As we all observe and fear the Coronavirus, we see many cities under “shelter-at-home” restrictions, and many “non-essential” businesses closing. Then on the other hand, the Fed lowered rates almost to zero, and mortgage rates, after a short spike, are starting to settle down near the lowest point ever. Some people fear a recession is likely to follow, and if we remember the recession of 2008, I think it’s quite possible. That depends, of course, on the length of the lock-down.
If a recession does occur, let’s point out some of the differences between the recession of 2008 and the next recession, if it hits.
Before the 2008 recession happened, there was a major boom in many states. Home prices in states like Arizona, Nevada and Florida went through the roof. The media was shouting “It’s a bubble! It has to burst!” Prices of homes in Phoenix, for example, nearly doubled from the beginning of 2004 till the middle of 2006. Not all states participated in the party, for example, Texas and Oklahoma have not gone up very much during that time.
When the 2008 recession hit, the markets that went down precipitously were, of course, the exact markets that had participated in the 2004-2006 boom. Places in Arizona, Nevada, Florida, and other states. Prices tanked and crashed quite a bit. However not across the board, states like Texas and Oklahoma did not go down very much during the recession of 2008.
By contrast, at the present time, especially in affordable markets like Oklahoma City, Tulsa, Baton Rouge, Central Florida, parts of Atlanta, Raleigh and others, there are currently no price bubbles. No major boom has happened, Thus the likelihood of a major price crash in such markets is much slimmer than the markets which crashed in the 2008 recession. There are very high priced markets now, the expensive markets in San Francisco, for example (which has already started going down in price last year). In such markets, there may be a stronger effect on prices. Also, when you invest in a brand new home in a good area in Oklahoma and pay $170,000. You are buying the home not much over the basic construction and land cost. Again, the probability of an “intrinsic value” home like this going down much is small. By contrast, a $2M home in San Francisco, which cost $900K to build, has a lot of “air” in the price, with a higher likelihood of prices going down in San Francisco.
The recession of 2008 was created by housing. Lenders released all limits, and loans were made to virtually anyone that was human, almost regardless of credit or ability to pay. Some loans were up to 125% of the value of the house. This bad debt, called “sub-prime”, was then packaged among other debt, and amazingly, the credit agency gave these packages high ratings, as if it was a quality debt product. Then these faulty packages sold on Wall Street, and financial wizards found way to leverage them enormously. Once defaults on the bad loans started to hit, the entire structure unraveled.
By contrast, at the present we are still under the Dodd-Frank Act, which was drafted after the 2008 recession. Borrowing is now much harder and lengthier than it was before the 2008 recession. Even borrowers with great credit are finding the current loan processes frustrating. The amount of sub-prime loans is minuscule relative the period preceding the 2008 recession, and steps were taken to make the abuses with rating agencies be much harder to repeat. Thus the next recession is likely not to be caused by bad loans. It is clear that if another recession comes, its effects on rental home investing will be quite different than the recession of 2008.
I believe that the best way to invest in real estate is to buy brand new homes, in affordable large metropolitan areas, where the rent numbers match well with prices. Then finance the homes with a fixed-rate loan. To the best of my knowledge long term fixed rate loans like we get here in the US don’t exist elsewhere. The monthly payment and the mortgage balance never change with the cost of living, while everything else does. That means inflation constantly erodes the true buying buyer of your debt, making your debt ever smaller in real dollars.
For these kinds of homes, purchased anywhere from $150K to $250K, I believe the effects of the next recession will be minimal. Rates are very low, however, so fixed rate loans will retain these great rates forever.
The act of buying good rental homes in large metro areas and holding them as rental for the long term, where the loan erodes, is a future-changer. It does not change your future instantly or even within a short time, but over the long term, this strategy is a powerful future changer. I have seen people retire well, send kids to college, and look much stronger financially thanks to these simple yet powerful investments.
Since these investments show their power over the long term, and since the interest rates are so favorable now, and since a possible impending recession is unlikely to have effects on prices like the 2008 recession, I believe this would be a good time to invest.
As an extra “bonus”, the virus fear creates more flexibility with sellers, including builders, and the ability to negotiate better prices.
I would be happy to discuss it with anyone who may wish to inquire further.
