In Real Estate, There’s No Such Thing as “Recession-Proof”
The following is adapted from Billion Dollar Portfolio by
Brent Sprenkle.
You can’t avoid a recession. No one can, and as a commercial real estate investor, you’ll want to think about how the next crash will affect your portfolio.
True, you can’t plan for every possible scenario, but at some point, you’re going to be faced with a downturn and have to endure. It happens, and when it does, you shouldn’t say, “I don’t want to buy more buildings because I don’t want to get hurt in a recession.”
Everyone from every walk of life gets hurt in recessions, and there’s no such thing as “recession-proof.” Fortunately, you can prepare for the worst and weather the bad times better than most by following a few simple rules.
Don’t Become Overleveraged
The first rule of surviving a recession with your portfolio intact is to make sure that you’re not overleveraged. That means not having massive loans on your properties, typically no more than 60% of the property’s value.
When you become over-leveraged, there is probably little to no cash flow. Then if a recession hits and the property drops overnight in value and the rents also substantially drop, the building is what we call “upside down,” or the net income of the property is drastically lower than what it costs you to operate the building. In other words, your expenses are higher than your income and every month you are pulling cash out of your bank accounts to keep the property out of foreclosure.
To check your recession readiness, I recommend performing a stress test, as in run a model on your properties and see what happens if the rents drop 10–20% percent. Also imagine that your vacancies go from 3% to 10%. Ask yourself, with the loan you are thinking of putting on the property through a refinance, does it at least still break even?
If it’s completely upside down, maybe don’t be so aggressive on loan amounts. Recessions are inevitable and usually lead to higher vacancies and lower rent income. If you become overleveraged, you’re setting yourself up for failure when that recession eventually hits.
Always Have Money Saved
The second recession rule is to always have some money saved. You need that rainy-day fund to help pay for the lean years.
The bad times will come, but they will also pass, and typically massive opportunities lie on the other side. Many investors react with fear after a market crash, but if you’re willing to act, they can be a highly profitable time to buy. What do these opportunities look like?
Banks aren’t in the business of owning foreclosed properties, so they try to sell them one way or another. That means by having some money socked away, you can jump on those deals and buy while properties are selling at a discount. The truth is that there is no “perfect time” to make any financial decision.
The “right” time is when you finally decide to act, and if that time happens to be a recession, you can actually make a greater profit when the market corrects than if you bought during a booming market.
Aim to Add Value to Your Properties
There’s no way to completely recession-proof your real estate investments, but the closest you can get is by adding value to your properties.
If you’re able to increase the value, even if the real estate market drastically changes for the worse, you’re prepared to weather that storm. You are basically positioning the property to be as close to recession-proof as you can by changing the economics of the building.
Maybe you’re thinking you can simply find the property at the lowest value and set yourself up for success. However, there is no real “bottom” of the market, so it isn’t worth chasing. Instead, save some money for your rainy-day fund, avoid becoming overleveraged, and add value to your properties, and you should be able to weather the next recession better than most.
For more advice on commercial real estate investing, you can find Billion Dollar Portfolio on Amazon.
Brent Sprenkle has worked as a commercial real estate broker and investor in Los Angeles for two of the nation’s top firms, Berkadia and Sperry Van Ness, specializing in apartment sales. He brings more than twenty years of experience and expertise in assessing his clients’ real estate portfolios, helping them achieve their objectives of exchange, expansion, consolidation, and disposition. Brent has been one of Berkadia’s top ten brokers for the last six years. With more than 350 apartment buildings sold, his sales of commercial properties have exceeded $1.2 billion. He lives in Manhattan Beach, California, with his wife and four children.
