As investors, we strive to protect our assets and investments during times of economic hardships. As COVID-19 continues to spread, there is a tremendous amount of uncertainty and volatility as production and economic activity has come to a near halt in order to contain and reduce the coronavirus. There is no doubt our financial and global markets will be impacted, and the fear of a recession is no longer one of speculation but a reality.
So how will real estate fare during this global crisis? Real estate is a well-known asset class that has been used to build wealth for centuries and is sometimes referred to as recession-proof. But in reality, no investment -- real estate included, is truly recession-proof.
How real estate will weather the storm
Real estate investments can fare better than other investments during a recession, but not all asset classes and real estate investments will be able to weather the storm. The type of real estate investment you own, where the property is located, and the markets that are being affected in this particular recession will directly affect how recession-proof the investment actually is.
For example, owning income investments, such as single-family rentals or multifamily, does not necessarily make you recession-proof. If your tenant base is mainly blue-collar workers, who are often affected the greatest during a recession and unable to pay rent, and you still have expenses and possibly a mortgage to pay -- it's not recession-proof.
Or if you own retail stores that rely on in-store sales, and the current climate is promoting or requiring consumers to stay indoors -- the businesses (your tenants) will suffer, and it won't take long before they are unable to pay.
So, what is recession-proof?
Just as the specific stock you are invested in can determine whether you're experiencing a loss or seeing a gain currently, the type of asset you own (Class A, which are new, higher valued properties in top condition that attract the top tenant base, Class B, which are midrange properties with a slightly mixed tenant base and slightly older in age or features, or Class C properties, which are the lowest valued asset class in real estate with the lowest valued tenant base and older property age or features) and your tenant base, the amount of debt you carry, and the diversity of your portfolio will impact how recession-proof your investments are.
Generally speaking, cash flow is always king in real estate investing. But during a recession, cash flow is exceedingly valuable. The more income you have, the better positioned you are to cover expenses and debt service even if a significant portion of the income your investments earn is suspended for a period of time.
Diversification can also help reduce your risk exposure. If you own assets across multiple markets, industries, and property classes, your risk exposure is greatly reduced. One or two investments may get hit hard while the others may see increased income or reduced vacancy rates.
It also helps to have a well-balanced portfolio with minimal debts and low leverage ratios, which refers to the balance of equity and debt the company or investment carries. Having less debt will increase your odds of being able to ride out the recession, especially if you have a healthy reserves ratio to cover unexpected expenses or sharp declines in your investment income.
How to make your portfolio more recession-proof
The coronavirus is currently impacting our economy unlike any recessions in our past. Certain industries, such as travel, tourism, and hospitality, collapsed practically overnight, while other industries are doing extremely well in light of what is happening. Currently, real estate investments like short-term vacation rentals, retail, office, and Class B or C rental properties are being hit the hardest right now -- but in my opinion, every sector will be impacted eventually.
Speculative real estate investments, like a fix-and-flip or a commercial real estate (CRE) investment that requires pro forma projections to be met in order to achieve positive cash flow or sale value, are a higher risk during times of economic uncertainty.
Rather than feeling helpless, assess your portfolio and take measures to reduce your risk exposure. Take advantage of lower interest rates following the recent Fed base rate decrease. Being flexible with your tenants during this time of uncertainty will help reduce vacancy or delinquency. If needed, sell any speculative assets while the market values are still supported to reduce debt and increase liquidity.
Remember not to panic. Follow your core principles, and be realistic about the scenarios that could play out. Even during times of uncertainty and struggle, our country, economy, and people will recover -- things will get better. Households, businesses, and investors will creatively find ways to cope, renew, and restart. Play the long game with your real estate investments, and trust that after each recession, there is recovery and growth.