Why it is important to understand the value of property investments in a portfolio during a recession.
The coronavirus has created an economic storm that is putting stress on several business sectors ranging from transportation to hospitality and agriculture. But an economic slowdown may be a reason to buy real estate since this investment speaks to a variety of investor needs, including diversification and income generation. So it is important to understand the value of property investments in a portfolio during a recession.
"Real estate is an interesting asset," says Mihal Gartenberg, an agent at New York-based Warburg Realty Partnership. "When the stock market is doing poorly, investors who are looking for other opportunities find that real estate is a safe haven."Gartenberg says incorrect assumptions about real estate prices and recessionary environments can keep investors from pursuing a property investment, whether it is a real estate investment trust, known as a REIT, or buying rental properties."The fact that the last recession was caused by the real estate bubble has remained strong in investors' minds, making them think that recessions lead to depressed real estate prices," she says. "Even though during three of the last five recessions, real estate values actually increased."
A recession can be the best time to invest in real estate, says Jim Egan, head of commercial real estate banking and senior vice president at Bryn Mawr Trust. "An investment in a real estate investment trust is also an option that involves less capital and may add diversification to your portfolio." Egan says.
Still not sold on real estate investing?
Here is a look at the merits of investing in property when the stock market moves into a sluggish cycle:
-- Property investments can produce stable income.
-- Real estate may be less sensitive to volatility.
-- Property may outperform stocks and bonds.
Property Investments Can Produce Stable Income
One of the chief reasons to consider making property investments is the opportunity to generate income. REITs can provide dividend income; direct ownership allows investors to pocket rental income.
As an income stream, real estate investing tends to offer predictability in a recession.
"Consistency of the yield is what makes real estate investments more suited for riding out a recession," says Jason Laux, owner and retirement advisor at Synergy Group in White Oak, Pennsylvania.
Laux looks to rental properties, saying consistent rent payments from tenants do not fluctuate in a recessionary period.
"Their monthly rent payment is always due and is not tied to the stock market," he says. Real estate investors have another edge when it comes to using rental income to offset the effects of a recession. Laux says they are in a position to hedge against inflation and changing interest rates when they have control over rental prices. Raising the rent at lease renewals, for instance, allows investors to keep up with rising prices associated with inflation. In that respect, this asset class can offer more flexibility than stocks and bonds in a recession, Laux says.
Real Estate May Be Less Sensitive to Volatility
Stock market volatility can add to an investor's recession woes if stock prices are making wide swings. That can directly affect the return profile of a portfolio. Real estate's relative low correlation to stock market movements, on the other hand, can make it a more reliable choice during a recession.
"Because of the steady nature of revenues from real estate, it can often be a good hedge against volatility," says Diana Hill, director of real estate education at OTA Real Estate. "Even in times of recession, people need places to live, work and get services. So the market will always exist." Hill says that one of the hallmarks of real estate investing is its slower-to-move nature.
"Value on paper may change, but value, as it relates to the yearly income, doesn't tend to vary as quickly," she says. The real estate market is not completely immune to volatility, Egan says.
The 2008 financial crisis and the following downturn in the housing market are evidence of that. But managing volatility risk is all about strategy when investing in real estate in an economic downturn.
During the Great Recession, real estate investment properties were affected differently.
"Homeowners lost significantly, yet single-family rental assets were actually positive as a sector," says Quinn Palomino, principal at Virtua Partners in Scottsdale, Arizona. "Other assets such as storage and multifamily, have historically tended to be more durable in a downturn."
At the same time, industrial, retail and office space may prove riskier in a recession because the cash flow of those properties is dependent upon how well the underlying tenants can navigate a slower economy.
Property May Outperform Stocks and Bonds
Past performance is not a guarantee of future performance -- that is one of the oldest investing rules. But real estate could prove profitable when the economy moves toward a recession if stocks and bonds falter.
"Historically, there are a range of potential outcomes when it comes to performance during a recession," Palomino says. For example, retail commercial space may present more downside risk compared with multifamily housing and apartment buildings.
An investor's success with real estate in a recession depends largely on their strategy.
The quality of the property investment can directly dictate how well real estate performs in comparison to other securities."Real estate tends to be a better hedge for inflation than bonds, especially in this low-interest-rate environment," he says. In short, a recession can open up opportunities to invest in real estate. Investing wisely means managing the balance between supply and demand. When supply is high and demand low, it is possible to purchase property at deep discounts, Hill says. Investors can position those properties as rentals or rent-to-own until the needle shifts back to low supply and high demand. At that point, the property can be sold for a profit. When evaluating properties, focus on quality and return potential, as well as the time frame involved. "As an investor, you have to be comfortable with the long-term nature of this investment and understand the liquidity risk associated with real estate," Laux says.