Recessions tend to hit every 7-10 years. We had a massive recession in 2008-2009. We've had another unforeseen recession in 2020. Therefore, let me share some thoughts on buying property ahead of a potential recession.
There is a growing probability we will end up in a recession over the next 12-24 months. After aggressive Fed rate hikes since 2022, it takes 12-18 months for such higher rates to slow down the economy.
Therefore, buying a property ahead of a recession is a tricky situation. Let's learn from history.
My Experience Selling Property Before A Recession Hit
When I sold a key SF rental property for 30X annual rent in 2017, I was both ecstatic and sad. On the one hand, I was pumped someone was willing to pay 59% more than what I would have sold it for when I first tried to sell it in 2012. A small recession did hit in 2018 in SF.
On the other hand, my wife and I had lived in that house since early 2005. Our long-term vision was to raise a family there and live happily ever after. But our child never came. Therefore, in 2014, we downsized by buying 40% cheaper house and rented our old property out. We contemplated a simpler life without children. Then, as fate would have it, my wife got pregnant in 2016, and our son was born in early 2017.
After his birth, we really considered moving back to our previous larger house, which was in a much busier part of the city. However, we just couldn't bring ourselves to pack our things again and relocate so soon. So I set up a race between myself and a real estate agent. I was to find a new set of tenants and she was to find a qualified buyer. Whoever found new occupants first would win. I lost.
Once the global pandemic hit in 2020, I felt better about my decision to sell rental property. It felt great not having a $815,000 mortgage and so much exposure. However, the recession was violent and quick. We soon recovered and property prices took off again.
I decided to buy a forever property in mid-2020 because we needed the space due to two children and work from home. But what about buying a property ahead of another potential recession? Let's discuss.
Buying Property Ahead Of A Potential Recession
Let's see what we can learn about buying property ahead of potential recession. A lot of us have families to feed and lives to live. We can't base all of our decisions on where we are in the economic cycle. Here's a recession preparation checklist for good measure.
These are my thoughts on buying property ahead of a potential recession. The Fed has hiked aggressively and GDP growth is slowing down.
1) Real estate is cyclical.
If you end up buying property in a softening market, expect real estate prices to stay flat or go down for the next 3 – 5 years. You will not catch the bottom.
It takes 3 – 5 years for the market to work through inventory and find price stability. There are always delusional sellers in the first couple years who believe they can still get peak prices. It's only after seeing their property sit on the market for months that they finally acquiesce to cutting prices.
You can read about what happens if you buy a home at the top of the market.
Below is a simplified chart of the SF Bay Area real estate market cycles.
2) Real Estate Is Seasonal
The best time to buy property is in November, December, and January. The weather is generally terrible during this time of year, nobody wants to move during the holidays, and any seller listing during this time period is more motivated to make a deal.
As the weather gets better and people get paid their bonuses, the real estate market heats up in Spring.
Take a look at some housing data from the Federal Reserve, the Census Bureau, and Zillow. If you want to buy a house despite a potential recession, the fourth quarter of each year is your best bet.
3) The inherent demand for real estate is strong.
Why does the real estate market always seem to heat up in the first half? It's the same reason why Financial Samurai gets more traffic in the first half than in the second half. Hope and goal setting!
This is the year we will buy property might be as common a thinking as This is the year I will workout, eat better, and lose 10 pounds. As people come back from the holidays and get paid their bonuses, they get motivated to make positive changes in their lives.
The government also knows about human nature, which is why it makes us pay our taxes by April 15th before we run out of money.
Given owning real estate is one of the best ways to build long term wealth, buying real estate is always one of the most popular financial moves people want to make.
If you want to sell property ahead of a recession, it's best to list in the first half of the year when more people have more money and are looking to buy.
4) Follow a real estate buying rule
The homeowners who suffer the most during a recession are those who've simply bought too much house and lose their main source of income. It's important to follow the 30/30/3-5 rule of home buying.
Cash flow. Spend no more than 30% of your gross income on your monthly mortgage payment.
Down Payment. You should have at least 30% of the value of the home saved in cash. 20% is for the downpayment to avoid PMI insurance, and the other 10% is for a healthy cash buffer.
Value of the home. Cash flow affordability is a function of the price you pay. If you are able to meet the first two hurdles of cash flow and down payment, then you can tie it all together with a proper multiple of your yearly gross income to see what you can afford.
I recommend buying a property no greater than 3X your annual gross income. However, with interest rates so low, stretching up to 5X may be reasonable for some with larger cash buffers.
Remember, you can always refinance your home, but you can never change your initial purchase price!
Another real estate buying rule is called, Buy Utility, Rent Luxury (BURL). The idea is to rent in a low cap rate city and invest in a high cap rate city. This type of arbitrage is now feasible thanks to private real estate investing online through platforms like Fundrise and CrowdStreet.
5) Consider paying cash for a house.
If you can pay cash for your house and can comfortably cover all the ongoing maintenance expenses and taxes, then you've got the best house buying scenario if we enter a recession.
Being a cash buyer also helps you get the best price possible. Not having to depend on a bank to give a buyer a loan can easily shave off 1% – 5% from another buyer's offer who requires a loan.
It is much more stressful being a property seller than a property buyer. Each day a house goes unsold after an offer due date hurts the value of the house. Cash buyers can also offer quick closes that can also help get them a lower price.
If the property market proceeds to decline by 20%, a cash buyer is only down 20%. Having a paper loss of -20% won't feel pleasant, but it will feel much more pleasant than if a buyer put down 20% and lost 100% of his or her equity.
Another hedge against buying property before a recession is to sell stocks to buy property. This way, you are trading one riskier and more volatile asset for a less risky and less volatile asset. At least with a house, you can enjoy it! With stocks, their values generally plummet in a recession and provide no utility.
6) Buy property to fit your life.
I used to often wonder why anybody would get into a bidding war and overpay for a property, especially after an already massive appreciation in prices. But overbidding happens all the time because people have needs that are even more important than wants.
When couples have their first child or another child, they'll often want to buy a larger home. Sometimes, parents and in-laws need to move in to be cared for. These type of buyers can't wait until the perfect time to buy a house. They need to live their lives today.
I'd like to get a larger house for guests to stay longer term. Besides, I'm very bullish on single family homes with panoramic ocean views in San Francisco. If there are deals to be had, I'm pouncing because I've got a 20+ year time horizon.
So in reality, we are always buying property ahead of a potential recession if we buy long enough! And if you end up buying a forever home, then even if a housing recession comes, you won't mind because you plan to live in the house over many cycles.
7) Prime locations will suffer less in a housing recession.
The farther you have to commute to a major job center, the more likely your home price will drop during a recession. Vacation properties will likely suffer the most, so please avoid buying a vacation property until there is really blood in the streets. Finally, excessively large and expensive properties will also suffer
Heartland real estate with already high cap rates may outperform coastal city real estate with low cap rates. However, no area will be immune to a recession. The only difference will be the magnitude of declines. Please carefully study the demographic trends, job growth figures, upcoming inventory, and health of the major industries in the area you want to buy.
If you must buy before an impending recession, focus on the best location possible. Look to buy property priced no greater than 20% of the median price home in your area because that's where the demand is greatest. If you want to save money and get a deal by buying a property farther out, then you should wait until you can't go a day without seeing a bearish real estate headline.
8) Lower mortgage rates will create a soft landing.
In general, when we are heading into a recession, mortgage rates decline because investors buy Treasury bonds for security. Therefore, lower mortgage rates helps increase affordability and bring back demand into the real estate market. As a result, prices bottom and tend to rebound.
With rising inventory, softer prices, tough lending standards, strong employment, and lower mortgage rates, it's hard to see prices collapsing by more than 15% – 20%.
I just finished refinancing my mortgage and my payment is going from $3,920 down to $2,820 a month. A $1,000 increase in cash flow is significant. Thousands of other homeowners across the country will experience similar types of cash flow boosts as well that will enable them to more comfortably afford their homes.
Make Sure You Buy And Hold For The Long Term
Buying property ahead of a potential recession is suboptimal timing. I lost a bidding war ahead of a small downturn and I felt great in retrospect!
However, if you do buy property and a recession hits, you'll be fine so long as you keep paying your mortgage and property taxes. If you buy your property with cash, you probably don't have anything to worry about unless the property took all the cash you had.
Make no doubt about it. You will feel bad buying property before prices decline. But if you hold onto the property long enough and enjoy it, things will likely turn out ok.
Life goes on as usual during a recession. Recessions generally only last between 6 – 18 months anyway. Sometimes, by the time you realize you're in a recession, it's already over.
What Happens To Your Credit Score If You Foreclose Or Short-Sale
If you can't hold on during a downturn and decide to foreclose or do a short-sale, then you simply lose 100% of your downpayment. You also hurt your credit score by the following according to FICO:
- 30 days late: 40 to 110 points
- 90 days late: 70 to 135 points
- Foreclosure, short sale or deed-in-lieu: 85 to 160
- Bankruptcy: 130 to 240
Before you buy a property, please discuss and follow all the items in the post above. If you've crunched the numbers, are OK with taking a 15% – 20% hit, and plan to own your property for 10 years or longer, chances are high you're going to be fine.
Start looking at homeownership as a way to improve your lifestyle. If you end up making money over the long run, fantastic. Most people usually do. If not, it's OK because you were too busy making great memories.
Diversify Your Property Investments
Buying property ahead of a recession can be a bummer. However, to increase the chances of making a positive return, you should diversify your property investments.
I've invested in 17 real estate crowdfunding deals across the country, two REITs, and two real estate ETFs. It feels great to earn income 100% passively without having to deal with tenants or maintenance issues.
My favorite real estate platform is Fundrise, where they've created private diversified funds for passive income. Historical performance has been steady, especially during down years in the stock market. For most investors, investing in a diversified fund is probably the best way to go. Fundrise is free to sign up and explore.
For those of you who like to invest in individual real estate deals, check out CrowdStreet. CrowdStreet focuses on real estate projects in 18-hour cities, those cities with potentially faster growth and better valuations. With technology and the growth of work from home, I believe there will be continued migration to 18-hour cities. CrowdStreet is also free to sign up and explore.
I've personally invested $954,000 in real estate crowdfunding to diversify and earn income 100% passively. It's been great to diversify my expensive San Francisco real estate portfolio.