For years, prominent economists such as Peter Schiff have been predicting the next US recession. Common sense tells us that what goes up must eventually come down. Considering the record breaking 10 plus years of US economic expansion, sooner or later their bearish predictions will be right.
Many investors are wondering what to invest in during a recession. Stocks? Bonds? Gold? Bitcoin? Real Estate? Run for the hills and wait it out? Rather than stock piling food in your underground bunker, multifamily real estate investments may be the unexpected diversification you need to strengthen your portfolio.
What is a recession?
Recessions are a healthy and natural cyclical purging of the financial system. These purges result in billions in lost asset value while also presenting great opportunity. Preventing losses is easier when you are prepared before a recession occurs.
This is why institutional investors track all kinds of economic data, statistics, ratios and yield curve inversions attempting to predict a coming recession. Unfortunately, this leads to little more than information overload and sensational headlines. So, what data should you focus on?
"One key metric to follow is the gross domestic product (GDP)
One key metric to follow is the gross domestic product (GDP), a calculation of the market value of all finished goods and services produced within a country for a set time period. A negative GDP growth rate for two consecutive quarters is a widely agreed on recession definition.
By the time you realize you are in a recession however, you are already two quarters late and stuck playing catch-up. Given the difficulty of predicting a recession and its retrospective definition, one way to be on the offensive is to invest in recession proof assets
What assets are recession proof?
Unfortunately, no asset is recession proof. During a financial crisis performance in all sectors of the economy decline, some more than others. In 2008, health care spending declined to its lowest level in almost 50 years. The tech industry lost thousands of jobs. The stock market lost over $1 trillion dollars in value in a few short hours.
“Many of us have been sold the myth of a recession proof portfolio. A more achievable goal is a recession resistant portfolio
Many of us have been sold the myth of a recession proof portfolio. A more achievable goal is a recession resistant portfolio that invests in assets that will suffer the least and recover the soonest despite economy wide decline.
Building a recession resistant portfolio requires two steps. First you must diversify into multiple asset classes/ industries. Next you must identify which assets performed the best during the last economic downturn and the outlook for these assets.
When diversifying, one recession resistant asset class you should consider because of its [many advantages] is real estate.
Though, real estate was at the center of the great recession, the multifamily asset class was surprisingly resilient. Historic and current housing data suggest that it will continue to be recession resistant in coming economic downturns.
“When diversifying, one recession resistant asset class you should consider because of its [many advantages] is real estate.”
How did Multifamily perform during great recession?
Based on historic performance, multifamily is one of the best investments during financial crisis. During the great recession, single family homes were the first to experience a sharp increase in loan defaults with many homeowners simply walking away from their devalued properties. From 2007 to 2008, the beginning of the recession, the Mortgage Bankers Association recorded an almost 5% increase in single family home defaults, while multifamily assets remained largely unchanged.
Not only was multifamily a stable investment before the recession it continued to be resilient through the recession. In fact, during the entire financial crisis, The Joint Center for Housing Studies of Harvard University (JCHS) reports that Fannie Mae delinquent multifamily loans increased “from less than 0.10 percent at the start of 2008 to a peak of 0.8 percent in the second quarter of 2010” while Freddie Mac rose “from 0.04 percent to 0.35 percent.” Less than a 1% default rate. These two lenders were responsible for most multifamily loans originating the years before and during the recession.
Graph: Low multifamily apartment defaults during recession
Income producing real estate assets are largely valued based on their net operating income (NOI). The Mortgage Bankers Association reported an almost 4%, 5% and 8% decline in (NOI) for retail, office and industrial assets respectively while multifamily barely declined 2%. In addition to this, multifamily NOI decline was comparatively short-lived recovering sooner than retail, office or industrial assets.
Graph: Multifamily income stronger during recession
This historical data shows multifamily was not only resilient before and during the recession but also more resistant, recovering sooner that other real estate assets. Was this a fluke or is multifamily fundamentally recession resistant?
Why is Multifamily so Recession Resistant?
While people may cut back on retail shopping or failing business may give up office space people will always need a place to live. This is the core reason why multifamily apartments are more resistant to economic downturns relative to other real estate or asset classes.
“…people will always need a place to live
Having a high occupancy apartment community creates a financial cushion going into a recession. In the last recession the average vacancy increase was only 4%. Large apartments may have hundreds of residents. While vacancy may increase due to some residents leaving or losing their jobs, the income from remaining occupied units should cover your debt service and operating expenses.
When the economy is doing poorly, less people can afford to buy homes or qualify for financing. This leads to more people renting. Multifamily is recession resistant because it is a necessity in any economy and less sensitive to vacancy than other real estate assets.
How will Multifamily do in the next recession?
Population and housing trends suggest there will be increasing demand for rental housing for the near future. During the decade leading up to the 2008 recession the US was overbuilt with new home starts increasing from 1.7 million new units annually in 2000 to a peak of almost 2.3 million new units annually in 2006.
This oversupply amplified already large decreases in value and demand for real estate. New starts dropped to almost 500,000 during the recession and as of 2018 have yet to return to pre-recession numbers.
The JCHS projects 12.2 million new house holds will be formed between 2018-2028. At our current rate of building we are already struggling to keep up. If a recession occurs new home starts will decline further exacerbating the housing shortage that has already pushed rental vacancies to 20+ year lows. This trend will increase demand for housing as well as the value of multifamily apartment assets.
Graph: Household growth outpaced new home starts
Over 1 million immigrants, who are typically renters, move to the US each year. The biggest portions of the population are also increasingly turning to renting. Over the next decade Millennials (born 1985–2004) a population of 87 million, the largest in US history will just be entering their mid-30’s with the majority around 23 years of age in 2019. In the same time, baby boomers (born 1946–1964) will age 11.1 million people over 65. As of 2019, the majority of baby boomers are around 53 years of age. Over 25% of renters are over 55, while 38% are under 35.
Graph: Millennials and baby boomers prefer to rent
The under-supply of housing and increasing demand for rentals suggest demand for multifamily apartments may not only continue through the next recession but may even increase. This makes it a profitable recession resistant investment that you can capitalize on – but you must start now.
How to prepare for a recession
The most common way to invest in recession resistant multifamily apartments is through partnership/ team-based investments called syndications. This allows individuals to partner together and invest in larger, more profitable deals than they would be able to on their own.
Preparing for a recession requires building a strong base of knowledge and strategic partnerships needed to do a multifamily apartment syndication. When a recession rolls around people will be looking to partner with trustworthy people that have already proven their ability to execute. The new kids on the block will have to settle for leftovers.
One way to prepare is by building a track record before a recession occurs. Start by educating yourself on how to analyze deals, finding and networking with potential partners and most importantly taking action on an investment.
“…you should invest before a recession starts
So Yes, you should invest before a recession starts. Think of it this way, if you are unable to invest during a good market how will you survive during an unfavorable one? If capital is a limiting factor for you, consider all the [untapped sources of capital] you may be overlooking.
By the time the recession rolls around you should already know what markets to look in, who to call, and what strategies to employ or you may miss a great opportunity staring you right in the face. How much more confident will you be if you are going after your third or fourth investment rather than your first?
Investing during a recession
Just as difficult as predicting when a recession will occur is predicting how long it will last or how devastating it will be. When investing during a recession you must understand it may get worse before it gets better and choose your investments accordingly.
One of the reasons multifamily was so resilient in the last recession is because it is an income producing asset that provides one of life’s necessities- shelter. Despite this, there is still risk.
“Grow a large network and diversify
Improve your chances of a successful investment by partnering with experienced operators. Grow a large network so you can not only diversify by investing in multiple markets but also with multiple partners. Analyze investments more critically. There is less room for error. How bad can the economy get before your multifamily apartment community stops producing income or you take a loss? If there isn’t a margin of error or measures for risk mitigation in place it may be better to move on.
Look for deals that use conservative financing. That are not over-leveraged (80%+ LTV, or lower depending on risk involved) with financing that won’t force a sale at an inopportune time.
"Focus on markets with strong fundamentals
Focus on markets with strong fundamentals, diverse industry, growing populations and compelling reasons to recover quickly from an economic downturn. The residents at your apartment community should also have diversity in their work industries and employers.
Older multifamily assets or those in high distress typically have higher repair and maintenance costs. Increased economic vacancy combined with high repair costs can quickly derail an investment. If investing in such an asset, have a sizeable operating budget that factors this in.
Opportunity Awaits in the Next Recession
While there is no way for you to become recession proof, there are several strategies to becoming recession resistant. This starts with considering what you will invest in before and during a recession.
A recession resistant asset such as multifamily apartments may be the closest you get to a recession proof investment. Also, making sure you have already established strategies and partnerships in advance will give you an advantage when the inevitable recession occurs.
“Prepare rather than fear
Many millionaires built their wealth from real estate investing during the great recession of 2008. Taking the time to [prepare rather than fear] may turn the next economic downturn into the most profitable opportunity in your investing career.