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How Does an Economic Recession Affect Real Estate Investing?

Experts believe there may be an economic recession on the horizon.

And yet, I’m confident that this will be an evergreen article.

That’s because there are always experts who suspect that a recession is on the horizon. The economy is a big, complicated thing, and even our top experts frequently and intensely disagree with each other about the economic mechanics in play and how they might develop into the future.

Still, regardless of economist opinions, economic recessions are always a possibility – and are something you’ll need to consider in your real estate investing strategy. Since recessions are associated with unemployment, lower wages, and stagnating growth, most people believe them to be purely bad economic forces.

But while it’s true that there are some drawbacks associated with real estate investing during recessionary times, there are also some advantages for strategic and opportunistic real estate investors.

Defining an Economic Recession

First, what exactly is an economic recession?

If you ask 10 different people, you’ll probably get 10 different answers.

Generally, people use the term “recession” to describe any extended length of time in which there are economic problems. Under some definitions, an economic recession occurs when a country experiences two consecutive quarters of negative GDP growth, with GDP being gross domestic product, or the total amount of goods and services produced within a country. Essentially, this means that if a country produces fewer products and services for two consecutive three-month periods, it’s considered to be in a recession.

However, some economists and organizations intentionally define economic recessions differently, sometimes to avoid having to take accountability for an economic recession. As a purely hypothetical example, a Presidential administration may intentionally change the definition of an economic recession after experiencing two consecutive quarters of negative GDP growth, hoping to avoid negative publicity.

Not that that would ever happen in real life…

To be fair, the GDP definition isn’t a perfectly reliable one. That’s because GDP only accounts for a very small picture of the national economy. We also need to consider factors like employment rates, wages, stock market performance, and even general sentiments. After all, if unemployment is low, wages are high, and people are generally enthusiastic about how things are going, how is it fair to say that we’re in a recession?

Because of this, it’s difficult to come up with a concrete, reliable definition – and any definition we do come up with is contestable. For the purposes of this article, we’ll define a recession as any extended period (at least several months) of the economic turmoil, generally including half or more of the following: negative GDP growth, rising unemployment, stock market declines, stagnating wages, and pessimistic economic attitudes.

Keep in mind that the length of a recession varies, and not in predictable ways. Some recessions only last a few months, barely meeting definitional requirements, while others can last for a few years. That said, historically, most recessions are over within a couple of years, long before spiraling into a full-on depression.

Possible Effects on Real Estate Investing

So what are the effects of a recession on real estate investing?

  •       Interest rates. Interest rates have a powerful effect on real estate investing dynamics, and in several ways. The Federal Reserve establishes the target federal funds rate, which dictates the interest rate at which member banks can borrow from the central bank of the U.S. Because this rate affects how banks borrow money, it directly influences mortgage rates and other consumer interest rates. One of the main reasons why the Fed has such power to manipulate interest rates is because it allows them to exert some economic control; during recessions, the Fed often cuts interest rates significantly to encourage economic activity. Essentially, this means that in the early and middle stages of a recession, we usually see lower mortgage rates – and an environment that favors holders of good debt (a bit more on that later).
  •       Available capital. Capital can be a problem in a recession. If you lose your primary job, or if you lose significant value in your stock holdings, you may not have enough money to fund your real estate purchases. However, many other people will likely be in a similar position, ultimately driving down competition and preventing real estate prices from rising; in some recessions, real estate prices actually decline because so many people are unable to afford buying houses.
  •       Jobs and stability. The economic instability associated with recessions can make it difficult to predict how they unfold. There are several dynamics in play here. For example, if lots of people are losing jobs due to economic conditions, they may feel increased pressure to sell their houses, allowing you to buy real estate at a discount. But at the same time, if unemployment is spiking, you may have difficulty finding a tenant interested in moving to the property.
  •       General pessimism. Even people who don’t follow economic news and aren’t generally aware of market dynamics understand that recessions are a bad thing. Even if the rest of their life is relatively unscathed by the recession, constant news and commentary about the recession may force them to change some of their behaviors. In many cases, this means fewer real estate buyers are active.

Investing in Real Estate During a Recession: The Benefits

From the perspective of a real estate investor, there are many potential benefits of investing during a recession:

  •       Lower prices. The housing market functions somewhat independently from the rest of the American economy; during the Great Recession, we saw greatly plummeting real estate prices, but that’s because of a unique situation. In fact, the housing market crash is what primarily led to the recession in that scenario. Still, due to less available capital, less economic stability, and general pessimism, there are usually fewer people interested in buying houses, which keeps prices down. In some cases, this can present excellent buying opportunities.
  •       Lower interest rates. Though there are some exceptions, the Fed typically decreases interest rates in response to unfavorable or unpleasant economic conditions. Downstream of this, mortgage rates become lower, allowing savvy investors to take on more financial leverage and buy new properties. Just be careful not to over leverage yourself in the process.
  •       Less competition. It’s hard to see an economic recession as an opportunity, since many people grow fearful and conservative in response to seeing the decline of major economic metrics. This includes even experienced real estate investors. If you’re tired of getting outbid by competitive investors, a recession could be an excellent opportunity to avoid them.
  •       Inflation. Nobody likes to pay higher prices at the grocery store, but there’s no denying that there are some benefits associated with inflation, especially for experienced real estate investors. Inflation represents the devaluation of our currency, so any good debt you hold in that currency also loses value. In short, holding significant debt while inflation rates are high can help you build a much better financial position in the long run. Recessions aren’t always associated with inflation, but they are commonly associated with lower Fed interest rates, which tend to cause inflation to spike.
  •       Potential bounce back. So far, every recession in American history has been temporary, and very commonly, things return to normal after two years or less. If you purchase real estate during the decline, you’ll likely see significant growth when the market bounces back. And if you hold your real estate through the dip, it’s likely that you’ll eventually see a return to your normal growth trajectory. Just keep in mind that this isn’t a guarantee, and past performance isn’t always an indication of future performance.

Of course, it’s still your responsibility to do your due diligence before making any real estate investing decision.

Investing in Real Estate During a Recession: The Complications

There are some downsides and complications associated with real estate investing during a recession, however.

  •       Less capital. For starters, you and other investors may have less capital to work with. If a good chunk of your portfolio is tied up in stocks and real estate, you could easily lose a significant portion of your net worth during the downturn. This means you won’t have as much financial flexibility as you would before, which can be problematic even if prices are also down. The good news is that you can usually make up for this by taking out bigger loans, assuming you still have enough for the down payments you need.
  •       Lower equity. Any real estate you currently own may decline in value during a recession, though this isn’t always the case. Lower equity deprives you of the value of certain financial tools, like a home equity line of credit (HELOC), which allows you to borrow money against the existing equity of your properties. If you’re interested in snowballing your real estate portfolio or tapping into equity as part of your strategy, this can be a major weakness.
  •       Higher risk. Buying and managing real estate during a recession does present higher risk in a few different categories. For starters, the dangers of over leveraging are much more severe, as if you’re forced to sell off properties, you may have to do so at a loss. Additionally, because the economic environment is generally unfavorable, you may have a harder time finding qualified tenants to rent your place. Some specific neighborhoods may also be negatively affected by poor economic conditions, suffering from higher crime rates or other related problems.
  •       Potential for further decline. Sometimes, economists can’t even agree on whether a recession even exists – and they certainly won’t be able to agree on whether the recession will continue or turn around in the foreseeable future. It’s true that most recessions have recovered by themselves after several months to a couple of years, but this isn’t a guarantee. Buying during a recession, especially early on, could open you up to further decline.

Any Time Is a Good Time to Invest (Sort Of)

So is it a good thing or a bad thing to invest in real estate during a recession?

Well, it’s both. And it’s neither.

The reality is, real estate investing isn’t something you can reduce to overly simplistic, universal axioms – and if it was, everyone would be in it. Real estate investing, like the economy, is something complicated and hard to fully understand even for seasoned experts.

But the flip side of that is that almost any time can be a good time to invest in real estate if you know what you’re doing. There will always be local markets thriving. There will always be available inventory. There will always be deals to sniff out. What’s most important is that you understand all the variables and the full context of each real estate investing decision you make, so you can make the most of whatever conditions are available to you.

Are you considering stepping up your real estate investment game?

Or are you concerned about how your portfolio is going to perform in a recessionary environment?

Invest.net has the advisors to help. Contact us for a free consultation today!

Derek Bryan
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