Market, Economic, and cycle are three words that are essential components when you are working to recession-proof your investment business. We have all heard these words. And many people are sure that they know what they mean. But a clear and accurate understanding of these three words is essential before it is possible to begin the process of recession-proofing your business.
To really understand what a market is, we first need to clarify transactions. Financial transactions happen billions of times every day of the year. Every time money is exchanged for a good or service, a financial transaction has taken place. Transactions are also events when lending takes place, such as a loan for a car or paying for dinner with a credit card. Whenever money, credit, or another form of payment like e-currency change hands in exchange for a good or service, a transaction has occurred. And the market is an aggregate of all transactions around one specific product or service.
- All transactions involving automobiles create the auto market
- All purchases and sales of gold create the gold market
- All purchased, and sales of the real estate create the real estate market
There are literally thousands of markets. And you will determine the niche or market is best suited to help you turn a profit in your real estate investment business. You might choose commercial housing, self-storage buildings, residential housing, or commercial properties.
The economy is what you have when all of the markets are put together. So within the economy, you have thousands of different markets. And each of those markets is comprised of billions of transactions. The study of economics is simply the sum of all transactions that occur each day across all of the various markets.
What you need to remember is that the number and size of all of these transactions are never going to remain static. When there are more transactions and many more significant transactions, there is a massive amount of cash and credit flowing. These are what we call a strong market or economy. And when the number of transactions declines drastically, and there is less money flowing, we call this a weak market. Numerous factors play into creating a strong or weak economy, and the process trends in cycles.
A strong economy pattern leading to a weak economy and then leading back to a strong economy is referred to as a cycle. These cycles occur regularly, and over the last 160 years, we have experienced 33 economic cycles. And some fast math will tell you that the average cycle takes about 5 years to be completed.
During a typical cycle, a time of growth is called expansion. And a time of slowdown is called contraction. Each cycle starts and ends with expansion. And that center period is the contraction, economic downturn or recession that we are focusing on as the current conditions trend down. Investing in a recession can be challenging. When you make good decisions and focus carefully on your business structure, your real estate career can survive and thrive.
Identifying An Economic Downturn
Before you can act in a recession, you need to know how to spot the downturn coming. There are several qualitative and quantitative measures that you will need to evaluate. The qualitative indications are those that cannot actually be measured. But they are evident in our feelings and emotions. The quantitative signs are measurable with data and statistics.
Some examples of qualitative selling include:
- Desperation Selling- There are no numbers to support this; you just need to know it when you see it. Sellers are desperate to move properties. They sense the economy trending down, and they will do whatever it takes to salvage some of the equity that they have in their property. This is when you see a lot of inventory hitting the market from buyers who are willing to take low offers.
- Lending Tightening- The tightening of lending can occur gradually or suddenly. Lenders are no longer as open to commercial loan flippers. And conventional loans also begin to get more challenging. They require higher credit scores and larger down payments while also getting more cautious about verifying income and borrower assets. This means it is harder for you, the investor to get a loan, and also harder for a buyer to purchase the property from you in a flip or any other sale.
Some examples of quantitative selling include:
- Gross Domestic Product Falling- A fall in the gross domestic product or GDP is the government’s yardstick for a recession. When the government sees two consecutive quarters of slowdown in the GDP, they officially declare a recession.
- Housing Inventory Increase- When the housing inventory reaches six months or more, there is a reversal from a seller’s market to a buyer’s market. A very bad recession can result in an inventory of 12 to 18 months, which was last seen in some markets in 2008.
- Pre-foreclosures/Foreclosures Spiking- The three metrics used to monitor this situation are when home buyers are 30, 60, or 90 days late on their mortgage. When people can’t pay or don’t pay their mortgage, that is a strong indication that we are headed into a recession.
- Home Prices Falling- Some markets will fall slightly while others can fall dramatically just before a recession. But the drop usually is very widespread.
- Appraisals Coming In Low- As banks get more diligent about lending, there is a tightening in the appraisal amount in most homes. They are afraid to loan the full value and devalue appraisals to protect themselves in the event that you default on your mortgage.
- New Construction Slow Down- When the supply side is flooded, it makes sense that builders are less interested in building and adding more homes to the market. Builders need to move completed homes, and when the market is getting ready to head down, they do not want to be stuck with an extensive inventory that they can’t sell.
How To Invest Successfully In A Recession
In real estate investing, there is often a lot of talk about strategies versus tactics. Strategies are the most common high-level functions in the business, such as:
- Flipping Houses
- Buy and Hold
Tactics are how these strategies are implemented and how we use them to reduce risk and increase profits.
Wholesaling is a common strategy but one that does not often work well in a recession. But some tactics within the wholesaling strategy can be applied in a downturn. One in specific is selling to landlords instead of selling to investors or retail buyers. For the most part, wholesalers will focus on finding properties for these buy and hold investors to survive a recession.
Fix And Flip
Flipping houses in a recession or downturn is not a strong business plan. But if that is your business, then there are a few essential tips to follow to maximize your profit. First, buy in a great school district. These areas always have higher demand and more potential buyers. And second, focus on the median price point in the area. Again, this will increase the number of potential buyers.
If you favor commercial properties, there are a few sectors that fare better during a recession. Self-storage facilities are successful because many people are downsizing but need to purchase additional storage space. Medical offices are also a necessity that will tend to be more recession resilient than other office spaces.
The simple truth is that no business or segment of a business is recession-proof. But as a real estate investor, you can learn the signs that a recession is coming and act accordingly. There are many strategies and tactics that can help make your business profitable, even during a recession.