Are cash-flowing rental properties recession proof?

[Theo Hicks]

I need to stop doing this, but I had a discussion with a work colleague regarding investing. He has a few rental properties but does most of his investing in the US stock market. When I brought up the fact that I was in real estate and told him my strategy (BRRRR) he was up in arms. When I tried defending myself, he brought up the fact that I wasn't around for the 2008 recession where real estate investors (and investors in general) got hit pretty hard, and that if it were to happen again, I would be in trouble since I am only investing in real estate, for now (I am only 24...).

So I started thinking about how a cash-flowing real estate portfolio could be hurt by a recession. If my $100,000 property value is decreased to $70,000, as long as I still have tenants paying the rent, I am still making money. And since I bought at below the market value (let's say $85,000), I may have paid off enough of my mortgage to not even be upside down on my loan. Also, if a lot of people aren't on BP and bought above market value, aren't cashflowing, or are upside down on their mortgage, not only will I be able purchase their properties inexpensively, but they will still need to live somewhere, so the demand for rentals will go up resulting in rental rates going up resulting in increased cash-flow and more properties purchased! As long as I have a decent amount of cash saved up (since I won't be able to take out equity) and I have had some good success investing, I should have no issue buying properties outright or getting a loan.

In a nutshell, this was my response to my colleague and he was telling me that I didn't know what I was talking about and that I was wrong. 

So I write this post to get input to see if my logic is correct or if I am missing something? I am still very new to this so if what I said was ignorant or incorrect, I need to know lol Thanks in advance for the help!

[Jay Hinrichs]

@Robert Whitelaw  your absolutely correct it was location dependent in the major GFC we went through.

I had clients that bought 4 plexs in AZ that went 100% vacant and there simply were not enough renters most tenants were construction laborers construction stopped laborers moved.. they lost those units in droves.

Central CA  this happened  FLA  Vegas... anywhere that was really dependant on new construction jobs. 

[Robert Whitelaw]

@Jay Hinrichs Yeah, understanding the dynamics of your market is really the only way to "future proof" things as much as you can. Nothing is for sure, but I like to stack the odds in my favor as much as I can.

[Jay Hinrichs]

@Robert Whitelaw   generally speaking I agree with the buy hold will win the day.. but its just cannot be a blanket statement

there was  a very big apartment owner here in PDX that rolled up all his units  and cashed in 20 million in equity.. went to vegas in 05 on a massive 1031... bought 100 million in multi there.

vacancy rates as you know on fully leveraged multi  in excess of about 10 to 15% put huge strains on those and much more than that you have to feed them.

vacancies in 08 in vegas hit 10 to 40%  he LOST THEM ALL....

had he just held pat on his vanilla PDX he would be fine and our stuff here has sky rocketed  must like a little brother to silicon valley real estate..  PS I went to Cupertino High  LOL

[Robert Whitelaw]

@Jay Hinrichs Sorry to hear about your substandard high school experience ;-P

Lynbrook High School class of '84 here. 

[David Faulkner]

The quality/consistency/volatility of the cash flow matter as much (more IMO) than the quantity. If you have high cash flow on paper but highly unstable and irresponsible tenants in the ghetto somewhere, then your paper cash flow won't do you much good as you will not be able to realize it. If on the other hand, you buy in a nice neighborhood, that appeals to more stable tenants who can afford and choose to spend extra on rent to live there, then your cash flow while less on paper day 1 will be much more stable and you will have infinitely fewer headaches collecting rent, turn overs will be easier and less frequent, and they will generally be kinder on your units. The problem is, if you just look at cash flow projections on paper without considering this, the ghetto property will look way better on paper ... what a stock investor might call a "value trap".

That's a long preamble to the point about recessions ... in a recession, the quality of cash flow becomes even more important. In the ghetto, rent doesn't go down in a recession, it stops ... even in a nice neighborhood your tenants can lose their job in a recession and stop paying rent ... it will be less frequent, but it still can and does occasionally happen. And if/when you do need to evict for this reason, it will likely be much easier and quicker to find a good tenant for the property in the nice neighborhood. So, how long can you afford to carry the property if the tenants stop paying rent? That is where cash reserves come in. The other equally important place cash reserves come in BTW is for CapEx; those big ticket items like a roof that need to be replaced from time to time. And as a last resort, if you need to sell, could you still sell at a profit? Would you need to bring cash to the closing table? How much of a dip in prices could you take and have this still be true? That is where equity comes to play.To add insult to injury, not only do vacancies go through the roof, but prices in the less desirable neighborhoods tend to get hit first and the hardest in a recession.

So, to summarize, quality of cash flow counts as much as quantity, and that is mostly to do with the quality of the neighborhood. Never forget to adjust your projections for risk/volatility so as to avoid value traps. Cash flow alone will not save you in a recession ... it is the combination of high quality cash flow, cash reserves, and equity that will save you. Make sure you have all three.

[Lee S.]

Lots of factors to this, most of which have been mentioned. Funny that someone in this thread would use a "historical stock market return" and compare it to real estate during the financial crisis. Apples to Oranges much? This lack of logical thinking is more dangerous than the market or real estate combined. You have to make comparison on same time scale. I don't know what the historical appreciation of real estate PLUS cash flow is in my town but I think I'll do alright. I'm also not in a town that is dependent on one big employer and I plan to only keep rentals in nice neighborhoods/locations and buy them below market and do BRRR with ample reserves.

Imagine relying on that 11% market return (7% reality) and have a financial crisis hit right when you need to retire and your portfolio value is cut in half.  I know people this happened to in 2008-2011.  Market dropped by ~50% during that time, pretty sure rents did not!

Not all cycles are like 2008 either, be aware that could happen but very unlikely to repeat any time soon.

[Amit M.]

quality

over

quantity

3words

[Ben S.]

Probably the biggest factor is the local economy. If it's in a factory town where one factory shut down then everything (including rentals) would crash hard. So long as the location in or near a larger city with variety of employment rentals would likely be recession proof so long as some basic safety measures are taken (cash on hand to cover a few months vacany from multiple homes). 

[Andrew Syrios]

Nothing is completely recession proof. Cash flowing rentals certainly are about as good as you can get because sooner or later the recession will end and if you're cash flowing all the while, you'll be fine. But, sometimes a recession seriously damages a rental market. Rents go down and vacancy goes up and then you're not cash flowing anymore. After all, look what happened in Detroit. So I would say, relatively recession proof.

[David Faulkner]

Originally posted by @Amit M.:

quality

over

quantity

3words

That's 4words if you count 3words as 1word ;)

Agree BTW.

[Jatin Patel]

Stocks and Real Estate, both have produced millionaires. You will hear arguments from both sides of the table and they are all valid. I personally invest in Real Estate (more) as well as Stocks (lesser) and I continue to split between the two.

Real Estate --- Rent usually never goes down. Exceptions--- Some big business that was pumping economy in the town moved, rent would go down as well as economy in that town. You cannot do much about it. As long as you plan on holding your rental properties for a long time you can withstand recessions. But in Real Estate, you have to active. Look for good deals, be ready to pick up phone calls at night, deal with contractors on a regular basis. I will not buy Investment Properties on a loan. Cash is the best way to get into it imho.

Stock Pro--- Less proactive. Usually if you have two jobs and at a phase where pumping all the savings into investments, Stocks are good. Set up Mutual funds and you do not have to keep doing anything except move it to better performing ones every now and then. As long as you are not using it to save up to buy a new car next year buy planning on letting it grow until you retire, it can also withstand retirement. There will be ups and downs, but over a decade usually you would come up better. And stocks is always cash. NEVER borrow money to put in stocks.

All those that keep giving examples of the market crash last year, look at the market today. Those who weathered it and left it alone, are bigger and stronger today. 

Those that complain about rental properties sitting empty, most probably you made a bad deal or something has changed in the neighborhood. Just like putting money in a poorly thought stock thinking it will double tomorrow.

IMHO, best practice is to spread your investments. Do stocks, mutual finds, commercial properties, multiplexes, single homes, piggy bank savings (:D)....

[Anthony R.]

I started after the last major recession. I'm up to 12, lean, mean, hard core, money generating, doors. I've halted buying right now because I think the next major correction is coming soon. We'll see if I survive! 

See you on the other side ....

[Mark F.]

@Theo Hicks It might interesting to ask your colleague what happened to his stock portfolio in 2008. :)

[Joe Villeneuve]

Your "buddy" is so wrong it's funny. The biggest reason is he doesn't understand that REI is nothing like Stock Market investing. There are not connections...and you most certainly don't invest, or analyze the same way for both.

Your "buddy" probably is, which would explain his beliefs. 

[Derek Luttrell]

Just yesterday I told a friend that I put an offer what could be property #5 for me, and he said "better hope the market doesn't crash soon." I responded with "Why?" and he didn't know what to say next. 

It's people's favorite thing to say when they hear you invest in real estate, and they all seem to be from the future and claim we are "due" for another recession. Honestly, what does being "due" for a recession even mean? No one seems to understand that your rate is fixed until the property is paid off, and stays constant no matter what the market is up to at any given time. 

I am comforted by the strong demand in the areas that I invest in, and the fact that I would need to take about a 50% hit to my rents in order to break even on all expenses. And yes, reserves are paramount in this game, but I would argue that, when staring down the barrel of a recession, the stock market is much more risky than buy and hold REI.

[Joey Raquel]

@Theo Hicks There is no recession proof. But we all have to have a house (rent or buy tI lIve wIth ) unless you choose to be a homeless.. So if recessions comes. U still have to received rent.

[Bjorn Ahlblad]

I have gone out of my way to compare notes with many investors on rental properties through various recessions and downturns and it has varied from zero effect to 10% down and even 5% up. The devastation that hit Detroit, Cleveland and Flint were not recession related. I think if you buy well-no negative cash flows-and have reserves it should not be a problem.

[Chris Purcell]

@Theo Hicks

No. Your cash flowing property could become very not cash flowing quickly if your tenant were to happen to lose their job 

[David Krulac]

Nothing is "recession proof". there is no warranty given when you buy real estate.  It is upon you to make the best choices when you buy.  I have bought and sold over 900 properties for my own inventory, and of those I can only remember once that I lowered the rent, and it wasn't due to any recession, though I have invested through several.  Things do happen, illness, job loss, divorce, and death, which happen during good economic times and bad economic times. 

Just yesterday I was talking with an attorney and in his community, there were NO building permits issued in about 10 years since 2008 depression. But there are still people living there, its not a ghost town and people are still renting there, even if its not a growth area.  And you can make money there renting properties, the rents are not as high as some other areas, but the prices are lower there also.

[Joe Villeneuve]

Originally posted by @Andrew Dorazio:

The fewer units in a specific building that you have the more risk you would have when there would be a market meltdown (ie if you are renting a single family home out you have only one renter bringing money in, hence higher risk of you having 100% vacancy for a while)
Your line of thinking is accurate though, and as long as your renters don't all lose their jobs simultaneously and move out you would be fine. The ones who lose their shirts in these times are the ones who are not properly prepared or the ones that invested on speculation and over paid. Even if your property goes underwater it doesn't matter as long as you do not need to see immediately.

As a general rule I keep 6 months operating expenses on hand at all times per property to weather any storms.

 OK.  The following is a series of math questions for you.

1 - If you have 1 building with 4 units in it, how many rents are you collecting?
2 - If you have 4 SFH, how many rents are you collecting?
3 - If one of your tenants in #1 was vacant, how many rents are you collecting?  What is your % of vacancy?
4 - If one of your SFH from #2 was vacant, how many rents are you collecting?  What is your % of vacancy?

[Joe Villeneuve]

Originally posted by @Derek Luttrell:

Just yesterday I told a friend that I put an offer what could be property #5 for me, and he said "better hope the market doesn't crash soon." I responded with "Why?" and he didn't know what to say next. 

It's people's favorite thing to say when they hear you invest in real estate, and they all seem to be from the future and claim we are "due" for another recession. Honestly, what does being "due" for a recession even mean? No one seems to understand that your rate is fixed until the property is paid off, and stays constant no matter what the market is up to at any given time. 

I am comforted by the strong demand in the areas that I invest in, and the fact that I would need to take about a 50% hit to my rents in order to break even on all expenses. And yes, reserves are paramount in this game, but I would argue that, when staring down the barrel of a recession, the stock market is much more risky than buy and hold REI.

 I would say this just about covers it.

[Clinton Fisher]

@Theo Hicks You'd be wrong in my area. In 2008 a lot of homeowners who would be sellers became landlords. What do you expect of flippers who get caught without a chair when the music stops? You get higher quality rentals at lower prices, it affects the whole food chain. I would advice you to know your area well enough to not have to ask the question.

[Grant Rothenburger]

Originally posted by @Clinton Fisher:

@Theo Hicks

You'd be wrong in my area. In 2008 a lot of homeowners who would be sellers became landlords. What do you expect of flippers who get caught without a chair when the music stops? You get higher quality rentals at lower prices, it affects the whole food chain.

I would advice you to know your area well enough to not have to ask the question.

I think you're saying that a lot of flippers in your area were stuck with their project in 2008 so they kept it and rented it out - is that correct? If so, doesn't that support the claim that rentals are relatively safe in a recession (if you've taken the right precautions)?

[Gordon Starr]

Leverage leads to a boom bust cycle. If too many people are leveraged, all it takes is something to go south and it feeds on itself because everyone was counting on their asset being worth some value or some rent at some future time when that is unknown. Its a risk all investors take. Being underwater stinks, don't kid yourself. Look at how many boomers are all leveraged out on a 30 year tied to their current income, with no hope of even living that long. Sorry to be alarmist, but I don't like the demographics or the current price/rent in most places or the degree of leverage in the US real estate. Rents are rigged at the federal level to go up slowly over time, though. So you MIGHT be ok anyway.

[Caleb Heimsoth]

@Theo Hicks I’m also 24. I have a no real estate discussion policy with Co workers. This is why. Your right. He’s mostly wrong. Nothing, including real estate is completely recession proof. I suggest you sell all your real estate and go buy bitcoin. The next crash is coming. I can feel it. Lol