3 Steps to Recession Proof Your Real Estate
Reposted from Marshall Commercial Funding’s blog:
SAM ZELL’S ASSESSMENT OF THE R.E. MARKET
Last month real estate magnate Sam Zell stated, “The real estate cycle is nearing its end.” Mr. Zell is the founder and chairman of Equity International, a private investment firm focused on building real estate-related businesses. He is a self-made billionaire. Back in the early 1990s he coined the phrase “Survive til ’95.” You see, there have been other real estate busts. So when Sam Zell says we are nearing the end of the current real estate cycle we should all take heed.
Does this mean we should start panicking? Heck no! As Sam Zell would tell you, there is big money to be made during real estate recessions. Back in the 90s he was known for buying properties at well below replacement costs and when the market turned he made out like a bandit. And when this real estate cycle turns we can follow his example.
But before we get to that stage in the real estate cycle where properties are cheap again we need to survive the pending downturn. As I’ve stated in previous blog posts, I believe that the real estate market in the Pacific Northwest peaked in 2016. There will likely be a number of years before we reach the bottom of the market and when that happens doom and gloom and gnashing of teeth will be the overriding emotions. But before that happens there is plenty of time to prepare for the inevitable. And remember there is money to be made during a recession if we keep our heads when everyone else is losing theirs.
SO HOW DO WE PREPARE?
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1. Buy the right real estate asset classes that are less susceptible to a recession.
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2. Sell the real estate that we don’t want to get stuck with when the next recession happens.
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3. Recession-proof the properties we want to keep in our real estate portfolio.
BUY RECESSION-PROOF REAL ESTATE ASSET CLASSES
Are there really recession proof real estate asset classes? It depends on what you’re asking. If you mean, is there such a thing as risk free real estate, the answer is unequivocally, no. Heck no! But you already know that, don’t you? However, are there some real estate asset classes that do better in a downturn? Yes. Absolutely. I believe there are three asset classes that will do much better during a recession than the overall real estate market. They are:
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1. Medical Office –
Even during a recession, people need healthcare. It is true that those who end up unemployed are likely to postpone elective procedures. Some will even forgo life-saving operations though they don’t need to as no one is turned away from a hospital’s emergency room. Counter balancing this behavior of using less healthcare in a recession are the estimated 10,000 baby boomers that are currently retiring daily. The Centers for Medicare and Medicaid Services project a 5.8% annual increase in healthcare spending through 2025. The aging of the Baby Boomer generation makes the medical office asset class almost bullet-proof.
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2. Senior Housing –
As the Baby Boom generation continues to age, the need for senior housing will be in greater demand. We are currently facing a supply shortage of all types of senior housing – independent living, assisted living, memory care and skilled nursing care. As long as you have an experienced senior housing operator managing your property, this asset class also looks like a sure bet.
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3. Class B & C Apartments –
Everyone needs a place to live, but those who become unemployed don’t necessarily need to live in upscale, trendy, Class A apartments. During the Great Recession, Class A apartments suffered from concessions and higher than normal vacancy. However, Class B & C apartments did much better weathering the recession. This will likely be the case this time around as well.
SELL BABY, SELL!
I currently have listed a small apartment that I don’t want to get stuck with when the next recession hits. Although the property has substantially appreciated in value over the years, it has consistently been a disappointment when it comes to cash flow after debt service. We have it listed at a “silly-stupid price” and because of the lack of product on the market, we will likely get close to the asking price.
How about you? Do you have a property that during the good times has at best only limped along? Now’s the time to get rid of it because you know that during a recession it’s performance will only worsen. I firmly believe in the Greater Fool Theory. It’s time to find a greater fool than me to own the property I currently have listed.
3 WAYS TO RECESSION-PROOF YOUR REAL ESTATE PORTFOLIO
I hate to sound like a broken record as I’ve given this advice several times over the years. It will sound very familiar to those who read my blogs regularly, but it bears repeating. There are three things you can do to recession-proof your real estate portfolio
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1. Don’t overleverage your properties with debt –
Those who overleverage their properties may pay the ultimate price – the loss of their properties through foreclosure. To avoid that from happening, do a vacancy breakeven analysis. At what vacancy rate does your property break even? If the breakeven vacancy rate at your property is lower than the vacancy rate for your asset class during the Great Recession, you have a problem. Now’s the time to be proactive and pay down the loan, or if necessary, sell the property.
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2. Refinance properties with higher interest rate loans than currently being offered in the market –
If it’s been awhile since you financed your property, you need to compare your current interest rate with what you could get today. Do the math. If you can lower your monthly debt service by refinancing, now is the time to do so.
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3. Build a rainy-day fund –
It’s amazing what cash in the bank will do to save your bacon when the hard times hit. If you’re currently a bit thin on cash, now’s the time to start setting aside some money to help you weather the economic storm that’s coming. Be the proverbial ant, not the grasshopper.