4 Steps to Prepare for a Recession
Ready Up for Economic Downturns
If you’ve been watching the news lately, you’ve undoubtedly heard warnings of a pending recession and the effects that the current state of the economy is having on the real estate industry; however, the mainstream media typically focuses on the value of single-family homes or changes to interest rates. But what about long-term holders of multi-family-residential, office, retail, and industrial properties? How is the actual operation of those assets affected by possible economic downturns and what should you do (as a landlord) to position your investments wisely?
In this article, we’ve asked Coastline Equity’s CEO, Anthony Luna, to draw upon his experience as the head of a professional property management and asset management company in Southern California (one of the most dynamic markets in the country) and talk about the changes and adjustments he typically considers for his clients during more uncertain economic times.
RE-EVALUATE YOUR GOALS
The first action that any investor should take when foreseeing uncertain times is to take a step back and re-evaluate their goals (if they haven’t already been doing so, consistently). This is because the factors that typically change during tough economic times (e.g., interest rates, vacancy rates, property values, etc.) have varying degrees of impact, depending on what goals you have set for your property.
For instance, if the property you are considering is a long-term asset that provides a substantial source of income for you and your descendants, finding ways to maintain a healthy cashflow during unstable times is crucial. In this case, it may help to start investigating ways to restructure the debt on the property and lower your debt service before the economy starts to shift.
If, instead, you are more flexible with your investments, you may even consider positioning your property for sale in order to re-invest in a different asset class and/or a different market area. For example, a single investor that was previously receiving income from a small retail center (that brought in customers eager to enjoy a restaurant experience post-Pandemic) may want to consider pivoting into a small-to-medium-sized apartment building prior to a foreseeable recession. This could allow them to structure a new loan that can weather a number of years of a recession and acquire an asset that is relevant, no matter what the state of the economy.
Anthony Luna, Coastline Equity CEO, says: “The increased interest rates that we are starting to see could actually present some unique buying opportunities. Whereas those relying highly on leverage for their investments might find difficulty with an increase in rates, those who have more cash readily available may find that good deals are easier to come by.”
INCREASE YOUR RESERVES
Once you have evaluated your overall investment strategy, you will want to narrow your focus onto the specific elements of your real estate income statement. One of the first items we advise our clients to consider is the reserve amount their property holds.
As is common practice, your loan provider will require you to set aside a pre-determined amount of reserves to cover the loan payment, insurance, and taxes. In addition to that, a portion of the monthly rent that is collected is usually stored in the reserve account as well. This will build up over time and help to cover costs such as capital expenditures, basic repairs, and losses due to vacancies.
When a recession seems to be looming on the horizon, it may be wise to consider relinquishing some of the property’s net cash flow and reallocating income towards these reserve amounts. While this may leave you with less to draw from the property, it could help you navigate an economic downturn by storing funds that can be used for necessary maintenance, even when rent prices stagnate and tenants have difficulty paying their rent in the near future. Having the cushion to stay on top of small issues and prevent them from turning into big ones will reduce the risk of legal liabilities and the headaches that can follow.
Anthony Luna: “Building a larger safety net for your property when tougher times are ahead can be a great idea. As we have seen lately, the cost of goods, services and vendors have all risen dramatically. We’ve also seen the effects of global supply chain delays, increased overall operating costs, and a lack of general contractors. Add to that a limited ability to increase residential rents for existing tenants throughout California (and especially in areas such as Los Angeles). Landlords who do not thoroughly plan ahead and consider a conservative approach to making it through tougher times, will find themselves in a tough spot.”
KEEP RENTS LOW
For many real estate investors this may sound like blasphemy but keeping rents low or at least not raising them by much, just prior to a projected recession, can actually benefit you in some important ways.
First is that it enables your property to be very competitive in your local market, which helps you to quickly lease up any remaining vacancies you may still have. Second is that it encourages your tenants to stay in place, even once the economy starts to falter, because they can see that the value that they are getting will be hard to find elsewhere. Lastly (as we saw during the Pandemic), if the economy causes jobs and income to really take a hit, tenants are simply more likely to require rent relief and ask for lease negotiations when the rent they are paying is higher.
Anthony Luna: “It is important for us to build a mutual respect with our tenants, especially during tough economic times. Not only is it the right thing to do, but it makes more economical sense to keep a good tenant in place (even if elements such as lease negotiations, rent deferments, or rent abatements are considered), rather than finding a new one.”
CONSIDER SECTION 8 (HOUSING CHOICE VOUCHERS)
This one pertains specifically to residential properties. In places such as California, a property owner cannot deny renting to someone based on their source of income (1). This means that Section 8 (also known as Housing Choice) voucher holders that inquire about your vacancies must be treated equally to non-voucher holders. With that being said, you can still take the initiative and designate some of your available units as Section 8 rentals. Why would you do this? Intentionally marketing your spaces to Section 8 tenants just prior to an economic recession can help you to guarantee a continued flow of income, even when the market becomes very unstable.
We saw this during the Pandemic. This was an extreme case of tenants defaulting on their rent obligations, especially considering the protections that were put in place for them. In many cases, landlords were receiving zero dollars in rent from their tenants and had very little recourse. Yet tenants that were part of the Housing Choice Voucher program had 70% of their rent payments being delivered by the government, directly to the landlord’s bank account (2). This was a huge form of stability for landlords and tenants alike, during in an extremely volatile economic landscape.
CONCLUSION
These are just a few of the possible ways for a real estate investor to prepare themselves for rocky economic times. Did we miss anything, or do you have any specific questions that you would like to ask us? Contact us through our website at www.CoastlineEquity.net or via email at info@coastlineequity.net. With so much uncertainty and skepticism in the market today, it's certainly a good practice to consider ways in which you can withstand any changes. Working alongside a professional property management company that has been in business for over 40 years, like Coastline Equity, is one great way to do that!
RESOURCES:
- Senate Bill SB-329 Discrimination: housing: source of income. California Legislative Informations website. October 9, 2019. https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201920200SB329
- Housing Choice Vouchers Fact Sheet. U.S. Department of Housing and Urban Development website. https://www.hud.gov/topics/housing_choice_voucher_program_section_8
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