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Updated almost 6 years ago, 12/23/2018
Are cash-flowing rental properties recession proof?
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!
- Andrew Dorazio
#4 All Forums Contributor
- Plymouth, MI
Originally posted by @Andrew Dorazio:
If you lose a tenant in a single family who is paying the mortgage on the property (or any of the other costs)?? how long can you sustain a vacant single family home?
My point is, if you own a 4 unit, and one unit goes vacant, chances are the three units filled will at least cover a majority of your fixed costs, if not all. Not the case, in my opinion, with SFRs. So I stand by my point of the risk being reduced with more units.
Add up the mortgages on 4 SFH.
Compare that total to one 4-plex.
If they are the same, then if you have one SFH vacant, and have to cover the mortgage, it has the exact same impact on you financially if you have to cover 1/4th of a 4-plex if you have one tenant vacant there.
...or, what is the CF of the 4-plex vs the 4 SFH's?
Everything everyone else said, also you can make your funds more recession resistant if you invest in submarkets that have recession resistant industries. That way, during recessions there will still be jobs. No Jobs= No paying tenants. So invest in areas with recession resistant jobs- government, education, medical.
I often wonder this too. All of my homes will break even if either half full or if rents fall by 50%. I own on average 20% of all of my properties value and that’s not taking into account improvements, appreciation, and a square footage expansion here and there. Considering those factors I own maybe 40%. Admittedly I don’t have huge cash reserves at the moment but it’s a top priority for me especially in light of recent stock market plunges. I figure the worst thing that can happen is that I don’t cash flow. Oh well, I’ll just have to keep a job then.
My questions are:
1) what happens to your mortgage if the bank holding the mortgage goes belly up?
2) I am in the process of pulling equity to the tune of $125k. They assure me this will never be cancelled/nixed. Yes the rate fluctuates. I’m now thinking of waiting to use this. I’d like to score a little duplex around cocoa beach (I’m a rocket, beach, and theme park enthusiast). Thoughts?
Real Estate is not recession proff. But I've been through several recessions. Rents didn't decline during any of those recessions. And during those recessions, I was piling on by buying more real estate. Even if property values decline by 50%, which i have never seen in the areas that I'm buying, the rents don't decline by 50%. There is no direct coorelation between decline in the value of the property and a decline in rents. Some may say that rents are rising during a price decline because less people can buy therefore there are more renters!
It all comes down to buying right, buying in the right areas, chosing the right financing, and chosing the right tenants. If the economy scares you or you are concerned about a downturn in real estate values, stay on the side lines. That just means that there is less competition and more property for me to buy. Thanks
I've bought and sold over 900 properties, and the last year that I DIDN'T buy a property, the Chicago Bears were 15-1
There is the problem. I was just speaking to a landlord and he said his on time pay went form about 90% to 60%. In a recession you could have more problems collecting rent.
My landlord friend also said he had a lot of bank call loans. He was paying the loans on time but the bank paniced and called the loans. He was stuck.
You still owe the money. It goes to the new bank that took over the loans.
@Theo Hicks Your friend is not entirely wrong. What if your tenants lost their jobs or you did or worse both, and your property values declined and you didn’t have the monthly cash flow to pay all your debts. This can and did happen to several investors in the crash of 08. This is the risk of being over leveraged in a big recession. Also what if you were renovating a brrr property and the market crashed you would not be able to refinance most likely. It doesn’t mean it will happen but there is risk that it can happen. It sounds like your friend is a conservative investor. I would at least listen to him so you understand another investors perspective. If you are less risk adverse than him that is fine but at least understand all the risks and have a plan to mitigate if you want to leverage more. Your plan can work as long as the recession doesn’t hit you or your tenants.
Great discussion!
@Margie Pierce We had a HELOC with a bank that failed. We received calls and notices from the FDIC on what was taking place. We continued making payments, another local bank was handling the payments for the FDIC. When we weren't in town to utilize that bank location we paid directly to the FDIC.
Eventually the note was bought by another lender. They reviewed everything and gave us a loan. One could also have gotten a loan with some other bank of choice to pay off the HELOC.
If your NOI is $1000 and purchase price was $85,000 that is not a bad cap rate. 7% if the market tanks, that 7% will be a dream for him. At the age you are if you can get 7% on every investment.... long term TAKE IT.
Those numbers may not work for older investors, but pretty solid. Good luck sir
@Theo Hicks
It is excellent you were asking these questions. I highly suggest having a years worth of bourbon serves to whether any storms that may come your way. I know a person that had 50 units before the crash came. I asked him virtually the same question and he said he had a 50% vacancy rate when the market went down. His suggestion was I have property is paid for and keep reserves on hand
Originally posted by @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!
Theo,
As someone who has survived the 2008 market crash, I can say this: for the most part, you are correct. Cashflowing real estate is better than stocks and will survive the recession. The only thing you have not factored in is during a recession, a lot of people LOSE their JOBS which result in rents DECREASING and vacancies increasing.
Having said that, if your cashflow is healthy now, during a recession, your cashflow will decrease and might even be $0. In the last recession, the landlords who lost their properties are those who bought with breakeven or negative cashflow when times were good, so when the recession hits, their cashflow became negative in addition to their equity being negative so they were forced to sell.
So, as long as your rental properties can sustain themselves, so what if their property values decrease? You can afford to hold them until rents increase and vacancies decrease.
Hence, as much as possible don't buy properties with negative cashflow.
Cashflowing stocks can also survive a recession. The Dividend Aristocrats (of which I have a cherry-picked portfolio), for example, are S&P 500 companies with a track record of at least 25 years of annual dividend increases. A lot has happened over the past quarter century, so these companies know how to do something right to make it through the rocky times.
Dividend raisers are not a guarantee of continued performance, however. GE, for example, was a Dividend Aristocrat done in by the Financial Crisis of 2008. A carefully-selected portfolio of these companies from different industry sectors might be a way to spread the risk.
The advantage of using both direct real estate and dividend stocks is diversification. Most large companies are global and derive their revenues from businesses they run all over the planet. While some countries might be in recession, others might be experiencing prosperity. Investors have no control over the management of these companies other than voting for the members of the board of directors (which is usually a rubber-stamp process).
Cashflowing real estate is subject to the risks in the local economy, but investors have control over the properties they own. Buying with a healthy margin of safety provides a cushion to weather the economic storms that happen from time to time.
As long as you can hold the property for 10 years you can wait out a recession and be able to sell for at least what you bought it for