Over the past decade, the real estate market has appreciated significantly. Especially in the last five years, it’s soared to unparalleled heights.
For investors who have been plugged in the entire way, the gains have been massive. But if history tells us anything, it’s that markets are cyclical.
The American economy won’t enjoy unbridled growth indefinitely. At some point, a recession will happen, and savvy real estate investors will be prepared. Will you?
Is a Market Crash Coming?
Recessions can emerge swiftly, but they don’t materialize out of thin air. When we look back and study past recessions, the warning signs are apparent. Three of the biggest indicators are:
- Quickly escalating real estate prices. Appreciating real estate values are good, but hefty increases over a very short period of time can create a bubble. If there’s one thing we know about bubbles, it’s that they eventually burst. When the supply of properties outstrips demand, and listings sit for longer periods of time and then sell below asking price, you have the ingredients for an impending collapse. (At least a market correction is on the way.)
- Slowing economy. When the larger economy begins to slow down or show signs of instability, you’ll see a trickle-down effect in real estate. Signs of instability include significant fluctuations in the stock market, rising unemployment, and a lack of borrowing among consumers.
- Significant policy changes. Any time significant changes in tax or finance policy occur, consequences will surface further down the line. Sometimes the effects are positive, but other times they’re not.
Some observers perceive these three factors in today’s economy. Others argue we’re still firmly in a bull market.
Regardless of your personal opinion, recession will undoubtedly show up someday. Whether it happens in one month or a decade, you should be ready for it.
Five Ways You Can Prepare for a Downturn
If you believe a recession is coming down the turnpike, then get to work. With a few decisive steps, you can insulate your portfolio and ensure minimal losses. Here are five key suggestions.
1. Slow Down on Fix and Flips
Just before the start of a recession isn’t the ideal time to purchase a bunch of fix-and-flips. You’ll purchase a property at the market’s peak, spend money fixing it up, and then discover it’s worth less than when you purchased it.
The better time to buy fix-and-flips is when the market bottoms out and you can get a good deal on a property that will recover and someday be worth far more. Instead of fix-and-flips, you should look at buy-and-holds.
Put your money into stable neighborhoods where it’s easy to attract renters. If you treat these properties as cash-flow engines, you won’t have to worry about the property value hit they may suffer.
Common sense tells you they’ll recover eventually. In the meantime, you may continue to collect rent checks.
2. Build Up Cash Reserves
Savvy real estate investors don’t regard recessions as catastrophes. They view them as opportunities to purchase real estate at discounted prices.
In order to for you to do that, though, you must have sufficient resources. In the months leading up to a recession, you should do everything you can to boost your cash reserves.
This is not the time to be over-leveraged. You’ll want access to funds, and the only way to put yourself in a position to purchase discounted real estate is to pile up cash. When the time comes, you’ll be able to cut a check and buy properties outright.
3. Load Up on B- and C-Class Rentals
The good thing about owning rental properties is that there is still an abundance of renters during a recession. In fact, it could be argued that more people look to rent at that time.
But in order to reach these folks, you need the right properties in your portfolio. “Real estate investors tend to evaluate neighborhoods like school grades,” investor David Greene writes.
“A-class properties are the best spots in town, B-class is where the upper middle class lives, C-class is your average neighborhoods with lots of renters, and D-class properties are problematic with high-crime and high-vacancy rates.”
As a general rule — but particularly during a recession — you want your portfolio to consist primarily of B- and C-class properties. These are economically diverse markets that will experience less impact from a downturn in the market. They’ll produce consistent cash flow.
4. Open Lines of Credit
Though you want to avoid becoming over-leveraged in the days leading to a recession, access to funds is an undeniably desirable thing. Once the recession hits, it’s likely that banks and lenders will clam up and be less interested in dishing out loans.
This being the case, you should open up a line of credit today. This at least will give you the option, should a deal come along and you’re unable to get access to traditional financing.
5. Offload Risky Investments
If you own any risky investments, get rid of them. You have to be prepared for a 15-to-20-percent drop in rents, occupancy rates, etc. If you have a property that can’t withstand that magnitude of a hit, now’s the time to dump it and pool your resources into something else.
Partnering With Green Residential
Over the last few years, the Houston real estate market has been one of the healthiest in the country. If you’re a real estate investor who specializes in residential rental properties, you can benefit from partnering with a professional property management service in order to offload some of the time-consuming responsibilities that fill your schedule and prevent you from focusing on the big picture.
At Green Residential, we’ve been in the Houston property management business for more than 30 years. Over that time, we’ve developed a dynamic approach to residential management that’s helped our clients remain profitable in both hot and cold markets.
To find out more about how we can help you accomplish your investment goals, please contact us today!