Diversifying portfolio in recession preparation?

Question

I've been building my portfolio for a couple of years aiming at two things:

- good tenant profile (working history, credit score, security deposit)

- area reliability (easiness to rent, density of working options)

I also didn't want to leverage too much and not to bet exclusively on the appreciation factor, always planned to have enough cash flow so all the (large) expenses are covered by the portfolio itself without requiring additional inflows.

My ideal house was a ranch 3bdr, 2bth, about 1450-1750 sq ft in areas with a modern appreciation rate and I bought a few duplexes in an area with a higher appreciation although, much better ROI (when rented) while the tenants proved to be more troublesome as well.

I talk to other landlords who invest aiming at the appreciation factor mostly with their rental ROI way worse than mine. I'm offered houses in the areas where the ROI is extremely good but the appreciation is non existent.

Given the recently growing talks proclaiming coming recession (and in the long-term real estate the question is not if but when) how do you make your portfolio ready for it? What are the risks that you're trying to mitigate? Do you focus your portfolio on high ROI, appreciation, tenant strength, etc.? Do you focus on a single factor or spread it over?

If the task is to survive the recession (assuming you don't have to sell) and keep the rental income steady what questions one need to ask for herself and what factors to take into consideration?

many thanks for your input!

Roman Rytov · Answer

Lance, of course having all the houses paid reduces the risk  but I wouldn't call it an optimized situation. A moderate leverage (or an ability to cover for vacant units) significantly improves ROI.

My question was more about how to keep rentability high. Are the SFH more likely to stay occupied than condos or duplexes? Areas with higher appreciation rather than lower? When you expand your portfolio do you keep the same type of properties or trying to diversify? What parameters to take into account?

Lance Robinson · Answer

@Roman Rytov I think you are realizing the reality that everyone on BP seems to ignore.

Your position both with risk and cash flow would be much better if you didn't have the debt. Everybody preaches debt forever, but most of those people never fared a recession.

My advice would be to stock up a big emergency fund, use excess money to pay off properties, and sell underperforming assets if concerned.

Properties that are highly leveraged have a hard time making much cash flow. They are literally one big expense or eviction away from being negative for the year, sometimes big time.

Hope this helps to offer a different way to look at these problems.

Lance Robinson · Answer

@Roman Rytov

Specifically to this:

My question was more about how to keep rentability high. Are the SFH more likely to stay occupied than condos or duplexes? Single Family Homes should have higher rentability and longer term tenants if you buy within an A area. I always look at the median house price of the area and try to buy in that range. This is a nice balance between renters and home owners. If you buy a solid 3/2, then the result, in my experience, is high demand with family renters that tend to stay a while.

Areas with higher appreciation rather than lower? Appreciation is VERY market specific. I think the above metric is the best way to find the right balance between good rents and rentability and appreciation. You will have the first time home buyers driving the prices up while still having a good higher end rental pool.

When you expand your portfolio do you keep the same type of properties or trying to diversify? I used to diversify, I have owned everything from SFH up to a 22 unit Apartment building in many different markets (7+ markets) and I love my SFH the best. They have been the best returns with the lowest hassle. I used to diversify markets, but not anymore. As of today, I only own SFH's in 3 markets, but will consolidate to 1 within the next 2 years I imagine. I like the main market I'm in due to my feet on the street. I have an amazing PM. Your PM is VERY undervalued in the equation!

What parameters to take into account? See above.

Scott Meyers · Answer

Hey Roman!

If you don't mind me "short-cutting" on a Friday, I typically reply with brand new posts, but I copied & pasted something verbatim that I wrote about five months ago to answer pretty much the same question & scenario you're asking above...

Lots of posts and I certainly agree with most of them.  Fact: the economy is and always has had up's & down's of business cycles, typically every 8 - 10 years.

It doesn't take a genius to make money in a bull market.  However, when things change (and they will) you need to be ready to both defend yourself (that means your business, assets, etc.) and capitalize on the opportunity.  Disclaimer: I'm not calling myself a genius; I've learned a lot through the school of hard knocks.  Wasn't pleasant while going through it, but the wisdom & experience in hindsight is priceless.

At my Storage Mastermind just a couple of weeks ago we discussed this exact topic.  The nuggets of insight was basically this:

1) Go through your business & stress-test it all, as in what happens in mild, bad, & worst-case scenarios.

2) Be sure that you are not over-leveraged.  Most of the defaults in all categories came from being over-leveraged against the equity and if it decreases and/or disappears a lot of the fine print on these loans allows them to be called if X, Y, or Z happens.  A lot of folks gave keys back to the bank on a lot of property.

3) Sell anything that is a challenge now.

4) Cash flowing assets (properties, of course, since this is a Real Estate forum) will be king.  But see #1 & #2 above if you've borrowed money against it as this is not a blanket statement.

5) Align yourself with other folks and be ready to capitalize if things go bad.  Certainly don't wish ill will and bad tidings on folks but it is what it is.  Deal with it.  (pun intended)

Good luck to all of us!

Scott

Scott Krone · Answer

@Roman Rytov  I think your strategy is correct.  Personally we have liquidated all our apartments as we feel we are at the top of the market.  We are bullish on self storage as they tend to do better in recessions.  With regard to SF in a recession, having the proper leverage is important.  During the 2008-9 crash, SF homes in Phoenix were renting for less than apartments.  Who wouldn't want a whole house with a pool vs a 2 bed apartment.  The way to test your leverage is to "Stress Test it".  How much reduction in cost can you absorb and still cash flow.  Go back and look at what rents were during the 2008-9 Great Recession as a data point.  If you are cash positive with those rental rates, then you are being conservative.

Kenneth Garrett · Answer

@Roman Rytov

I try to base all decisions on cash flow and moderate leverage.  I do not count on appreciation even if the property is located in an appreciable area.  If it appreciates it is a bonus.  I try to keep leverage at 65% or less.

During the last crash everyone was effected in many markets.  I’m not a condo fan or any area purchase with association dues.  If the market turns bad those dues can increase to cover vacant/foreclosed properties.  You do not have much choice or control.

Just had this conversation with my business partner today.  Keeping a healthy 6-12 month of expenses banked for each property is an important factor.  A crash like the last one is very difficult to plan for.  Diversify your portfolio in types of buildings and locations are important as well.

Good Luck.

Diversifying portfolio in recession preparation?

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