The Building Blocks of a Recession-Proof Investment Property

With recent rate hikes and Federal Reserve Chief Jerome Powell saying there are several more to come, investors should expect a recession right around the corner. Some say we are already in one, and that could be true, except that unemployment is still very low, job creation is high, banks have high reserves and corporations are sitting on lots of cash. Retail sales are strong and consumers are still spending. Plus the Fed is planning to continue raising rates, which is not what they do during a recession. They lower rates in a recession. This tells me the economy has been racing at full speed, while the Fed is stomping on the breaks. That sounds like a volatile ride, and Powell admitted it could be a hard landing. Investors need to be wearing their seat belts, and maybe a helmet and pads.

Hi, I'm Kathy Fettke and this is Real Estate News for Investors. If you like our podcast, please subscribe and leave us a review.

If you haven't recession-proofed your life yet, you better get on it. This means cutting back on unnecessary expenses, sticking to a budget and saving money so you have plenty of cushion. I was at a real estate conference in yesterday, and it seemed that a lot of people were not fully aware of how much the economy is changing and will change over the next year. Last year's strategies may not work today. In fact, strategies from the last decade may not either.

Real estate investors should take an audit of their portfolios and make sure they have plenty of reserves for potential vacancies. After all, Powell is planning to wipe out a million jobs, at least. With that said, times like this can offer some of the best opportunities for investors.

We are seeing it already, as there is far less competition in the market. That's why I've launched a single family rental fund in North Texas where job growth is not slowing down. The Biden Administration wants chip manufacturing to come back to the U.S., so chip manufactures are headed to North Texas to build their factories, along with many companies escaping high tax/high regulation states like California. You can find out more about the massive job creation in North Texas, and our new fund at https://www.GrowDevelopments.com. It's a Reg D 506C.

When buying property in today's market, I stick with four building blocks that I've found to be resilient in any economy. Let’s call them the legs of a chair. (1)

Job Growth

The first leg is “job growth.” Today, it's not too difficult to find markets with job growth.

This year, companies created an average of 450,000 new jobs every month, compared to less than half that amount during the decade before the pandemic. There are now more than 11 million job openings. As investors, it's important that we understand where those jobs are. It's also important that the metro area be well diversified with employment opportunities, and not dependent on just a handful of industries that could be affected in a downturn.

According to John Burns Real Estate Investing, the top 5 markets that have had the highest growth of high paying jobs are Las Vegas, Dallas, Jacksonville, Austin, and Atlanta. Metro areas that have more high paying jobs today than before the pandemic are Austin, Dallas, Jacksonville, Raleigh-Durham, and Tampa.

When you are looking for a place to buy investment property, make sure the job growth we are seeing at the national level is also happening at the local level, because… where there are jobs, there will also be population growth.

Population Growth

That leads us to the second leg of the chair: “population growth.” Right now, there’s a whole generation of young people, the largest in U.S. history, ready to settle down, start families, and buy homes, or rent if they can’t afford to buy.

This generation is also highly educated and good with technology, so many can work remotely. That’s something to take into consideration when you are looking at migration patterns. You can check migration reports from U-Haul and Atlas Van Lines to see which metros are attracting the most newcomers. Texas and Florida have been at the top of that list.

You can also see which metros are losing more people than they are attracting. Those are the metros you might want to avoid. Lately, we’ve seen a lot of movement from the Northeast to the Southeast, and from the West Coast to the Northwest or further inland, like Arizona, Colorado and Texas.

Affordability

The third leg of our chair is “affordability.” Home prices have surged, along with interest rates, making it tough for first time home buyers to afford a home so they are forced to rent. Landlords can provide housing that is affordable to these want-to-be homeowners, solving one of the biggest problems today. In order to find property that a renter can afford, be sure to understand the average income of the area. Rent should be 3-4 times less than monthly incomes.

You can determine home-buying affordability by comparing the average mortgage payment to the average income of the area. Income should be 3-4 times housing costs to be considered affordable. If affordability is way out of whack, we can expect a price correction in those markets.

Every metro area has different insurance and tax rates, so be sure that the property you plan to purchase cash flows after all expenses. And again, have plenty of reserves in place for potential vacancies and repairs. I like to set aside 6-12 months rent in reserves. On older homes, I use 7-10% of rents set aside for potential repairs. If you want to be extra cautious and the property hasn't been updated, set aside funds for new roofs, plumbing, electrical and HVAC systems as they can be pricey when it's time to replace them. Newer homes generally don't need as much repair, especially if you have a home warranty.

Infrastructure Growth

The fourth leg of the chair is “infrastructure growth.”

As much as I love cash flow, I like appreciation even more. After all, if you purchase a rental property for $200,000 and put 20% down, that's $40,000 invested, plus closing costs. If the property increases in value by 5%, that's $10,000 or 1/4th of your down payment. You have loan pay down, cash flow and tax deductions on top of that!

Appreciation is speculative, as we have no idea if prices will continue to rise. However, if a metro area is investing heavily in its growth, you can expect there will probably be future appreciation. If new freeways, hospitals, and schools are being built, the city planners are expecting growth. Generally, values increase over time in the "path of progress."

For example, when we bought properties in Rockwall, Texas in 2005 and 2006, this was technically the top of that market cycle. We were still happy to buy properties, even though we were paying close to retail, because they cash flowed. More importantly, we knew there was high job and population growth nearby - in fact, the highest in the country. Additionally, we knew a new freeway was being built nearby, making the commute to those jobs much faster.

Texas hadn't been know for appreciation at all at that time, and we weren't buying for appreciation, but we also expected prices could rise due to all the growth. Sure enough, we paid between $120,000 and $150,000 for new homes in Rockwall. Today they are worth 3 times that.

Investing in cities that are investing in themselves is an important part of the formula, especially in today's environment. Beware of cities that are losing jobs and losing population.

Finding a Rental Property

Once you have found a market with all four legs of the chair, and you want to find an investment property, consider working with an agent who specializes in real estate investment properties. They will understand the rental market better than a retail agent. Even better, work with someone who owns rental properties in the area. They will really understand rental demand, cap rates and what to look for in a rental property vs retail.

Types of Rental Properties

Some properties perform better than others during a downturn.

Single-family rentals or SFRs have been extremely popular in recent years, especially during the pandemic. Many people moved out of apartments in search of stand-alone homes because they wanted more space to go outside and to work from home. Now, higher home prices have left many potential buyers still wanting a single-family home, even if they have to rent it. With supply still half of what it should be to meet demand, rents will likely stay strong.

However, returns on short-term rentals is starting to decline. This may be partly due to the increase in supply vs waning demand. You’ll also pay more for management, cleaning and maintenance. Local rules and fees for short-term rentals can also present a challenge.

Multi-unit buildings have traditionally performed well during recessions, because rents tend to be more affordable than single family homes. There’s also an advantage to financing a multi-family property because you will have more income-producing units with just one loan. However, the LTV's requirements today are much lower so prepare to put more money down, and definitely have plenty of funds in reserves.

Condos will be the least expensive to purchase, and thanks to the homeowners association, will be easier to maintain. The HOA might place more limits on what you can do with the property, so you need to check the rules ahead of time. Be aware that HOA fees can be high, wiping out cash flow. They can also be harder to finance. Older condo units may have deferred maintenance, so be sure to check the HOA minutes so you don't get stuck paying an extra assessment. HOA's should have plenty of reserves on hand to cover maintenance issues.

Storage facilities tend to do well during downturns, as people may need to downsize but don't want to sell their things. Mobile home parks and RV parks seem to cash flow well in any economy.

That’s a very short list of reasons to consider one type of rental over the other. They key to making any of them work is finding good property management, especially if those rentals are located far from where you live. If you are new to investing, leave the property management to the pros. Otherwise, you might have some big learning lessons along the way. Every city has different landlord laws, so if you do self manage, make sure you know the rules.

Financial Analysis

Owning rental property is a business, and must be treated like a business. Good financial book keeping is imperative. This is why owning rental property is somewhat passive, but not completely. You have to pay attention to your investments and make sure you have the right loans, insurance and property management in place.

Many people are simply too busy with their own businesses or jobs, which is why investing in a fund can give you the same benefits of tax savings, cash flow and appreciation, but someone else does the work for you. That's why we created our North Texas fund. You can find out more about that at GrowDevelopments.com.

If you want more information on how to build your own real estate portfolio, visit newsforinvestors.com. You’ll find in-depth articles that will help teach you how to invest in real estate. You’ll also find data on various markets and other resources to help you get started.

And please remember to subscribe to our podcast, and leave a review!

Thank you! And thanks for listening. I'm Kathy Fettke.

Links:

1 -https://www.youtube.com/watch?v=IXtWrY35dG0

2 -https://www.bankrate.com/mortgages/how-to-establish-a-rental-property/