What Happens to Real Estate During a Recession?
This post is written by Natasha Phipps and Alexandra Sell, and sponsored by Trusted Partner, Phipps Real Estate Group. To become a contributing editor, please contact our Real Estate Investor Solutions Specialist, David Maxwell at email@example.com.
The hot topic these days is high inflation and the looming recession. It is nothing new for the province of Alberta, which has battled recession for the past decade. However, for the rest of Canadian real estate investors, it is important to know what to expect and how to prepare for this economic slowdown.
By definition, a recession happens when GDP and the economy shrinks for at least two consecutive quarters or 6 months of negative economic growth. Right now, the national inflation rate sits at 7.7% and along with the tight labour market, there is little doubt that the Bank of Canada will continue raising interest rates in efforts to curb the overheated housing economy. But, in every crisis lies an opportunity. By understanding what happens during economic slowdown, real estate investors can recession-proof their portfolios and create wealth-building opportunities.
Higher interest rates are already showing the impact on home sales and starting to shift the market toward more balanced conditions. In some provinces, where home prices have gone up by hundreds of thousands of dollars in just a few years this will invariably put pressure on buyers, making it harder to borrow money while current homeowners will have to pay more on their mortgages. It may leave people wondering how they will afford to keep roofs over their heads.
What happens traditionally to real estate during a recession?
Both the resale housing market and rental markets are tightly intertwined. During recessions, buyers are fearful about getting into real estate and are less likely to buy or sell their homes. Renting during this period may be a good option for them. On the other hand, people who are leveraged or unable to refinance because they don’t have enough equity may face foreclosures.
Flippers are seeing longer days on market and lower prices which cuts into their profit margins, so they pull back. After a while the supply of homes outweighs the demand. Some people may lose their jobs and can’t afford to pay rent, producing higher vacancy rates and further depressing rents.
Where are the opportunities?
As home prices decline, a resulting buyer’s market opens new opportunities for real estate investors. Much like with the stock market, investors buy low and sell high. When the Canadian economy was booming so was real estate but during recession, the odds are finally in the buyer’s favor. For those with steady jobs and enough capital, a recession is an ideal time to buy. There is less competition in the market, and properties can be purchased with proper due diligence and at a discount.
What about inflation?
During inflation, prices increase and one’s purchasing power diminishes. Real estate is a good investment vehicle to hedge against inflation because mortgage payments are locked in all the while property values continue to appreciate. As inflation pushes prices upward, so do rents, resulting in higher revenues for landlords. Lastly, cash flow passive income and tax benefits are yet another reason why we should all be investing in real estate.
What are some options for real estate investors?
What should real estate investors be doing to recession-proof their portfolios? This would be a good time to focus on capital improvements to reduce energy bills and to take advantage of some of the government rebates. Consider investing in a new furnace and hot water tank, installing better windows to reduce energy leaks, improve insulation, legalizing an existing secondary suites etc. Renovations can also increase rentability and make the asset stand out against others.
Of course, each investor’s situation will vary; however, a recession provides an opportunity to stand back and re-assess one’s portfolio. Now is also a good time to organize your A-team of the right Realtor, real estate lawyer, accountant, and mortgage broker. Also, look over your leases and extra screen your tenants; are they employed, are their jobs at risk, can they afford rent increases and so on.
Focus on cash flow and the long term! Choose properties and areas that will generate consistent cash flow such as those with secondary suites. In the Calgary marketplace, suited properties and small multi-residential have performed with great stability through the shifting markets over the years. Another option is shorter-term leases allowing landlords to increase rents as the market dictates, this is provincial dependant. Investors with underperforming assets in their portfolios may wish to consider selling today while cap rates are low and prices are still high.
Lastly, consider diversifying to protect your real estate portfolio and this could mean by an asset class, location and/or investment strategy.
At Phipps Real Estate Group in Calgary, Alberta we have become experts in supporting our out-of-province investors’ access diversification, affordable pricing and consistent cash flow while supporting them through the sales process and into property management.
Let us know how we can help today by checking out our website at www.phippsgroup.ca