This is a chapter taken from the upcoming comprehensive guide titled, Market Cycles: How Investors Can Survive (+ Thrive) in a Turbulent Economy. If you would like to sign up for early bird access to this comprehensive guide, please sign up here.
As a V-shaped recovery looks increasingly unlikely, real estate investors need to prepare for what lies ahead. What is positive about this downturn is that housing appears poised to lead the economic recovery.
National Association of Home Builders (NAHB) Chairman Dean Mon commented on this, stating that “as the nation reopens, housing is well-positioned to lead the economy forward. Inventory is tight, mortgage applications are increasing, interest rates are low, and confidence is rising. And buyer traffic more than doubled in one month even as builders report growing online and phone inquiries stemming from the outbreak.” Mon’s comments are timeless, and point to the underlying overall robustness of the real estate sector.
That said, no investor likes uncertainty, so it’s good to know that down market cycles—both in the housing market and the wider economy—are completely normal. But how do we prepare ourselves for these? Here are 10 things you can do to minimize the impact on your business, and potentially profit by seizing opportunities that other investors simply aren’t prepared for.
1. Stress test
Stress testing lets you prepare and adjust your real estate portfolio for the market gyrations that come with every economic downturn. By running different scenarios with each of your properties you can determine which are the most fragile:
- Assume your tenants pay 30, 60, or even 90 days late
- Double or triple your current vacancy rate and tenant turn times
- Reduce property values by 10%, 20%, and 30% based on your local market trends
With each combination of variables, measure how long you can stay cash flow positive. This also lets you know if you’re holding enough money in your capital reserve account.
2. Short-term goals for long-term gains
An economic recession makes it very difficult to focus on the long-term. Market conditions can change quickly, and your daily business activity centers around maintaining your existing tenants and cash flow.
You can eliminate recession uncertainty by creating short-term weekly and monthly goals such as reviewing every line item on your P&L or pro-actively extending the lease for one tenant each week. By focusing on smaller, achievable steps you’ll set yourself up for success when the recession starts to bottom out.
3. Watch your expenses
There are two types of expenses when you invest in real estate: Fixed and variable. Expenses like paying your mortgage and insurance, making routine repairs, and property taxes are fixed and don’t change regardless of how good or bad the economy is.
During an economic recession, you’ve got to ensure that your variable expenses are returning an ROI. For every dollar you spend on marketing or upgrading, make sure you’re receiving a return on that investment.
It could be a specific financial return that directly increases your income. Or, the return might be more free time that you can then spend on tenant outreach. The key is to make sure you can justify the expense and measure the return.
One of the most critical real estate investing metrics you should watch here is the operating expense ratio. This is the ratio of recurring expenses compared to the income your property generates.
Patrick Carlisle, Chief Market Analyst at Compass notes that “The basics of running a well-run business, whether that of being a landlord or a real estate broker, never change. Those who know how to run their businesses, watch their P&L’s and their expenses, stay engaged, keep in contact with their clients (however they are defined), keep doing the right things (as opposed to getting depressed) – they generally ride out the bad times and then when the cycle turns again, and the good times return, their businesses soar.”
4. Invest in technology and systems
An economic recession is a perfect opportunity to move your real estate business online. Even if you’re not tech-savvy, the good news is that today you don’t have to be. There are plenty of turnkey systems that can help you go completely digital:
- Replace on-site meetings and showings with Skype, Zoom, and virtual tours hosted on your website.
- Consider tools to move the entire tenant screening process online, or use Google Forms to digitize your rental application.
- G Suite and DocuSign let you share and execute legally binding leases and documents.
- Stessa helps you to effortlessly organize, manage, and generate reports on all of your real estate investments.
5. Get to know your tenants
Real estate is a people business. When the market is strong, it’s easy to accidentally become impersonal and out of touch with your tenants. Now is the time to make amends and let your tenants know you’re a human being who cares as much about them as you do your investment.
The fact is that an economic recession is tough for everyone. To help keep your cash flowing and your occupancy stable:
- Allow reasonable changes to your lease.
- Prioritize communication to improve tenant satisfaction.
- Be cautious about increasing rents over the short-term.
- Maintain the property even if you have to make a rent payment arrangement.
- Carefully screen new tenants from the start to avoid have a problem tenant in your property.
On this topic, Carlisle notes that “The landlord-tenant relationship can easily become adversarial, especially in places with strong rent control rules and fierce tenant-rights movements (or even groups that don’t believe in private property at all). In this situation, landlords and tenants often demonize each other and stop seeing each other as human beings.”
6. Stick to your business plan
When a recession strikes inexperienced investors make three fatal mistakes: They panic, obsess over daily market trends, and wake up one day and decide to sell everything at the worst possible time.
Experienced investors, on the other hand, know that economic downturns are part of the normal business cycle. Instead of deviating from your criteria, be patient, and keep your end game in focus. Profits and cash flow are always important, but investing in real estate over the long term is more about quality, value, patience, diversification, and discipline.
Make it a habit of continually reviewing your long-term goals and strategies to remind yourself of your overall business plan. If you haven’t created this type of document for yourself, now is a perfect time.
7. Take a step back to look strategically at your business
As you develop and document your long-term business goals and plan, think more broadly about your goals as a real estate investor. History shows that the bigger the disaster is, the more potential opportunities there will be.
The Recession of 2020 will be no exception to the rule. It may sound terrible, but it’s absolutely true. Focus on maintaining your existing business, build your capital reserves, and sharpen your tactics. Make these core aspects of your strategic business plan.
Now is as good a time as any to double down on understanding the metrics behind each asset in your portfolio. Do you know your IRR? Cap rates? Net operating income? Operational expense ratio? And the list goes on.
8. Marketing and branding
Now is the perfect time to fine-tune your digital marketing and build your brand to grow your business. That’s because internet usage soars during an economic recession. Many investors make the mistake of slashing their marketing budget during a recession.
Profit from the weakness of your competition by thinking of your marketing as an investment instead of an expense. Effective marketing and branding during an economic recession can help your business by:
- Making your brand more visible.
- Boosting the number of visitors to your website.
- Capturing market share and great tenants from your competitors.
- Increasing cash flow.
- Generating bigger profits faster.
Here are some specific ways you can build up your marketing machine during recessionary times:
- Start a blog about your local real estate market and become the expert.
- Start a weekly podcast interviewing investors and real estate professionals in your market.
- Start a local meetup group of other investors in your area.
- Make connections with local journalists to act as commentary on local news articles related to real estate.
- Publish videos on YouTube that include tours and walkthroughs. This not only helps with brand awareness, but also gives you resources for prospective tenants to digest prior to renting a unit.
9. Stay informed
It’s easy to find yourself slipping into hibernation when a recession strikes. However, just because every other real estate investor is sleeping in late doesn’t mean you should too.
According to scientists, the best time for learning—technically defined as when your brain is in “acquisition mode”—is generally between 10 a.m. and 2 p.m. and later in the day after 4 p.m.
Figure out when your personal acquisition mode begins, then use that time wisely by staying informed and learning how the recession impacts housing markets in different parts of the county. While many economic sectors will contract, not every sector will slow down. Uneven shifts in the market can create new market opportunities, especially when no one else is looking.
Start building a bookmarks folder of all the local, state, and national news sites related to real estate investing to build a daily digest of content. It wouldn’t hurt to start here.
You don’t want to try and catch a falling knife if real estate prices begin to decline, but you do need to be ready to make your move when the time is right. Having plenty of “dry powder” on cash on sitting on the sidelines lets you seize investment opportunities that economic downturns inevitably bring:
- Delay discretionary personal expenses like that tropical island vacation and stash the cash instead.
- Divert free cash flow from your rental properties to pay down your mortgages faster and increase your equity reserves.
- Develop relationships with credit unions and local banks versus the big national chains.
- Establish a home equity line of credit (HELOC) to quickly turn accrued equity into cash to invest when the market begins to bottom out.
- Boost your capital reserves and build your war chest by refinancing existing properties while interest rates are still low.
As Warren Buffet once said, “Risk comes from not knowing what you’re doing.” If the economy continues to cycle downward, there will certainly be more risk—along with plenty of potential rewards. To prepare for what lies ahead, rental property investors should begin by stress-testing their portfolios and stabilize existing cash flows.
Then, make strategic investments in technology and marketing that will lead to bigger and better profits down the road. Liquidity will increase, providing additional cash for the deals that downturns always bring.