OK. So you follow the news, and you believe the next recession is just around the corner – or is it? Regardless of your take on the speculative world of market analysis, we can be assured that there will be sustained cycles of ‘boom and bust’ in our well-established capitalist economy that will tick-tock given enough time.
There are reams of research papers presenting the conclusion that yes COVID-19 and Brexit are causing significant market volatility in the United Kingdom. This volatility only has to stun GDP growth into negative numbers for two consecutive quarters for the market to be considered as ‘in recession’. As you can imagine, overall economic growth has been nigh-on impossible through a period of lock-down, as most businesses are trying to weather the storm in immensely adverse conditions.
The impact that a recession has on you and your property investments can be vastly different depending on the make-up of your portfolio and your objectives. However there are some common themes that can work well as a rule of thumb.
Non-luxury homes lose less value in an economic downturn
The capital value of a property is based on two simple economic factors:
- How much demand exists for the property? (QUANTITY)
- How much can the finance be raised to purchase the property? (QUALITY)
In prime locations such as London, the population is densely clustered and the city salaries are generally paying a premium. The competition driven by high demand from cash-rich buyers pushes prices up.
Taking a step back and applying these rules to property in general, we can see that in times of crisis, when cash-rich buyers are fewer and father between, both the quantity and quality of buyers is reduced at the higher ends of the market. The same overall demand for residences exists because people must live somewhere, but the knock-on effect of a recession is fewer reliably high-paying jobs. In tandem with this, the banks will typically be more conservative in their approach to lending during a recession in order to reduce their own risk exposure, which reduces the overall amount of finance that is available to purchase properties.
Bread-and-butter investment properties (apartments and small houses) will typically weather a recession better overall in comparison to luxury residences because the investment instrument has a greater skew towards rental yield over capital growth.
Adding value creates a buffer of flexibility
You may have managed to secure your property at a discounted price due either a distressed vendor (someone wanting to sell quickly) or a distressed property (a residence with an issue meaning it is not fit for sale on the open market). If you resolve this issue, then you may be starting immediately from a position of positive equity, meaning that you can be light on your feet and sell quickly without introducing additional funds even if the property market loses its tailwind.
Avoid over-leveraging an investment property’s financing so that it can still cashflow positively even if it is down-valued in a sustained recession. This would reduce the risk of having to pay out to sustain a mortgage at a time when your own finances might also be stretched.
Areas with long-term population growth have reduced risk
Properties located in central metropolitan areas typical have a higher chance of achieving reliable growth. The real estate markets in larger cities often have higher population and a higher rate of population growth than most regional centres, as there is still a general global trend of rapid urbanisation. Be careful of selecting towns or regional centres that rely on one single industry for their population growth prospects – if a large business goes out of business the knock on effect can be disastrous.
Cash is king
Although it might be difficult to predict exactly when a recession will affect the real estate market, it is much easier to determine when there are properties with excellent rental yields due to depressed values. If you can set aside enough cash to pick up some bargains during a downturn, then you set yourself up well to build in a buffer for the future.
The truth of the matter is simple: a well-balanced portfolio that is not too highly leveraged on financing and hits common demand audiences in growing population centres is likely to survive just fine through a financial recession. If you currently positioned for a strategy of huge growth and high leverage, you could dial it back in down with additional capital from a joint venture partner. If you are illiquid, then you might consider selling your worst performing asset. The best strategies are made with long-term thinking in mind, and trying to chop-an-change as the economy sours could cost dearly, so try to plan with your objective in mind up to five years.
If you liked this article, please follow EH Capital so we know what content to focus on in the future. Our team of property investment consultants would be happy to talk to you about your property wealth journey if you get in touch at email@example.com
Join nearly 2K subscribers for our weekly newsletter for property investment news, tips and exclusive offers: EH Capital Newsletter