- July 1, 2022
- Posted by: Jin Wang
- Categories: new investors, passive investing, syndications
Each time a recession hits, it takes us by surprise – no matter if you’ve been through a recession before or whether you’re heavily involved in market trends examination or not. Since recessions are inevitable, the US has experienced a recession every four years since 1900; it’s essential to know what to expect and how to handle your investments during this time.
So, what happens to real estate in a recession? How much is the real estate market as a whole affected? And when is the right time to invest in real estate?
To find these answers, we’ll look at previous recessions, which will prompt you to identify where the market is in its current cycle. This can help you look forward to the next few months or years and know when it’s the right time to buy again.
What is a Recession?
When the economy shrinks for at least six months or two quarters out of the year, the negative growth is called a recession. The GDP (Gross Domestic Product) represents the total value of goods and services sold within a country.
A recession is when the GDP goes down consecutively for at least six months. When GDP returns to pre-recession levels, that marks the end of the recession.
Red flags that a recession is happening or close are spiked unemployment rates and erratic stock market fluctuations. Experts often look toward history and highlight traits of The Great Recession of 2008 or even the Great Depression in the early 1930s.
By examining and understanding recessions and the sequence of events that occur before, during, and after a recession, you can purposely create life-changing wealth during the recovery period.
Where are we now, what should we expect, and when should we buy?
Based on previous recessions, here’s what could happen to real estate during the next recession and recovery cycle. Track your recent experience and research of the US economy compared to the below stages.
Stage 1 – Unemployment Rates Increase
As I mentioned, unemployment rises in the earliest stages of a recession. This is one of the big waving red flags that trouble is on the horizon. Businesses begin to feel the effects of fewer goods and services being exchanged (remember GDP?) and may close their doors or choose to furlough or lay off employees.
During the Great Recession of 2008, 2.6 million people were unemployed, and in 2020, the US hit an astounding unemployment number of 30 million, a historical record.
Stage 2 – Government Stimulus
As we’ve seen in recent history (2008 and 2020), the government may step in with a stimulus to boost the economy with cash. Sometimes programs are offered to keep businesses afloat, sometimes eligible households are sent currency, and sometimes all of the above.
Stimulus checks are a temporary band-aid that gets cash into the hands of Americans to encourage spending. This is why rents are still paid for the first couple of months of a recession. But what happens when people are still unemployed and they’ve spent their stimulus money?
Stage 3 – Loan Defaults
The longer businesses continue to close, and consumer spending decreases, the more likely we will see loan defaults. As tenants cannot pay rent, real estate owners deplete their reserves, resulting in a wave of defaults for residential and commercial loans.
As defaults occur, banks start to take over the properties, which brings us to the next step.
Stage 4 – Bank REO
When loan defaults occur, banks foreclose on those properties. Then, a wave of bank REO (real estate owned) properties appear on the market.
Since banks aren’t in the property management business, they are anxious to sell these properties quickly at a discount. At this point, real estate investors should be ready with their checkbooks.
Stage 5 – BUY!
In examining the real estate pricing cycle of the recent past, we saw peak market prices in 2019. So, when will bank REO properties begin to hit the market?
This depends on several factors, including the speed at which the real estate market reacts, which is slow. Examine the historical trends – notice the “bottom” of the recession versus when REO properties become available. There could be years between these two events, which means patience is key.
Stage 6 – Inflation
A rise in inflation is the inevitable final stage of the recession cycle. Inflation results from additional money being flooded into the economy (remember stage 2?) and ultimately devalues the dollar.
This is precisely why the same dollar buys much less now than it did 10 years ago AND what makes real estate such an excellent investment. Real estate investments with a fixed-rate loan lock in payments for about 30 years, hedging a bet against inflation.
As the value of your currency decreases, your mortgage payments remain the same, and your real estate values appreciate.
What You Should Do Now
Investing, market cycles, and our own experiences with these things come with guaranteed uncertainty. However, by examining history and economic fundamentals, we can better understand when each stage presented above will occur.
On the tail-end of a recession, during the recovery, it’s likely that you’ll see unprecedented deals flood the market, and you want to ensure you’re ready.
In the interim, the best thing to do is focus on education & mindset, in addition to readying your personal financial situation so that when a deal hits, you can confidently invest.
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