“Invest during a pandemic? Are you crazy?”
That’s a reasonable question. Why would anyone want to invest in a volatile market and in the midst of economic uncertainty?
But recessions create opportunities. Yes, it’s terrible that millions have lost jobs and suffered huge portfolio losses, but the unfortunate reality is recessions happen. Like it or not, this is our current situation. By looking at the market and asking “what opportunities can I find?,” we contribute to the recovery.
We contribute to the recovery in all types of investments: stocks, real estate, side hustles.
When we buy stocks, we infuse capital into companies that we believe in and/or into the market as a whole.
When we buy, renovate and rent properties, we create jobs for contractors, agents and property managers and we offer our tenants a safe, comfortable and well-maintained home.
When we start a side hustle, we build products or services that thrill our clients and create jobs for our team.
When we invest, we participate in the recovery. Recessions are an unfortunate fact of life, but they carry a silver lining. And for newbie investors in particular, recessions can open the door.
Unfortunately, during times of uncertainty, many people surrender to their fear of investing. They sit in cash until it’s too late.
To be clear, I’m not talking about people who don’t have the capital to invest. If someone is financially unstable — if they lack an adequate emergency fund, for example, or if they’re buried in high-interest credit card debt — then they should be applauded for focusing on the fundamentals first. Build the foundation; everything else rests on that.
But many financially stable people will sit on excess piles of cash.
I get it. Investing is scary during a recession.
It’s normal to feel scared of buying index funds, only to watch them drop the next day. It’s natural to feel scared to start a side hustle, when you know this is a tough time for small businesses. It’s normal to feel scared about buying a rental property; what if your tenants lose their jobs?
But by sitting on too much cash, you miss the opportunity to pick up undervalued deals.
You also miss the chance to start building momentum, so that when the economy starts rebounding, you’re already established. You’ve started the side hustle. You own the rental property. You’re not scrambling to get started after the recovery is underway; your projects are in place.
You might not have enough cash to buy cheap assets at this moment. That’s okay. Focus on the fundamentals (like building an emergency fund) and don’t worry.
If you’re fortunate enough to be able to invest, though, don’t sit out this opportunity due to fear.
We discussed stocks at length in this podcast episode, and we talked broadly about how to finish 2020 financially stronger than you started in this episode.
In this article, we’ll focus on real estate.
Should you invest in rentals during a pandemic? Might we see another housing crash, 2008-style? Is this a good time to buy? To sell? Let’s explore.
“Is the real estate market going to crash again?”
Have you heard of the availability heuristic?
It’s defined as “the tendency to overestimate the likelihood of events with greater ‘availability’ in memory.”
We overvalue examples that can easily come to mind, while we undervalue examples that are harder to imagine or recall.
If something happened recently or if something is emotionally charged, then it’ll easily come to mind. And if it easily comes to mind, we overestimate the likelihood that it’ll happen again.
Prior to the pandemic, the 2008 housing crash was the most recent recession. It comes to mind quickly: it was recent and suuuuper emotionally charged.
And so it’s natural — it’s logically flawed, but natural — to assume that this current recession will resemble the last one, to overestimate the likelihood of another housing crash.
But the factors that led to the 2008 recession (subprime lending, speculative building, shady credit-default swaps) are nothing like the factors that led to the 2020 economic collapse (a deadly virus).
The Great Recession was created by weakness in the housing market. The chain of events in 2008 wasn’t: “a recession struck, therefore home prices collapsed.” It was the opposite: “home prices collapsed, therefore recession struck.”
If you started investing before the 2002 dot-com burst, or if you were already an adult during the 1987 market crash, you’ve experienced bear markets that didn’t coincide with a housing crash. But if you’re under 40, the Great Recession was the first major recession in your adult life.
If that’s your situation, then it’s especially tempting to associate recessions with real estate crashes. After all, as a millennial, 100 percent of the recessions of your adult life — 1 out of 1!! — have been tied to a massive real estate crash.
But that was a dozen years ago. The underlying economic factors are different today.
There may or may not be a temporary slight dip in housing prices. (I doubt it, but it’s possible.) If that happens, clickbait headlines will refer to this minor dip as a “crash,” because that’s eminently more clickable. Don’t be fooled by the phrasing.
Study the housing market. Read the price-per-square-foot declines. Look at the average days-on-market of homes for sale. Scan for the number of new mortgage loan originations. This data will tell you far more than any screaming headline.
“What if my tenants can’t pay rent?”
Let’s look at statistics:
In a normal market, around 20 percent of tenants are late in paying their rent, according to data from the National Multifamily Housing Council, which tracks 11.5 million apartment units nationwide.
In April 2020, that number increased from 20 percent to 31 percent. That’s not as bad as many landlords feared.
- In normal conditions, 80 percent of tenants pay rent on time, and 20 percent are late.
- In pandemic conditions, 69 percent of tenants pay rent on time, and 31 percent are late.
But wait! It gets better.
The NMHC surveyed apartment managers again one week later. They found a huge improvement: 84 percent of apartment households paid rent by April 12th.
Tenants might not be able to pay rent on the 1st of the month. But the overwhelming majority — 84 percent — were able to pay after a delay of less than two weeks.
As far as the data shows so far, worries that tenants won’t be able to pay rent have largely not come to pass. Most tenants are still able to pay rent; they just need extra time.
(The NMHC noted that a huge number of apartment managers volunteered to waive late fees or offer flexible payment plans.)
That said, millions of people have been helped by a combination of stimulus checks, enhanced unemployment benefits (which currently provides an extra $600 per week in addition to normal state unemployment benefits), or payroll protection if either they or their employer qualifies for Paycheck Protection Program funds. Will these programs get renewed or extended? What will happen if they don’t? There are many lingering questions, and the future remains to be seen.
The simple truth is that nobody can accurately predict the future. We can look at data about our current situation, and as of now, we know that 84 percent of tenants (out of 11.5 million household units) paid rent within two weeks of its due date. But we do not know if or how that number will change in the future. Variables that cannot be predicted — such as the speed of recovery, the level of government intervention — will play a major role in shaping these answers. We don’t know how those variables will take shape.
The greatest risk is assuming that we know the future. Beware of certainty. Those who pretend to know the future are clinging to security at the expense of honesty and accuracy. Don’t listen to any economic or market projections that are expressed with too much confidence. We don’t have a crystal ball. Nobody knows what the future holds. The wise ones recognize this and accept it.
We cannot state what will happen. We can only state what IS happening. And from that, we make preparations for what is and what might be.
“What risks should I be wary of?”
Of course, there are serious risks ahead. We do not know:
- … how long the pandemic and global shutdown will continue.
- … how long such a large portion of the population will remain unemployed.
- … how many employees have had their hours reduced or accepted a temporary paycut, and how this will reverberate throughout the economy.
- … how long the recovery will take.
- … whether or not there will be a tragic second wave, or third wave, which triggers an unavoidable second or third shutdown.
How can you approach smart real estate investing in this context?
Here are a few Do’s and Don’ts:
Don’t avoid investing. The people who made that mistake during the Great Recession — those who avoided making new investments from 2009-2012 — missed out on massive, opportunity-of-a-lifetime recovery gains.
Do thoroughly analyze any new rental investment that you’re eyeing. Run a variety of “what if” scenarios on a spreadsheet, crunching the numbers with different assumptions.
What if occupancy rates fell by an additional 10 percent? What if you reduced the rent by 20 percent for the next six months? How would this affect your returns?
In our course, Your First Rental Property, we provide robust, detailed spreadsheets for heavy number-crunching.
We teach our students that the cliché thrown around by other investors — who tell you to “calculate the return” — is too simplistic.
You’re not calculating “the” return; you’re calculating a range of possible returns.
You’re not stubbornly insisting that a given rental property will have an 8 percent cap rate. You’re calculating a range of cap rates in best-case, worst-case and middle-case scenarios.
Unfortunately, there are sellers who will advertise properties as having an “X” cap rate, and there are investors who take that information as a fixed number. That’s baloney.
Properties don’t have a single fixed cap rate; they have a range of cap rates, and we teach our students how to assess this range before they commit to a six-figure investment.
Don’t over-leverage. You don’t need to borrow every penny you qualify to receive.
Ignore the real estate investors who are fixated on cash-on-cash return, a popular formula that inherently rewards overleveraging.
Instead, focus on an investing strategy that prioritizes the property’s cap rate (essentially its dividend stream). This is the investment philosophy and strategy that we teach in our course.
Do maintain strong cash reserves. We teach our students to keep a minimum of three months’ gross rent, which translates to six months of operating expenses.
Don’t jump in without a specific, carefully-thought-out written plan. Before you start investing in rental properties, write your personal investor statement.
Your written investment statement should articulate how many properties you want to purchase, the speed or rate of acquisition, the type of financing you want to use, your ideal debt-to-equity ratio or leverage maximum, the type of neighborhood you want to target, the age and condition of properties you want to purchase, and more.
We provide a fill-in-the-blank template to guide you through this exercise in our course.
Do prepare a variety of ways that you can accommodate tenants who are financially struggling. Here are some examples:
Offer an incentive:
Offer your tenants one month of free rent — which they can use immediately — if they extend their lease by an additional year.
This is a win-win scenario. You’re spared from the costs of a turnover and vacancy. You pass these savings directly to your tenant.
Waive late fees:
If your tenant is waiting on unemployment benefits, they may not be able to pay rent on the 1st of the month. That’s fine; they’ll have the money once their benefits arrive.
Offer to waive late fees, under the condition that they stay communicative.
You want to avoid a tenant ‘ghosting’ you, screening and dodging calls from you or your property manager.
You can avert this situation by (1) letting them know you’re flexible and accommodating, and (2) telling them you’ll waive late fees as long as they send you frequent updates about their situation, like a quick text message or email, every two to three days.
Set specific and measurable communication criteria, such as: “Please text me with an update at least once every three days, even if your text is as simple as ‘hey I’m still waiting on my benefits to start’.”
Spread the payments:
Another option? If your tenant is waiting for their unemployment benefits to arrive, offer to spread next months’ payment across the rest of their lease.
Let’s say their rent is $800 per month, and they have 9 more months remaining on their lease. In this example, they would pay $0 next month, and their rent would rise by $100 per month for the remaining 8 months.
The Bottom Line: Recessions are tragic, but they also carry the hope and promise of a recovery. If you have money to invest, don’t let fear hold you back. Invest in the market, start a side hustle, or invest in rental properties. Don’t let another year or two slip by, and then scramble to get a foothold after the recovery is well underway.
Our flagship course, Your First Rental Property, opens for enrollment again on Monday, November 30th.
Learn about the course in this video below, or check out this page for FAQs, testimonials, and your chance to join our VIP waitlist. When you join, you get a free 7-day crash course on the fundamentals of residential real estate investing.
If you’re interested in investing in rental properties and want an A-to-Z guide of everything you need to know, learn all the details here.
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Source: affordanything.com