Preparing for various economic situations, including a recession, is important for real estate investors. One way to do this is by conducting a stress test on your investment properties. This involves running through various “worst-case scenarios” to see which of your properties are the most vulnerable and what you need to do to protect them.
If you’re a real estate investor, it’s important to prepare for anything that life throws your way. This article will discuss ways to do a stress test to see how you would do in different scenarios. We’ll also share some tips on how to maintain liquidity during a recession so you can take advantage of any opportunities that come your way.
A stress test aims to see how long you’ll be able to remain cash flow positive should a recession or economic hardship negatively impact your portfolio. It also helps you know how much money you should save in your capital reserve account, just in case.
Here are a few stress test scenario examples to consider:
In most markets, property values aren’t expected to drop to 2007 recession levels since there’s an inventory shortage in most major cities. However, you should still research to see how much property values might drop in your local market during a recession.
Doing your research will help you ensure that you’re still covered should you lose value on the homes in your portfolio. This is especially important for fix and flip real estate investors who aren’t planning to buy and hold their properties.
Landlords saw vacancy rates increase by 11.1% during the last recession.
While this number is probably the most extreme example for most real estate investors, you may still want to run the numbers to see if your portfolio can withstand an increase of double or triple your average vacancy rate. This will give you a clear picture of which properties are the most fragile and what you need to do to protect yourself.
During the 2007 recession, about 1 in 5 renters paid late.
If you have rental properties, you might want to consider what would happen if 20% of your renters paid 30 days late. And if you want to prepare for the worst-case scenario, you’ll also want to run the numbers to see if you can withstand those renters paying 60 and 90 days late.
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” —Warren Buffet
While a recession can be scary, it can provide opportunities for knowledgeable investors. To capitalize on opportunities that may come your way, you’ll need enough cash to spend when the timing is right. Keep reading for some ideas that can help you maintain liquidity.
While it’s important not to panic during a recession, you also don’t want to get stuck with excess inventory when prices fall, especially if you’re a fix and flip investor.
If the market begins getting tricky, consider shifting your strategy to wholesaling or buy and hold rentals if you can afford to do so. After all, even if the current economy slides into a recession, the need for rentals will likely remain unaffected, especially if interest rates continue to rise as this makes homeownership less affordable.
You probably know this, but you need to be careful with your money during a recession. You might not want to spend money on that expensive vacation or a new car. Instead, save your money to take advantage of opportunities that come your way.
Some types of debt can be helpful during a recession. Low-interest loans could free up your cash reserves, enabling you to invest should an opportunity arise. With that said, you’ll want to ensure that the interest you’ll pay on the loan is worth it compared to how much money you’ll earn from your investment. This leads us to our next topic.
Here are a few ways to capitalize on the opportunities a recession might bring.
If you’ve heard of the advice, “buy low, sell high,” then you know that a recession can present unique opportunities for investors to purchase properties and stocks at low prices. Having a little extra cash on hand will enable you to invest when the timing’s right.
While it may seem counterintuitive to reinvest in your properties during a recession, doing so can help you weather the storm. Strategic upgrades and improvements can make your properties more valuable and allow you to charge more in rent. These upgrades will also increase the value of your property when it comes time to sell.
Capitalize on the opportunity to increase your equity reserves on your rental properties by applying any extra cash flow from rent towards your mortgage.
Many investors have been able to retire early thanks to the “snowball method.” They do this by purchasing one investment property, renting it, applying 100% of the rent towards paying down the mortgage fast, then buying the next property after their first investment property is paid in full. Rinse and repeat.
A rental portfolio of 14 paid-off houses could afford you a fully funded retirement within ten years, with passive income earned for life!
During a recession, some investors lose rental income as tenants move out in search of cheaper options. To offset this potential loss, consider diversifying your income streams by adding additional revenue sources such as laundry facilities or storage units. This will help ensure that you’re still cash flow positive even if vacancy rates rise.
You can also look into peripheral business opportunities like becoming an affiliate of a product or service you use for your business, enabling you to make easy money off referral fees. For example, REIComplete offers a $1,000 referral fee for new Done-For-You Member referrals, offering an excellent way for members and affiliates to earn extra income.
If you need help preparing for any potential recession impacts on your business, we’d love to help. Our expert coaches can help you create and execute a marketing strategy that will keep deals flowing so you can remain agile and prepared no matter what happens in the future.