Is buying real estate investment in the beginning of a recession a mistake?

Question:

Right now, I’m in the middle of a home purchase. The price negotiated ended up at nearly $30k under asking, and that’s before the coronavirus stuff starting getting real.

This morning I saw an article speculating that this virus may soon cause another housing market crash. I am terrified both of closing this deal, and of backing out. I’m just afraid of getting into the property, seeing a major crash, and then having the property’s value never recover.

I know news stories tend to be sensationalist, but I want to know, from a Realtor’s perspective, would you buy an investment property right now?

Tom Barron

Quick answer: I’d be cautious and work the numbers. But if the numbers work, I’d go ahead and buy.

Longer answer: There are many factors involved here, some of them unique to investment properties. Here are some considerations.

Cash Flow

Investors primarily buy properties for cash flow, not for appreciation. Appreciation is nice, but it shouldn’t be the major consideration. I know investors who are doing very well with properties that aren’t appreciating. They may never appreciate. And the investors don’t care.

The goal, simply, is to take in more in rent and other rent-related income than is being spent on the rental property. (We’re leaving aside the issue of depreciation which, in itself, can turn a positive cash-flow property into one that, for tax purposes, shows a loss.)

So the first step is to work the numbers. On the expense side, what are the monthly mortgage (principal, interest, taxes, and insurance) costs? Factor in a repair/maintenance figure. Very rough rule of thumb: 1%-2% of a property’s value per year. So a $300,000 property might—again, very roughly—have a repair budget of $3,000-$6,000 per year…or $250-$500 a month. Factor in vacancy costs. Most investors factor in 1 month per year. So if you’re charging $1,000 a month in rent, factor in a vacancy cost of $1,000 a year, or $83 a month. If there are other costs: condo fees, HOA fees, management fees, and so on, be sure to include those, too. Subtract the expenses from the income. What’s left is cash flow, and it should be large enough to provide a reasonable return on investment.

That’s what any investor should do with any property, coronavirus or no coronavirus.

Clearly, the other half of the equation involves rental income. Who will be your renters? How stable is their income? Is the property in a stable area? Is it strengthening or declining?

For example, I’d be cautious about buying investment properties in areas that are likely to be affected by the virus. Example: Close to a Boeing assembly plant, especially if the property’s renters are likely to be Boeing employees. It could be difficult around tourist destinations such as Las Vegas or Orlando. That’s for perhaps the next year. (On the other hand, I know investors who made a lot of money buying Las Vegas property during and after The Great Recession—around 2010 or so. But that gets into appreciation, which we’ll deal with in a moment.) The immediate concern is the economy of the area—and in some cases that may be as targeted as something within a 5-10 mile radius.

Remember that rent stability has less to do with the affluence of an area than with the stability of the income of the residents. That’s why some investors love Section 8 housing. They know that the government will pay most of the resident’s housing costs. That, too, provides a massive incentive for the residents to pay their share. If they don’t, they lose their housing and the government’s contribution to their rent. Section 8 landlords may worry about wear, tear, and maintenance on their properties. But they don’t generally worry about getting their rent on time.

So the two main points to keep in mind regarding cash flow are:

  • Buy an investment property based on its anticipated/calculated cash flow.
  • Buy an investment property in an economically stable area, one in which renters will have income stability.

Appreciation

Appreciation is a bonus. It shouldn’t be the major factor in deciding whether to buy a property.

Over time, most properties will appreciate. Still, the rate of appreciation has slowed over the past decade, and appreciation really varies by region, state, and municipality. See The truth about real estate market article for two perspectives on the issue.

Further, the rent paid by tenants will help reduce the size of the mortgage, thus increasing the investor’s equity in the property. On Wall Street, it’s often said that you can’t time the markets. Real estate is somewhat different. It does run in cycles—generally, about 14 years. Here’s a fairly typical chart

Source: www.strategicinvestmentrealtors.com

Although the housing market hasn’t followed this typical curve in the past month, nor is it likely to in the next several months, note that the Buyer’s Market occurs during a downturn and at the trough of the curve. And as noted above, anecdotally I know quite a few investors who bought in the 2008-2010 timeframe and have done extremely well.

That raises the question of whether you’re overpaying for the property you’re buying. It’s impossible for me to tell. Although getting a price that’s $30,000 under what was initially asked sounds great, and it may be, it’s no guarantee in any market that you’re getting a bargain. So I can’t reassure you on that point. But if you got a good deal—that is, if you did get it for under-market—and the numbers work vis-à-vis cash flow, then I don’t see a good reason not to proceed.

You say: “I’m just afraid of getting into the property, seeing a major crash, and then having the property’s value never recover.” That’s an understandable concern but, as we saw during past recessions, prices have recovered. It may take years (my guess is, if there’s a sizeable decline, maybe three-six years), but they will recover and, meantime, you’re still getting positive cash flow. Keep in mind that people need somewhere to live. It may be in rental or owned housing. It may be in single-family homes, townhouses, or apartments. So you may see more appreciation in some housing units and less in others. But prices have always recovered.

And here’s a very small excerpt from a long post by the head of a turnkey rental company. The company buys rental houses, usually just fixed up, and sells them to investors…often with tenants already in place. The posting is here: Impact of Corona Virus Pandemic on the Real Estate Market. Honestly, I don’t agree with some of his predictions and—because he sells turnkey rentals—he’s got a vested interest in saying that things will work out well. Still, the posting makes some valid points:

  1. The coronavirus will have a positive impact on the U.S. real estate market if interest rates remain low and the return to normalcy is only a few months away. And residential real estate is likely to fare far better than the commercial real estate sector.
  2. Sometimes, you have to take advantage of these market disruptions to see that many investors will pump the brakes on investing out of fear and other illogical emotional reasons, while others see the opportunity of having access to more real estate inventory, possibly better pricing, and still historically low-interest rates.
    So hang in there and don’t let your investment strategy and goals get derailed by the media hype, and emotional hysteria you see today. Stay focused on opportunities and let the dust settle as it always does.

Conclusion

Double-check your income and expense numbers. And talk to your real estate agent, particularly about whether the price you’re paying is still a good price (do the comps still support it) and whether your projected rental income is reasonable.

If everything still checks out, I’d be inclined to proceed with the purchase.