To help you navigate the complexities of real estate investments during an economic downturn, we’ve gathered insights from nine experts, including a real estate investor and a wealth management advisor. From strategies like buy right and manage debt to renovate and redevelop existing properties, here are the top nine specific ways an economic downturn can affect your investments, and the strategies you can employ to mitigate this risk.
- Buy Right and Manage Debt
- Hedge with Fixed-Income Investments
- Diversify and Maintain Cash Reserves
- Improve Property Value
- Look into Guaranteed-Rent Programs
- Invest in Low-Tax States
- Invest in Value-Add Properties
- Use Conservative Financing
- Renovate and Redevelop Existing Properties
Buy Right and Manage Debt
One specific way an economic downturn can drastically affect your real estate investments is a decrease in rents and overall tenant quality. During a downturn, your tenants may ask to pay less, or not pay at all.
You may have evictions and periods of no rental income. Investors that get hurt the most during this time are the ones that are over-leveraged, using too much debt, and did not “buy right” up front. Buying right, and keeping your debt-to-income ratio low, will help you weather the storm during these times so you come out clean on the other side. Real estate continues to rise over time, but the data shows a storm here and there is inevitable.
Hedge with Fixed-Income Investments
Real estate investments are desirable due to their unique ability to provide two rates of return, as opposed to a singular rate of return that we expect in non-real estate investments. Real estate allows an investor to expect an ROI on property value appreciation, as well as a second ROI on the rental income one will expect passively throughout the term of ownership. Together, they combine to create the uniqueness found in real estate investing.
An economic downturn increases the risk of losing the rental income ROI we expect on the investment. An investor should mitigate this risk by complementing the real estate investment properly in their portfolio. A hedge to losing rental income on a real estate investment in the event of a downturn can be achieved through proper fixed income investment selection.
An investor will have fixed income investments outside real estate ownership, regardless. Fixed income vehicles that offer guarantees in growth and leverage will hedge, and dismiss this risk.
Taylor Robinson, Wealth Management Advisor
Diversify and Maintain Cash Reserves
Economic downturns often impact real estate investments in several ways, the most prominent being the decline in property values. Reduced consumer confidence and lower spending capabilities cause a diminished demand for real estate, thereby leading to decreased property valuations.
Moreover, rental incomes can suffer as potential tenants, grappling with reduced incomes or even job losses, struggle to meet rental obligations. The decline in economic activity can spike vacancy rates, especially in commercial sectors, further dampening investor returns.
Distributing investments across various property types and regions can shield against widespread downturn impacts. While one property type or location might suffer, another could remain resilient.
Maintaining a robust cash reserve aids in covering expenses during lean periods. It provides flexibility, allowing investors to hold properties until market recovery instead of incurring losses.
Improve Property Value
Economic downturns can devalue homes, posing a risk for real estate investors. Lower consumer spending reduces demand, impacting both purchase and selling prices. Investors may buy at a discount but may also struggle to sell at a profit.
To mitigate this, diversification is essential. Investors should consider a mix of property types, like rentals. This can act as a financial cushion if the new home-buyer market is sluggish. Another strategy is to focus on significant home improvements that add intrinsic value, making properties more appealing to buyers in a competitive buyers’ market.
By diversifying and enhancing value, investors can build a resilient portfolio capable of weathering economic challenges.
Look into Guaranteed-Rent Programs
Real estate investments can be impacted by a decrease in property values and a potential decline in rental demand. At UpperKey, we’ve strategically addressed this challenge by offering guaranteed-rent programs. We’ve utilized this approach to ensure consistent income for property owners, regardless of economic fluctuations. This safeguards their investment and stabilizes their revenue streams, providing a buffer against the uncertainties of economic downturns.
Diversification across different types of properties and locations within our property management portfolio has proven effective. By investing in a mix of residential properties across various regions, we can mitigate the risk associated with localized economic downturns. This enables us to maintain a steady cash flow, even if certain segments are impacted by economic shifts. Our commitment to guaranteed-rent programs and strategic diversification exemplifies our dedication to managing risks and delivering value to our investors.
Invest in Low-Tax States
High interest rates and low savings mean that a few investors will control more of the rental market. Low inventory across the country will continue to drive up prices in desirable areas and give huge discounts to landlords in others. The question should not be “if to buy,” but “where.”
The states with low or zero income tax will continue to have high demand in real estate. High-tax states will continue to see a mass exodus with teleworking becoming more practical. Finally, the states in between will see rental rates skyrocket as fewer qualified buyers are in the market!
Prioritize Value-Add Properties
Fortunately, there are strategies that investors can use to mitigate the risk associated with economic downturns and decreasing property values. One of these is diversification, which involves investing in a variety of different properties or geographical areas so that if one area experiences a decrease in value, it does not have a significant impact on the entire portfolio.
Another strategy is to invest in value-add properties. These are properties that can be acquired and improved for the purpose of increasing their value. These improvements may include renovations or updates that make a property more attractive to buyers, thus potentially increasing its resale value should the market conditions change suddenly.
Use Conservative Financing
An economic downturn can significantly impact real estate investments in various ways, but one specific challenge is the potential decline in property values. During a recession or economic downturn, property values tend to decrease due to reduced demand and increased financial constraints on potential buyers. This can erode the profitability and value of real estate investments.
To mitigate this risk, investors can consider the following strategies:
- Diversify your real estate portfolio.
- Maintain ample cash reserves to cover all financial obligations.
- Focus on the property’s long-term income potential and appreciate the cyclical nature of real estate.
- Screen tenants thoroughly to secure reliable and stable rental income.
- Use conservative financing strategies to provide stability in times of rising interest rates.
Renovate and Redevelop Existing Properties
During an economic downturn, one specific way it can affect real estate investments is through decreased construction activity.
To mitigate this risk, investors can explore opportunities in the renovation and redevelopment of existing properties. This strategy allows investors to leverage their expertise in identifying undervalued properties and improving their marketability, ultimately increasing their potential for long-term returns.
For example, an investor could purchase a run-down commercial building in a prime location, renovate it to modern standards, and attract new tenants at higher rental rates. By revitalizing existing properties, investors can adapt to market conditions and create value even during an economic downturn.