market
The benefits of investing in real estate in a recession are impressive, but there are also some drawbacks to consider. Making the best decision requires careful consideration of both sides, so here are some potential downsides to consider.
Stricter lending practices
One of the biggest challenges when buying real estate in a recession is tighter credit requirements. While mortgage rates and home prices typically fall to attract more customers, lenders will often impose stricter restrictions on who qualifies for these loans.
Unemployment often rises in a recession and revenues fall, meaning lenders take on more risk by offering loans. As a result, many of them will raise their qualification standards to reduce their chances of lending to someone who can’t pay it off. These stricter requirements can make it more difficult to win a deal.
There may also be fewer properties on the market as some owners wait to sell until they can get more. The increased demands from lenders further limit some buyers’ options, so the real estate market can be challenging to enter.
Uncertain return timelines
It’s also important to remember that while bigger returns are more likely if you buy in a recession, they still carry some uncertainty. You’re not sure how long the recession will last or when the best time to sell will be, making it difficult to determine when you can get the highest returns.
How much money you can expect in rental income is also uncertain. The economic pressures of the recession may make tenants more likely to miss payments. High rents at the end of 2022 saw roughly 15% of US renters behind on their rent.
This problem also affects commercial real estate. Rent arrears small businesses reached an all-time high in 2022. If similar trends continue in the upcoming market downturn, it may take some time for your real estate investments to pay off.
When is it right to invest in real estate in a downturn?
Given these pros and cons, whether you should invest in real estate during a downturn will depend on your specific situation. It can be a profitable investment that will help you weather the falling market, but only if you can handle the challenges that come with it.
Before looking at the real estate market, consider your current financial position. Do you have a nest egg big enough to get you through tough times? Keep in mind that after buying a property you may also have to pay for some maintenance and repairs. The average recession lasts 17 monthsso expect to wait at least that long, if not longer, before you start seeing significant returns.
Likewise, you should assess how secure you are in your job. If you think you could lose your job in a recession, real estate may be too much of an investment to be worth it right now.
If you have a stable job with long-term prospects, significant cash reserves, and don’t mind taking risks, a recession could be the ideal time to invest in real estate. If not, it’s best to wait for another chance.
Best Practices for Investing in a Recession
Real estate investing in a recession requires careful planning if you want to get the most out of it. Here are some best practices to keep in mind when investing in these assets in a down market.
Choose residential over commercial real estate
It can be tempting to invest in commercial real estate when the economy is low, but residential properties are often safer. Although it may seem that a company is more resilient than a person, companies do not depend on buildings in the same way that people do.
About half of all Americans can now work from home at least one day a week and 35% can work remotely full time. That trend highlights the problem with commercial real estate in a recession. When businesses begin to lose money, they may shift to remote working and downsize their physical presence, leaving property owners with less or no rental income. In contrast, people need housing, so housing demand is more consistent.
Evaluate properties carefully
If you’re looking for properties to invest in, make sure your excitement about their potential doesn’t speed up the process. Inspect everything carefully to make sure it’s a good investment.
Some properties may need extensive renovations, delaying your return. You also have to consider the location. Recessions can mean job shortages, leading to lower-paying tenants, so look for an area with promising job prospects.
Compare multiple financing options
Likewise, you should check out a few ways to invest in real estate. Renting a home is a great way to generate income, but a real estate investment trust (REIT) may be more accessible. Consider your skills, experience and cash reserves, then weigh your options to find the best way forward.
Deciding between sole proprietorship and partnership is another choice you must make. A joint venture limits transactions on both sides but could make it easier to buy a more expensive property for a higher return.
Prioritize cash flow, but keep reserves
Next, consider how you can generate cash flow from your property. Renting is the simplest way, but you can also renovate and flip houses. Whichever you choose, you should approach any investment thinking of it in terms of potential income.
While generating cash flow involves some expenses, make sure you keep some reserves. Average buyers of existing homes spend more than $5,700 on renovations, so these investments may be significantly more than they appear at first glance. It takes time to make a profit on those costs, so make sure you can afford the wait.
Keep your portfolio diverse
Finally, remember that real estate should not be the only asset class in your portfolio. Real estate can be one of the best investments to weather a recession, but diversity is key to long-term resilience. Don’t sell all your other assets to put more money into real estate and keep an eye out for other investment opportunities.
Make the most of a market downturn with smart investing
Market downturns are impressive, but the right investment can help you build a better reputation on the other side. If you have the right resources, real estate can be one of your best options for weathering a recession.
Real estate investments are not a guaranteed success in a falling market, but they are more reliable than many other asset classes. As the threat of a recession looms, review your financial strength, consider your options, and consult this guide to make the most of the situation.
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