When a recession takes hold, your first instinct may be to do some strategizing with your portfolio.
Seeking out recession-proof investments can help balance stock holdings.
Rental properties can act as a natural hedge against market volatility, but is real estate a good investment in a recession? That depends on whether you're taking the right approach.
"Real estate is more stable than many other investments when the economy slows down," says Jeff Checko, a real estate broker with Ashton Real Estate Group of RE/MAX Advantage in Nashville, Tennessee.
"Demand for rental properties actually goes up during a recession because if homeownership is down, then people have to live somewhere," Checko says. Assuming tenants are able to keep up with their financial obligations, a rental property could provide a steady stream of passive income even when the stock market is down.
Recessions can also make getting into the landlord business easier if property values drop.
"If you're looking to purchase a new investment property, a recession means you're going to get that property at a discounted price," says Mark Zawaideh, CEO of MARK Z Real Estate Experts in Detroit.
That's a plus if you have limited capital to invest in a rental property or you're interested in purchasing more than one property to create multiple income streams.
"It's nearly impossible to time out exactly when the market will hit the bottom or the top, but if you're making deals in the in-between area, there is money to be made," Zawaideh says.
As with any other investment, it's important to have a plan when incorporating rental properties into your portfolio and even more so during a recession. There are some unwritten rules to follow to help ensure that your rental property investment pays off. Keep these tips in mind:
-- It's still mostly about location, location, location.
-- Consider cash flow.
-- Follow the rules when using IRA funds to invest.
-- Research deals thoroughly.
Location, Location, Location
In evaluating rental property investments for a recession, always get the full lay of the land.
"When purchasing an investment property in a recession, the key rule is 'don't buy the house, buy the location'," says Ryan Shuchman, partner at Cornerstone Financial Services in Southfield, Michigan. Specifically, that means scouting out areas that have stable employment bases and a positive job growth outlook.
Job scarcity can throw a wrench in your rental income plans, so it's important to test the economic waters before you buy. "If your tenants are out of work, they can't pay rent and may move to areas where jobs are available," Shuchman says.
Lifestyle is another factor to consider when choosing a location.
For example, Zawaideh says areas that are walkable or close to downtown have grown more desirable for renters. If a recession doesn't shift renters' desires dramatically, investment properties in those areas could prove profitable.
Consider Cash Flow
Keeping cash flow in sight is another important rule for how to invest in rental property during a recession.
If you want to add a rental property to your portfolio in a market downturn -- while still erring on the side of caution -- look for properties that are still cash-flowing, Zawaideh says. "In other words, property that still has cash coming in after taking out expenses and the mortgage payment."
Cash flow rental properties can help to minimize risk during a recessionary environment. Zawaideh adds that if you've bought in at the bottom of the market, the only place to go is up.
While cash flow properties can be attractive, don't overlook the need for cash reserves when buying a rental investment.
"In a recession more than other times, there may be more of a delay between acquiring the property and getting it to a position to generate income," says Christopher Rogers, partner at Capital Fund Law Group. Having liquid cash available can help cover expenses in the meantime and minimize the need to try to obtain capital through a lender.
Follow the Rules When Using IRA Funds to Invest
Getting a loan is one option for funding a rental property purchase. During a recession, lenders tend to tighten the purse strings, making it harder to borrow.
In that scenario, using a self-directed individual retirement account to purchase an investment property could make sense and offer some tax advantages. That said, there are some guidelines to keep in mind.
"It's important to remember that investing in real estate using your retirement funds comes with some strings attached," says Kelli Click, president of STRATA Trust.
First, the property in question must be an allowable investment. That includes vacant lots, raw land, single-family or multi-unit homes, apartments, townhomes, condos and foreclosures. Mobile homes and timeshares, on the other hand, are generally excluded.
Next, there are regulations regarding the property's use. "IRS rules do not allow you to live in or use a property owned by your IRA," Click says. Furthermore, any improvements or repairs to the property can't be made by you or by a company that is owned by you or another disqualified person.
In other words, if you run a painting business, you'd have to outsource painting your rental property to someone else. Otherwise, you'd forfeit any tax benefits associated with owning real estate inside an IRA.
Finally, remember that things like maintenance, repairs, property taxes and even your earnest money deposit when buying the property must come from the IRA to avoid triggering tax consequences. For that reason, it's important to make sure you're planning ahead properly if you're considering using a self-directed IRA to buy a rental investment.
"The best way to prepare for any property-related expenses is to ensure your IRA has sufficient funds to cover them," Click says.
Research Deals Thoroughly
A good rule of thumb for how to buy a rental property during a recession or at any time is that if something seems too good to be true, it probably is.
"In a recession, there will likely be a number of owners trying to unload properties that they can no longer maintain or afford," Rogers says. While this means you could scoop up some bargains, don't skip out on due diligence.
Rogers says real estate investors should be on the lookout for red flags, such as a lack of income, poor location, tax or other liens and an obvious lack of maintenance or upkeep. Getting a detailed inspection, checking court records for liens and researching rental trends for the area can help you gauge an investment property's short- and long-term potential.
And if you come across what looks like a great deal, ask yourself why the property is for sale to begin with, Shuchman says. "Don't buy someone else's problem child."
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