How a Recession Can Be an Incredible Buying Opportunity
Legendary investor Warren Buffet once said that it is wise to “…be fearful when others are greedy and to be greedy when others are fearful.” This quote is helpful for all investors because it highlights something that he knows from decades of experience – that recessions and economic downturns can be a phenomenal opportunity to generate outsized returns.
In this article, I am going to define what a recession is, why they happen, and how they can be an incredible opportunity for investors well positioned to take advantage of them.
I’m Rod Khleif. I am an entrepreneur, real estate investor, multiple business owner, author, mentor, and community philanthropist who is passionate about business, life, success, and giving back. As one of the country’s top real estate trainers, I have personally owned and managed over 2,000 properties and authored the book “How to Create Lifetime Cash Flow Through Multifamily Properties,” which is considered to be an essential “textbook” for aspiring multifamily investors.
What is a Recession?
Let’s start with a simple definition to orient ourselves.
The official definition of a recession is “two consecutive quarters of negative GDP growth.” When this happens, the byproducts of a recession are things like rising unemployment, rising interest rates, a falling stock market and falling demand for goods and services nationwide. These events are a negative for the economy as a whole and, if they are severe, can result in major monetary losses for investors in all industries.
In the world of multifamily investment, recessions can create several issues for property owners:
- Slow or negative rent growth
- Increasing vacancy and collection costs
- Rising operating costs
- Rising cost of capital
- Rising cap rates / falling sales prices
- Slowing transaction volume
- Rising days on market before sale
Property owners not prepared to face these issues can run into serious problems including loan default and/or a forced sale of their property for a loss.
However, for those investors well positioned to manage through these downturns, many attractive opportunities may present themselves. Remember, be greedy when others are fearful.
How Recessions Can Create Great Opportunities
Because recessions typically lead to falling prices for multifamily properties, there are going to be a certain number of property owners who are over leveraged and find themselves in a position where they have to sell their asset(s) to raise cash to meet other obligations. For well capitalized investors, a seller under pressure provides maximum negotiating leverage – which can create once in a decade buying opportunities. To illustrate this point an example is helpful.
Imagine an investor purchases a multifamily apartment building for $1M and they finance it with 85% debt and 15% equity. For a while, everything is fine, but then a recession hits. As a result of the challenging economic conditions, vacancy rises to 15% and cash flow falls to a point where it is no longer enough to cover debt service. Depending on their amount of cash on hand, there is only so long that a property owner can feed a cash flow deficit. If they run out of money, they will be forced to sell.
In this scenario, a well funded investor could approach the struggling owner with an enticing offer – a guaranteed close, quickly. But, they also have negotiating leverage to drive a hard bargain and could demand a significant discount in return for the certainty that they can close. Assume they came in with an offer of $850,000 cash. This may look attractive to a seller who is desperate to get out of a property and cut their losses.
A Word About Market Cycles and Timing
Multifamily markets, and the economy in general, run in cycles, but the long term trend is up. It can be difficult to illustrate this point using real estate specific data, but we can use the performance of the S&P 500 Index as a proxy. The chart below shows the price movements in the S&P 500 Index for the last 90 years:
I want to point out two key things about this chart.
First, there may be periodic ups and downs, but the long term trend for the 90 years shown is up. The same trend applies to multifamily assets.
Second, recessions are highlighted in gray. For example, the most recent recession was in 2008/2009 when the housing market collapsed, driven by a rash of loan defaults. Prior to, and during, the recession a precipitous drop can be seen in the index. But, once the recession was over, we started what became the longest bull market in the history of the stock market. Investors that were well positioned to snap up properties during the depths of that recession made an absolute killing over the next ~10-12 years. That said, it can be incredibly difficult to time the tops and bottoms of market cycles so it is best to take a long term, conservative, approach to financing to be sure you are in the right position to manage through all phases of the economic cycle.
How To Take Advantage of a Recession
So, at this point we have defined what a recession is and discussed how great buying opportunities can come from them. In this section, I want to review how to take advantage of these opportunities with three key points.
#1 – Cash is King
Another old investing maxim is that cash is king – and it is never more true than during a recession. Investors who have cash to deploy are in prime position to scoop up distressed assets when they become available. Those who can pay cash and get the deal done quickly are in an even better position.
So, we approach a potential recession, evaluate your portfolio, talk to your investors, and look at your bank accounts to come up with a strategy to raise as much cash as you can. It may even be wise to talk to your lenders to get debt financing lined up as well.
#2 – Be Proactive
Great buying opportunities rarely just appear. You have to find them. This is especially true during a recession. There are several things that investors can do to proactively find good deals:
Send Letters: Identify streets and areas within your chosen market(s), research the addresses of the owners on the property appraiser website, and send them letters asking if they want to sell their property. The response rate is likely to be very low, but it only takes one deal to make it worth it.
Drive Your Market(s): If you want to take a more targeted approach, drive your market(s) and take note of specific properties that look like they might be in distress. For example, if the landscaping is in rough shape or the buildings look like they need some work, this may be a sign that an owner may be open to a sale.
Monitor Bankruptcies and Foreclosures: When a property owner files for bankruptcy or their property is foreclosed upon by a lender, these activities are recorded with the local clerk of the court. So, monitor bankruptcy filings for potential opportunities and reach out to the owners to see if they are interested in a deal.
Make Friends With Lenders: When a bank forecloses on a property, they do not want to hold it. They want to get rid of it. So, network with all of the lenders in your market and let them know that you have capital available to deploy. Often, they may be willing to give you a good deal on a property – and may even give you a loan for it – as long as you take it off their hands quickly.
Network: Finally, it is always a great idea to network with other investors in your market. Doing so may uncover opportunities before they ever even hit the open market.The more proactive you are, the more recession driven opportunities you are likely to uncover.
#3 – Be Conservative and Patient
Finally, once you are able to acquire a property it is important to be conservative and be patient.
By, “be conservative”, I mean that you have to operate like the recession is going to be around for a while. For example, you should plan for higher than normal vacancy rates and should seek to minimize operational costs to the extent possible without sacrificing safety or comfort.
By, “be patient” I mean that recessions can take time to work themselves out. Recessions can be very short or they can drag on for years. You have to be prepared for a worst case scenario and have enough capital on hand to make it through to the other side.
In multifamily real estate, you make your money on the buy – meaning that a large portion of your return depends on the price paid to acquire the property. For this reason, recessions can be a great time to snap up deals. But, you have to be in the right place at the right time and have the funds ready to deploy when a great opportunity is discovered. But, it isn’t easy. You won’t be the only person with this idea. So, be patient, underwrite your deals conservatively and operate your properties as if the recession will go on longer than you think.
P.S. If you are interested in capitalizing on the opportunity of a lifetime to invest in your first or next Multifamily property NOW is the time! Come to my Multifamily Virtual Bootcamp event coming up on Oct 15-16 where I’m going to be breaking down exactly how to come out on top of these unprecedented times!