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.